**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

** **

**FORM10-Q**

 

**(MarkOne)**

**ý****QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OFTHE SECURITIES EXCHANGE ACT OF 1934**

 

**For the quarterly period ended June 30, 2005**

 

**OR**

 

**o****TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OFTHE SECURITIES EXCHANGE ACT OF 1934**

 

**COMMISSION FILE NUMBER 001-16785**

 

**AmericanSpectrum Realty, Inc.**

(Exactname of Registrant as specified in its charter)

 
| **State of Maryland**                                           | ** ** | **52-2258674**                        |
|-----------------------------------------------------------------|------------|---------------------------------------|
| (State or other jurisdiction of  incorporation or organization) |       | (I.R.S. Employer  Identification No.) |
|                                                            |       |                                  |
| **5850 San Felipe, Suite 450  Houston, Texas 77057**            | ** ** | **77057**                             |
| (Address of principal executive offices)                        |       | (Zip Code)                            |

 

**(713) 706-6200**

(Registrant’s telephone number, includingarea code)

 

 

(Former name, former address and formerfiscal year, if changed since last report

 

Indicate by check markwhether the Registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the Registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days. Yes ý  No o

 

Indicate by check markwhether the Registrant is an accelerated filer (as defined in Rule 12b-2 of theExchange Act).  Yes o  No ý

 

As of August 5, 20051,463,311 shares of Common Stock ($.01 par value) were outstanding.

 

 

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**TABLE OF CONTENTS**

 
| PART I  | FINANCIAL  INFORMATION                                                                                       |   |
|---------|--------------------------------------------------------------------------------------------------------------|--------|
|    |                                                                                                         |   |
| Item 1  | Financial  Statements                                                                                        |   |
|    | Consolidated Balance Sheets at June 30, 2005 (unaudited) and December  31, 2004                              |   |
|    | Consolidated Statements of Operations for  the three and six months ended June 30, 2005 and 2004 (unaudited) |   |
|    | Consolidated Statement of Stockholders’  Equity for the six months ended June 30, 2005 (unaudited)      |   |
|    | Consolidated Statements of Cash Flows for  the six months ended June 30, 2005 and 2004 (unaudited)           |   |
|    | Notes to Consolidated Financial Statements                                                                   |   |
| Item 2  | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                  |   |
| Item 3  | Quantitative  and Qualitative Disclosures about Market Risk                                                  |   |
| Item 4  | Controls  and Procedures                                                                                     |   |
|    |                                                                                                         |   |
| PART II | OTHER  INFORMATION                                                                                           |   |
|    |                                                                                                         |   |
| Item 1  | Legal  Proceedings                                                                                           |   |
| Item 2  | Unregistered  Sales of Equity Securities and Use of Proceeds                                                 |   |
| Item 4  | Submission  of Matters to a Vote of Security Holders                                                         |   |
| Item 6  | Exhibits  and Reports on Form 8-K                                                                            |   |

 

2

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**PART I****.  FINANCIAL INFORMATION**

 

**ITEM 1****.  FINANCIALSTATEMENTS**

 

**AMERICAN SPECTRUM REALTY, INC.**

**CONSOLIDATEDBALANCE SHEETS**

(Dollarsin thousands, except per share amounts)

 
| ** **                                                                                                                                                                      | ** ** | **June 30, 2005** | ** ** | **December 31, 2004** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                      | ** ** | **(Unaudited)**   | ** ** | ** **            | ** ** |
| **ASSETS**                                                                                                                                                                      | ** ** | ** **        | ** ** | ** **            | ** ** |
|                                                                                                                                                                            |       |              |       |                  |       |
| Real estate held for investment                                                                                                                                                 |       | $                 | 197,661    |                  | $          | 195,834 |   |
| Accumulated depreciation                                                                                                                                                        |       | 32,613            |       | 27,303                |       |
| Real estate held for investment, net                                                                                                                                            |       | 165,048           |       | 168,531               |       |
|                                                                                                                                                                            |       |              |       |                  |       |
| Real estate held for sale                                                                                                                                                       |       | —            |       | 2,595                 |       |
| Cash and cash equivalents                                                                                                                                                       |       | 855               |       | 589                   |       |
| Tenant and other receivables, net of  allowance for doubtful accounts of $85 and $223, respectively (including $244  from related party)                                        |       | 575               |       | 721                   |       |
| Deferred rents receivable                                                                                                                                                       |       | 1,677             |       | 1,566                 |       |
| Investment in management company                                                                                                                                                |       | 4,000             |       | 4,000                 |       |
| Prepaid and other assets, net                                                                                                                                                   |       | 9,949             |       | 9,543                 |       |
|                                                                                                                                                                            |       |              |       |                  |       |
| Total Assets                                                                                                                                                                    |       | $                 | 182,104    |                  | $          | 187,545 |   |
|                                                                                                                                                                            |       |              |       |                  |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                   |       |              |       |                  |       |
|                                                                                                                                                                            |       |              |       |                  |       |
| Liabilities:                                                                                                                                                                    |       |              |       |                  |       |
| Notes payable, net of premiums of $2,122  and $2,355, respectively                                                                                                              |       | $                 | 149,299    |                  | $          | 149,589 |   |
| Notes payable, litigation settlement                                                                                                                                            |       | 9,512             |       | 9,512                 |       |
| Liabilities related to real estate held for  sale                                                                                                                               |       | —            |       | 1,712                 |       |
| Accounts payable                                                                                                                                                                |       | 2,271             |       | 2,330                 |       |
| Deferred tax liability                                                                                                                                                          |       | 1,109             |       | 1,109                 |       |
| Accrued and other liabilities (including  $281 and $185, respectively, to related parties)                                                                                      |       | 6,187             |       | 6,374                 |       |
|                                                                                                                                                                            |       |              |       |                  |       |
| Total Liabilities                                                                                                                                                               |       | 168,378           |       | 170,626               |       |
|                                                                                                                                                                            |       |              |       |                  |       |
| Minority Interest                                                                                                                                                               |       | 5,122             |       | 5,492                 |       |
|                                                                                                                                                                            |       |              |       |                  |       |
| Commitments and Contingencies:                                                                                                                                                  |       |              |       |                  |       |
|                                                                                                                                                                            |       |              |       |                  |       |
| Stockholders’ Equity:                                                                                                                                                      |       |              |       |                  |       |
| Preferred stock, $.01 par value;  authorized, 25,000,000 shares, none issued and outstanding                                                                                    |       | —            |       | —                |       |
| Common stock, $.01 par value; authorized,  100,000,000 shares; issued, 1,597,645 and 1,597,160 shares, respectively;  outstanding, 1,462,826 and 1,509,801 shares, respectively |       | 16                |       | 16                    |       |
| Additional paid-in capital                                                                                                                                                      |       | 46,043            |       | 46,031                |       |
| Accumulated deficit                                                                                                                                                             |       | (35,095           | )          | (32,623               | )          |
| Receivable from principal stockholders                                                                                                                                          |       | (950              | )          | (950                  | )          |
| Deferred compensation                                                                                                                                                           |       | (18               | )          | (55                   | )          |
| Treasury stock, at cost, 134,819 and 87,359  shares, respectively                                                                                                               |       | (1,392            | )          | (992                  | )          |
|                                                                                                                                                                            |       |              |       |                  |       |
| Total Stockholders’ Equity                                                                                                                                                 |       | 8,604             |       | 11,427                |       |
|                                                                                                                                                                            |       |              |       |                  |       |
| Total Liabilities and Stockholders’ Equity                                                                                                                                 |       | $                 | 182,104    |                  | $          | 187,545 |   |

 

Theaccompanying notes are an integral part of these consolidated financialstatements

 

3

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**AMERICAN SPECTRUM REALTY, INC.**

**CONSOLIDATED STATEMENTSOF OPERATIONS**

(Dollars in thousands, except per share amounts)

(Unaudited)

 
| ** **                                                     | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|----------------------------------------------------------------|------------|---------------------------------|------------|-------------------------------|------------|
| ** **                                                     | ** ** | **2005**                        | ** ** | **2004**                      | ** ** | **2005** | ** ** | **2004** | ** ** |
| **REVENUES:**                                                  |       |                            |       |                          |       |   |   |   |   |
| Rental revenue                                                 |       | $                               | 6,708      |                          | $          | 6,631 |   | $ | 13,566 |   | $ | 13,487 |   |
| Interest and other income                                      |       | 208                             |       | 82                            |       | 257 |   | 162 |   |
| Total revenues                                                 |       | 6,916                           |       | 6,713                         |       | 13,823 |   | 13,649 |   |
|                                                           |       |                            |       |                          |       |   |   |   |   |
| **EXPENSES:**                                                  |       |                            |       |                          |       |   |   |   |   |
| Property operating expense                                     |       | 2,894                           |       | 2,561                         |       | 5,767 |   | 5,055 |   |
| Corporate general and administrative                           |       | 924                             |       | 1,181                         |       | 1,844 |   | 2,308 |   |
| Depreciation and amortization                                  |       | 2,812                           |       | 2,577                         |       | 5,604 |   | 5,064 |   |
| Interest expense                                               |       | 2,888                           |       | 2,994                         |       | 5,869 |   | 5,803 |   |
| Total expenses                                                 |       | 9,518                           |       | 9,313                         |       | 19,084 |   | 18,230 |   |
|                                                           |       |                            |       |                          |       |   |   |   |   |
| **OTHER LOSS:**                                                |       |                            |       |                          |       |   |   |   |   |
| Loss on extinguishment of debt                                 |       | —                          |       | (613                          | )          | — |   | (613 | ) |
| Total other loss                                               |       | —                          |       | (613                          | )          | — |   | (613 | ) |
|                                                           |       |                            |       |                          |       |   |   |   |   |
| Net loss before minority interest and  discontinued operations |       | (2,602                          | )          | (3,213                        | )          | (5,261 | ) | (5,194 | ) |
|                                                           |       |                            |       |                          |       |   |   |   |   |
| Minority interest                                              |       | 329                             |       | 423                           |       | 358 |   | 686 |   |
|                                                           |       |                            |       |                          |       |   |   |   |   |
| Net loss before discontinued operations                        |       | (2,273                          | )          | (2,790                        | )          | (4,903 | ) | (4,508 | ) |
|                                                           |       |                            |       |                          |       |   |   |   |   |
| Discontinued operations:                                       |       |                            |       |                          |       |   |   |   |   |
| Loss from discontinued operations                              |       | —                          |       | (141                          | )          | (29 | ) | (248 | ) |
| Gain on sale of discontinued operations                        |       | —                          |       | —                        |       | 2,460 |   | — |   |
| (Loss) income from discontinued operations                     |       | —                          |       | (141                          | )          | 2,431 |   | (248 | ) |
|                                                           |       |                            |       |                          |       |   |   |   |   |
| Net loss                                                       |       | $                               | (2,273     | )                             | $          | (2,931 | ) | $ | (2,472 | ) | $ | (4,756 | ) |
|                                                           |       |                            |       |                          |       |   |   |   |   |
| Basic and diluted per share data:                              |       |                            |       |                          |       |   |   |   |   |
| Net loss before discontinued operations                        |       | $                               | (1.54      | )                             | $          | (1.79 | ) | $ | (3.29 | ) | $ | (2.90 | ) |
| (Loss) income from discontinued operations                     |       | —                          |       | (0.09                         | )          | 1.63 |   | (0.16 | ) |
| Net loss                                                       |       | $                               | (1.54      | )                             | $          | (1.88 | ) | $ | (1.66 | ) | $ | (3.06 | ) |
|                                                           |       |                            |       |                          |       |   |   |   |   |
| Basic weighted average shares used                             |       | 1,476,363                       |       | 1,556,250                     |       | 1,487,891 |   | 1,555,846 |   |

 

The accompanying notes are an integral part of these consolidatedfinancial statements

 

4

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**AMERICAN SPECTRUM REALTY INC.**

**CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY**

 (Dollars in thousands)

(Unaudited)

 
| ** **                                                 | ** ** | **Common  Stock** | ** ** | **Additional  Paid-In  Capital** | ** ** | **Accumulated  Deficit** | ** ** | **Deferred  Compensation** | ** ** | **Treasury  Stock** | ** ** | **Receivable  from  Principal  Stockholders** | ** ** | **Total  Equity** | ** ** |
|------------------------------------------------------------|------------|-------------------|------------|----------------------------------|------------|--------------------------|------------|----------------------------|------------|---------------------|------------|-----------------------------------------------|------------|-------------------|------------|
| Balance, December 31, 2004                                 |       | $                 | 16         |                             | $          | 46,031                   |       | $                          | (32,623    | )                   | $          | (55                                           | )          | $                 | (992       | ) | $ | (950 | ) | $ | 11,427 |   |
| Conversion of operating partnership units  to common stock |       | —            |       | 12                               |       | —                   |       | —                     |       | —              |       | —                                        |       | 12                |       |
| Repurchase of common stock                                 |       | —            |       | —                           |       | —                   |       | —                     |       | (400                | )          | —                                        |       | (400              | )          |
| Amortization of deferred compensation                      |       | —            |       | —                           |       | —                   |       | 37                         |       | —              |       | —                                        |       | 37                |       |
| Net loss                                                   |       | —            |       | —                           |       | (2,472                   | )          | —                     |       | —              |       | —                                        |       | (2,472            | )          |
| Balance, June 30, 2005                                     |       | $                 | 16         |                             | $          | 46,043                   |       | $                          | (35,095    | )                   | $          | (18                                           | )          | $                 | (1,392     | ) | $ | (950 | ) | $ | 8,604 |   |

 

The accompanying notes are an integral part of these consolidatedfinancial statements

 

5

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**AMERICAN SPECTRUM REALTY, INC**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

(Dollarsin thousands)

(Unaudited)

 
| ** **                                                                               | ** ** | **Six months Ended June 30,** | ** ** |
|------------------------------------------------------------------------------------------|------------|-------------------------------|------------|
| ** **                                                                               | ** ** | **2005**                      | ** ** | **2004** | ** ** |
| **CASH FLOWS FROM OPERATING ACTIVITIES:**                                                |       |                          |       |   |   |
| Net loss                                                                                 |       | $                             | (2,472     | ) | $ | (4,756 | ) |
| Adjustments to reconcile net loss to net  cash used in operating activities:             |       |                          |       |   |   |
| (Income) loss from discontinued operations                                               |       | (2,431                        | )          | 248 |   |
| Depreciation and amortization                                                            |       | 5,604                         |       | 5,064 |   |
| Deferred rental income                                                                   |       | (111                          | )          | (396 | ) |
| Minority interest                                                                        |       | (358                          | )          | (686 | ) |
| Deferred compensation expense                                                            |       | 37                            |       | 56 |   |
| Mark to market adjustments on interest rate  protection agreements                       |       | —                        |       | (67 | ) |
| Interest on receivable from principal  stockholders                                      |       | (26                           | )          | (34 | ) |
| Loss on extinguishment of debt                                                           |       | —                        |       | 613 |   |
| Amortization of note payable premiums,  included in interest expense                     |       | (233                          | )          | (263 | ) |
| Amortization of note receivable discount,  included in interest income                   |       | —                        |       | (50 | ) |
| Changes in operating assets and  liabilities:                                            |       |                          |       |   |   |
| Decrease (increase) in tenant and other  receivables                                     |       | 139                           |       | (92 | ) |
| Decrease in accounts payable                                                             |       | (59                           | )          | (287 | ) |
| Increase in prepaid and other assets                                                     |       | (870                          | )          | (1,005 | ) |
| (Decrease) increase in accrued and other  liabilities                                    |       | (138                          | )          | 312 |   |
| Net cash used in operating activities –  continuing operations:                     |       | (918                          | )          | (1,343 | ) |
|                                                                                     |       |                          |       |   |   |
| Net cash provided by operating activities –  discontinued operations:               |       | 122                           |       | 123 |   |
|                                                                                     |       |                          |       |   |   |
| **CASH FLOWS FROM INVESTING ACTIVITIES:**                                                |       |                          |       |   |   |
| Proceeds received from sales of real estate  asset                                       |       | 4,921                         |       | — |   |
| Capital improvements to real estate assets                                               |       | (1,827                        | )          | (3,303 | ) |
| Collections on mortgage loan receivable                                                  |       | —                        |       | 28 |   |
| Net cash provided by (used in) investing  activities:                                    |       | 3,094                         |       | (3,275 | ) |
|                                                                                     |       |                          |       |   |   |
| **CASH FLOWS FROM FINANCING ACTIVITIES:**                                                |       |                          |       |   |   |
| Proceeds from borrowings                                                                 |       | 16,168                        |       | 7,958 |   |
| Repayment of borrowings – property sale                                             |       | (1,574                        | )          | — |   |
| Repayment of borrowings – refinances                                                |       | (14,459                       | )          | (3,820 | ) |
| Repayment of borrowings – scheduled  payments                                       |       | (1,235                        | )          | (1,474 | ) |
| Repayment of borrowing from principal  stockholder and director                          |       | (532                          | )          | — |   |
| Repurchase of common stock                                                               |       | (400                          | )          | — |   |
| Net cash (used in) provided by financing  activities:                                    |       | (2,032                        | )          | 2,664 |   |
|                                                                                     |       |                          |       |   |   |
| Increase (decrease) in cash                                                              |       | 266                           |       | (1,831 | ) |
|                                                                                     |       |                          |       |   |   |
| Cash, beginning of period                                                                |       | 589                           |       | 2,937 |   |
|                                                                                     |       |                          |       |   |   |
| Cash, end of period                                                                      |       | $                             | 855        |   | $ | 1,106 |   |
|                                                                                     |       |                          |       |   |   |
| **SUPPLEMENTAL DISCLOSURE OF CASH FLOW  INFORMATION:**                                   |       |                          |       |   |   |
| Cash paid for interest                                                                   |       | $                             | 5,681      |   | $ | 5,786 |   |
| Cash paid for income taxes                                                               |       | 88                            |       | 24 |   |
|                                                                                     |       |                          |       |   |   |
| **SUPPLEMENTAL DISCLOSURE OF NON-CASH  INVESTING AND FINANCING ACTIVITIES:**             |       |                          |       |   |   |
| Conversion of operating partnership units  into common stock                             |       | $                             | 12         |   | $ | 43 |   |
| Payable to principal shareholders offset  against receivable from principal shareholders |       | —                        |       | 120 |   |

 

Theaccompanying notes are an integral part of these consolidated financialstatements

 

6

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**AMERICAN SPECTRUM REALTY, INC.**

### **Notesto Consolidated Financial Statements**

 

**NOTE1.  DESCRIPTION OF BUSINESS**

 

American Spectrum Realty,Inc. (“ASR” or, collectively, as a consolidated entity with its subsidiaries,the “Company”) is a Maryland corporation established on August 8, 2000.  The Company is a full-service real estatecorporation, which owns, manages and operates income-producing properties.  Substantially all of the Company’s assets areheld through an operating partnership (the “Operating Partnership”) in whichthe Company, as of June 30, 2005, held the sole general partner interest of..93% and a limited partnership interest totaling 86.25%.  As of June 30, 2005, through itsmajority-owned subsidiary, the Operating Partnership, the Company owned andoperated 24 properties, which consisted of 18 office buildings, threeindustrial properties, two shopping centers and one apartment complex.  The 24 properties are located in sevenstates.

 

During the six monthsended June 30, 2005, the Company sold an industrial property located in SanDiego, California.  During 2004, theCompany sold three properties, which consisted of an office building, anindustrial property and a parcel of undeveloped land, and acquired two officebuildings in Houston, Texas.   Theproperty sales are part of the Company’s strategy to sell its non-core propertytypes - apartment and shopping center properties – and to sell its propertieslocated in the Midwest and Carolina’s, its non-core markets.  The Company intends to focus primarily onmulti-tenant office and industrial properties located in Texas, California andArizona.

 

The Company is the solegeneral partner of the Operating Partnership. As the sole general partner of the Operating Partnership, the Companygenerally has the exclusive power to manage and conduct the business of theOperating Partnership under its partnership agreement.  The Company’s interest as a limited partnerin the Operating Partnership entitles it to share in any cash distributionsfrom, and in profits and losses of, the Operating Partnership.  If the Company receives any distributionsfrom the Operating Partnership, it intends, in turn, if permitted by law, topay dividends to its common stockholders so that the amount of dividends paidon each share of common stock equals four times the amount of distributions paidon each limited partnership unit in the Operating Partnership (“OP Unit”).  The intended dividend of four times thedistribution from each limited partnership unit is a result of the Company’sone-for-four reverse stock split in March 2004. Most of the properties are owned by the Operating Partnership throughsubsidiary limited partnerships or limited liability companies.

 

Holdersof the OP Units have the option to redeem their units and to receive, at theoption of the Company, in exchange for each four OP Units (i) one share ofCommon Stock of the Company, or (ii) cash equal to the market value of oneshare of Common Stock of the Company at the date of conversion, but nofractional shares will be issued.

 

Management continues toconsider whether it is in the best interest of the Company to elect to betreated as a real estate investment trust (or REIT), as defined under theInternal Revenue Code of 1986, as amended. The Company currently operates in a manner that will permit it to electREIT status; however, the Company may enter into transactions which couldpreclude it from electing REIT status in the future.  In general, a REIT is a company that owns orprovides financing for real estate and pays annual distributions to investorsof at least 90% of its taxable income.  AREIT typically is not subject to federal income taxation on its net income,provided applicable income tax requirements are satisfied.   For the tax year 2004, the Company was taxedas a C corporation.  It is anticipatedthat the Company will be taxed as a C corporation for the 2005 tax year.

 

TheCompany expects to meet its short-term liquidity requirements for normalproperty operating expenses and general and administrative expenses from cashgenerated by operations and cash currently held.  In addition, the Company anticipates capitalcosts to be incurred related to leasing space and improvements to propertiesprovided the estimated leasing of space is complete, litigation settlementcosts and other fees from professional services.  The funds to meet these obligations areexpected to be obtained from proceeds of the sale of assets, lender held fundsand refinancing of properties.  There canbe no assurance, however, that the sales of these assets will occur and thatsubstantial cash will be generated.  Ifthese sales or refinancings do not occur, the Company will not have sufficientcash to meet its obligations.

 

7

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TheCompany has successfully refinanced or extended substantially all debt comingdue in 2005, with the exception of scheduled principal payments.  The Company has substantial debt coming duein 2006.  The Company believes it will beable to obtain funds necessary for the refinancing of these maturing debts aswell.  Based on the Company’s historicallosses and current debt level, there can be no assurances as to the Company’sability to obtain funds necessary for the refinancing of these maturingdebts.  If refinancing transactions arenot consummated, the Company will seek extensions and/or modifications from theexisting lenders.  If these refinancingsor extensions do not occur, the Company will not have sufficient cash to meetits debt obligations.

 

**NOTE 2.SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

 

**BASIS OFPRESENTATION**

 

The accompanying unauditedconsolidated financial statements have been prepared pursuant to the rules andregulations of the Securities and Exchange Commission.  In the opinion of the Company, theaccompanying interim unaudited consolidated financial statements contain allmaterial adjustments, consisting only of normal recurring adjustments necessaryto present fairly the financial condition, the results of operations andchanges in cash flows of the Company and its subsidiaries for interim periods.

 

The results for such interimperiods are not necessarily indicative of results for a full year.  It is suggested that these consolidatedfinancial statements be read in conjunction with the consolidated financialstatements for the year ended December 31, 2004 and the related notes theretoincluded in the Company’s 2004 Annual Report on Form 10-K filed with the SEC.

 

All significant intercompanytransactions, receivables and payables have been eliminated in consolidation.

 

**RECLASSIFICATIONS**

## ** **

Certain prior year balanceshave been reclassified to conform with the current year presentation.   In accordance with SFAS No. 144, “Accountingfor the Impairment or Disposal of Long-Lived Assets”, real estatedesignated as held for sale are accounted for in accordance with the provisionsof SFAS No. 144 and the results of operations of these properties are includedin income from discontinued operations. Prior periods have been reclassified for comparability, as required.

 

Pursuant to a one-for-four reverse stock split of theCompany’s Common Stock, every four shares of Common Stock outstanding as of theclose of business on March 1, 2004 became one share of new post-split CommonStock.  Share and per share data (exceptpar value) in the consolidated financial statements and notes for all periodspresented have been adjusted to reflect the reverse stock split.

 

**USE OFESTIMATES**

 

The preparation of financialstatements in conformity with accounting principles generally accepted in theUnited States of America requires management to make estimates and assumptionsthat affect the reported amounts of assets and liabilities and disclosure ofcontingent assets and liabilities at the date of the financial statements andthe results of operations during the reporting period. Actual results couldmaterially differ from those estimates.

 

**NEWACCOUNTING PRONOUNCEMENTS**

 

InJune 2005, the FASB issued SFAS No. 154, *AccountingChanges and Error Corrections, a replacement of APB Opinion No. 20,Accounting Changes, and Statement No. 3, Reporting Accounting Changes inInterim Financial Statement.* SFAS No. 154 changes the requirements forthe accounting for, and reporting of, a change in accounting principle.  Previously, most voluntary changes inaccounting principles were required to be recognized by way of a cumulativeeffect adjustment within net income during the period of the change.  SFAS No. 154 requires retrospectiveapplication to prior periods’ financial statements, unless it is impracticableto determine either the period-specific effects or the cumulative effect of thechange.  SFAS No. 154 is effectivefor accounting changes made in fiscal years beginning after December 15,2005;

 

8

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however,the Statement does not change the transition provisions of any existingaccounting pronouncements. The adoption of SFAS No. 154 is not expected tohave a material effect on the Company’s consolidated financial statements.

 

In December 2004, the FASB issued SFAS No. 153, *Exchanges of Nonmonetary Assets – an amendment of APBOpinion No. 29,* to address the measurement of exchanges ofnonmonetary assets.  SFAS No. 153eliminates the exception from fair value measurement for nonmonetary exchangesof similar productive assets and replaces it with a general exception forexchanges of nonmonetary assets that do not have commercial substance.  A nonmonetary exchange has commercialsubstance if the future cash flows of the entity are expected to changesignificantly as a result of the exchange. SFAS No. 153 is effective for nonmonetary exchanges occurring afterJune 30, 2005.  The adoption of SFASNo. 153 is not expected to have a material impact on the Company’s consolidatedfinancial statements.

 

In December 2004,the FASB revised SFAS No. 123, *Share–BasedPayment*(“SFAS No. 123R”). SFAS No. 123R is a revision of SFAS No. 123 and supersedes APBNo. 25.  SFAS No. 123R requiresa public entity to measure the cost of employee services received in exchangefor an award of equity instruments based on the grant–date fair value of theaward.  That cost will be recognized overthe period in which an employee is required to provide service in exchange forthe award.  SFAS No. 123R also requires apublic entity to initially measure the cost of employee services rendered inexchange for an award of liability instruments at its current fair value.  The fair value of that award is to beremeasured subsequently at each reporting date through the settlement date.  Changes in the fair value during the requiredservice period are to be recognized as compensation cost over that period.  The Company will adopt SFAS No. 123R January1, 2006.  The adoption of SFAS No. 123Ris not expected to have a material impact on the Company’s consolidatedfinancial statements.

 

**REAL ESTATE**

 

Rental properties are statedat cost, net of accumulated depreciation, unless circumstances indicate thatcost, net of accumulated depreciation, cannot be recovered, in which case thecarrying value of the property is reduced to estimated fair value.  Estimated fair value (i) is based upon theCompany’s plans for the continued operation of each property and (ii) iscomputed using estimated sales price, as determined by prevailing market valuesfor comparable properties and/or the use of capitalization rates multiplied byannualized net operating income based upon the age, construction and use of thebuilding.  The fulfillment of the Company’splans related to each of its properties is dependent upon, among other things,the presence of economic conditions which will enable the Company to continueto hold and operate the properties prior to their eventual sale.  Due to uncertainties inherent in thevaluation process and in the economy, actual results of operating and disposingof the Company’s properties could be materially different from currentexpectations.

 

Depreciation is providedusing the straight-line method over the useful lives of the respective assets.The useful lives are as follows:

 

| Building and Improvements |   | 5 to 40 years             |
|---------------------------|--------|---------------------------|
| Tenant Improvements       |   | Term of the related lease |
| Furniture and Equipment   |   | 3 to 5 years              |

 

**CASHEQUIVALENTS**

 

Cash equivalents include allhighly liquid investments with a maturity of six months or less at the date ofpurchase.

 

**FAIR VALUEOF FINANCIAL INSTRUMENTS**

 

The Company’s financialinstruments consist of cash and cash equivalents, tenant and other receivables,notes payable, accounts payable and accrued expenses.  Management believes that the carrying valueof the Company’s financial instruments approximate their respective fair marketvalues at June 30, 2005 and December 31, 2004.

 

9

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**DERIVATIVEFINANCIAL INSTRUMENTS**

 

The Company followsStatement of Financial Accounting Standard No. 133, as amended, whichestablishes accounting and reporting standards for derivative financialinstruments, including certain derivative instruments embedded in othercontracts and hedging activities.  Allderivatives, whether designed as hedging relationships or not, are required tobe recorded on the balance sheet at fair value. If the derivative is designated as a fair value hedge, the changes inthe fair value of the derivative and of the hedged item attributable to thehedged risk are recognized in earnings. If the derivative is designated as a cash flow hedge, the effectiveportions of changes in the fair value of the derivative are recorded in othercomprehensive income and ineffective portions of changes in the fair value ofcash flow hedges are recognized in earnings.

 

The Company had nointerest rate swaps to hedge against fluctuations in interest rates on specificborrowings during the six months ended June 30, 2005.  At June 30, 2004, the Company had interestrate swap contracts in notional amounts of approximately $9,600,000.  During the six months ended June 30, 2004 theCompany recorded a benefit of $67,000 attributable to changes in the fair valueof its derivative financial instruments.

 

**DEFERREDFINANCING AND OTHER FEES**

 

Fees paid in connection withthe financing and leasing of the Company’s properties are amortized over theterm of the related note payable or lease and are included in other assets.

 

## **STOCK-BASED COMPENSATION**

 

The Financial AccountingStandards Board issued SFAS No. 123, “Accounting for Stock-Based Compensation”(“FAS 123”) in October 1995.  Thisstandard establishes a fair value approach to valuing stock options awarded toemployees as compensation. In December 2002, FASB issued SFAS No. 148, “Accountingfor Stock-Based Compensation - Transition and Disclosure” (“FAS 148”), whichamended FAS 123.  FAS 148 providesalternative methods of transition for a voluntary change to the fair valuebased method of accounting for stock-based employee compensation.  Additionally, FAS 148 amends the disclosurerequirements of FAS 123 to require prominent disclosures in the annual andinterim financial statements about the method of accounting for stock-basedemployee compensation and the effect of the method used on reportedresults.  FAS 148 is effective forfinancial statements for fiscal years ending after December 15, 2002.  In compliance with FAS 148, the Company haselected to continue to follow the intrinsic value method in accounting for itsstock-based employee compensation arrangement as defined by APB No. 25 “Accountingfor Stock Issued to Employees”.

 

The Companyhas in effect its Omnibus Stock Incentive Plan (the “Plan”), which is describedmore fully in its Form 10-K filed with the Securities and ExchangeCommission.  The Company haselected, as permitted by FAS 123, to use the intrinsic value based method ofaccounting for stock options consistent with Accounting Principles BoardOpinions No. 25, “Accounting for Stock Issued to Employees”.  The intrinsic value method measurescompensation cost for stock options as the excess, if any, of the quoted marketprice of the Company’s stock at the measurement date over the exerciseprice.  No stock-based employeecompensation cost is reflected in net income related to stock options, as alloptions granted under the Plan had an exercise price equal to the average ofthe high and low sales prices of the underlying common stock on the date ofgrant.

 

The following tableillustrates the effect on net income (loss) and earnings per share if theCompany had applied the fair value recognition of the provisions of FAS 123 tostock-based employee compensation (thousands of dollars):

 

10

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| ** **                                                                                                         | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------|------------|---------------------------------|------------|-------------------------------|------------|
| ** **                                                                                                         | ** ** | **2005**                        | ** ** | **2004**                      | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net loss, as reported                                                                                              |       | $                               | (2,273     | )                             | $          | (2,931 | ) | $ | (2,472 | ) | $ | (4,756 | ) |
| Deduct: Employee compensation expense for  stock option grants under fair value method, net of related tax effects |       | (23                             | )          | (79                           | )          | (42 | ) | (147 | ) |
| Pro forma net loss                                                                                                 |       | $                               | (2,296     | )                             | $          | (3,010 | ) | $ | (2,514 | ) | $ | (4,903 | ) |
|                                                                                                               |       |                            |       |                          |       |   |   |   |   |
| Per share data:                                                                                                    |       |                            |       |                          |       |   |   |   |   |
| Basic and diluted, as reported                                                                                     |       | $                               | (1.54      | )                             | $          | (1.88 | ) | $ | (1.66 | ) | $ | (3.06 | ) |
| Basic and diluted, proforma                                                                                        |       | $                               | (1.56      | )                             | $          | (1.93 | ) | $ | (1.69 | ) | $ | (3.15 | ) |

 

# **MINORITY INTEREST**

 

Unit holders in theOperating Partnership (other than the Company) held a 12.82% and 12.50% limitedpartnership interest in the Operating Partnership at June 30, 2005 and December31, 2004, respectively.  Each of theholders of the interests in the Operating Partnership (other than the Company)has the option (exercisable after the first anniversary of the issuance of theOP Units) to redeem its OP Units and to receive, at the option of the Company,in exchange for each four OP Units, either (i) one share of Common Stock of theCompany, or (ii) cash equal to the value of one share of Common Stock of theCompany at the date of conversion, but no fractional shares will be issued.

 

**RENTALREVENUE**

 

Certain leases provide fortenant occupancy during periods for which no rent is due or where minimum rentpayments increase during the term of the lease. The Company records rental income for the full term of each lease on astraight-line basis.  Accordingly, areceivable is recorded from tenants equal to the excess of the amount thatwould have been collected on a straight-line basis over the amount collectedand currently due (Deferred Rent Receivable). When a property is acquired, the term of existing leases is consideredto commence as of the acquisition date for purposes of this calculation.

 

Many of the Company’s leasesprovide for Common AreaMaintenance/Escalations (“CAM/ESC”) as the additional tenant revenue amountsdue to the Company in addition to base rent. CAM/ESC represents increases in certain property operating expenses (asdefined in each respective lease agreement) over the actual operating expenseof the property in the base year.  Thebase year is stated in the lease agreement; typically, the year in which thelease commenced.  Generally, each tenantis responsible for his prorated share of increases in operating expenses. Tenantsare billed an estimated CAM/ESC charge based on the budgeted operating expensesfor the year.  Within 90 days after theend of each fiscal year, a reconciliation and true up billing of CAM/ESCcharges is performed based on actual operating expenses.

 

The Company’s portfolio ofleases turns over continuously, with the number and value of expiring leasesvarying from year to year.  The Company’sability to re-lease the space to existing or new tenants at rates equal to orgreater than those realized historically is impacted by, among other things,the economic conditions of the market in which a property is located, theavailability of competing space, and the level of improvements which may berequired at the property.  No assurancecan be given that the rental rates that the Company will obtain in the futurewill be equal to or greater than those obtained under existing contractualcommitments.

 

# **NET LOSS PER SHARE**

 

Netloss per share is calculated based on the weighted average number of commonshares outstanding.  Stock optionsoutstanding of 39,875 at June 30, 2005 and OP Units (other than those held bythe Company) outstanding of 861,043 (convertible into approximately 215,260shares of common stock) at June 30, 2005 have not been included in the net lossper share calculation since their effect would be antidilutive.  See “Minority Interests” paragraph above.

 

11

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**INCOMETAXES**

 

Management is unable toaccurately estimate the Company’s income taxes in interim periods due to theuncertainty of the gains or losses that would be recognized on propertysales.  Factors contributing to thisuncertainty include the number of properties the Company will eventually sellduring the year, the sales price to be obtained on each sale, the timing ofwhen the sale will occur, and whether such sale will be part of a tax-deferredexchange or an outright sale with full gain or loss recognition.

 

Annually, in preparing theCompany’s consolidated financial statements, management estimates the incometax in each of the jurisdictions in which the Company operates.  This process includes an assessment ofcurrent tax expense, the results of tax examinations, and the effects oftemporary differences resulting from the different treatment of transactionsfor tax and financial accounting purposes. These differences may result in deferred tax assets or liabilities whichare included in the consolidated balance sheet. The realization of deferred tax assets as a result of future taxableincome must be assessed and to the extent that the realization is doubtful, avaluation allowance is established.  TheCompany’s annual income tax provision is based on calculations and assumptionsthat will be subject to examination by the taxing authorities in thejurisdictions in which the Company operates. Should the actual results differ from the Company’s estimates, theCompany would have to adjust the income tax provision in the period in whichthe facts and circumstances that give rise to the revision become known.  Tax law and rate changes are reflected in theannual income tax provision in the period in which such changes are enacted.

 

## **SEGMENTS**

 

The Company owns a diverseportfolio of properties comprising office, industrial, shopping centerproperties, and an apartment property. Each of these property types represents a reportable segment withdistinct uses and tenant types and requires the Company to employ differentmanagement strategies.  The propertiescontained in the segments are located in various regions and markets within theUnited States.  The office portfolioconsists primarily of suburban office buildings.  The industrial portfolio consists ofproperties designed for warehouse, distribution and light manufacturing forsingle-tenant or multi-tenant use.  Theshopping center portfolio consists of community shopping centers located inSouth Carolina.  The Company’s soleremaining apartment property is located in Missouri and is rented toresidential tenants on either a month-by-month basis or for terms generally ofone year or less.

 

## **ALLOWANCE FOR DOUBTFUL ACCOUNTS**

 

The Company maintains an allowance reserve for accounts receivablewhich may not be ultimately collected. The allowance balance maintained is based upon historical collectionexperience, current aging of amounts due and specific evaluations of thecollectibility of individual balances. All tenant account balances over 90 days past due are fully reserved.   Accounts are written off against the reservewhen they are deemed to be uncollectible.

 

## **NOTE 3.  REALESTATE**

## ** **

# **ACQUISITIONS**

 

*2005.*

 

Noproperties were acquired during the first six months of 2005.

 

*2004.*

 

OnOctober 21, 2004, the Company acquired an office property in Houston, Texas,consisting of approximately 81,538 rentable square feet.  The aggregate acquisition costs ofapproximately $5,900,000 included proceeds from a previously sold property, theassumption of existing debt and seller financing.

 

On August 2, 2004, the Company acquired a 42,860 square foot officeproperty in Houston, Texas, which is adjacent to an office property owned bythe Company.  The Company previously heldthe note on the

 

12

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property.  Acquisition costs ofapproximately $2,084,000 included the settlement of the note, the issuance of10,000 shares of restricted Common Stock and cash.   The shares, which are currently heldin escrow, will be released in August 2005 so long as the property’s largesttenant does not default on its lease agreement. The Company also entered into an agreement with the seller in which theseller will participate in any profits generated from the future sale of theproperty or, if demanded by the Company or seller after the third anniversarydate of the agreement, a sum determined by the property’s fair market value atthat time.

 

## **DISPOSITIONS**

 

*2005.*

 

OnMarch 1, 2005, the Company sold Sorrento I, a 43,036 square foot industrialproperty located in San Diego, California for a sales price of $4,918,000.  Proceeds of $3,169,000 (net of debtrepayments and sales costs) were received as a result of the transaction.  A gain of $2,460,000 was generated inconnection with the sale, which is reflected as discontinued operations in theconsolidated statements of operations.

 

*2004.*

 

During the third quarterof 2004, the Company sold three properties for an aggregate sales price of$12,213,000.  The properties, whichtotaled 316,054 square feet, consisted of one office property, one industrialproperty and a 16.65 acre parcel of undeveloped land.  These three sales produced proceeds of approximately $4,316,000 (net ofdebt repayments and sales costs) of which $1,191,000 was used to assist thefunding of an office property acquisition in a tax-deferred exchange.  Reference is made to the Company’sAnnual Report on Form 10-K for 2004 for more information with respect to the2004 property dispositions.

 

In the accompanyingconsolidated statements of operations for the six months ended June 30, 2005and 2004, the results of operations for the properties mentioned above areshown in the section “Discontinued operations” through their respective saledate.

 

**INTANGIBLEASSETS PURCHASED**

 

Upon acquisitions of realestate, the Company assesses the fair value of acquired tangible and intangibleassets (including land, buildings, tenant improvements, above and below marketleases, origination costs, acquired in-place leases, other identifiedintangible assets and assumed liabilities in accordance with Statement ofFinancial Accounting Standards No. 141), and allocates the purchase price tothe acquired assets and assumed liabilities. The Company also considers an allocation of purchase price of otheracquired intangibles, including acquired in-place leases.

 

## **TheCompany evaluates acquired “above and below” market leases at their fair value(using a discount rate which reflects the risks associated with the leasesacquired) equal to the difference between (i) the contractual amounts to bepaid pursuant to each in-place lease and (ii) management’s estimate of fairmarket lease rates for each corresponding in-place lease, measured over aperiod equal to the remaining term of the lease for above-market leases and theinitial term plus the term of any below-market fixed rate renewal options for below-marketleases.  Based on its acquisitions todate, the Company’s allocation to intangible assets for assets purchased hasbeen immaterial.**

 

## **NOTE 4. DISCONTINUED OPERATIONS**

 

As of December 31, 2004, Sorrento I, a 43,100 square foot industrialproperty located in San Diego, California was classified as “Real estate heldfor sale”.  Sorrento I, which had beenunoccupied since December 2002, was sold March 1, 2005.

 

The carrying amount of Sorrento I at December 31, 2004 is summarizedbelow (dollars in thousands).  All realestate assets held by the Company on June 30, 2005 are considered held forinvestment.  No real estate wasclassified as held for sale by the Company at June 30, 2005.

 

13

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| **Condensed Consolidated Balance  Sheet**         | ** ** | **December 31, 2004** | ** ** |
|---------------------------------------------------|------------|-----------------------|------------|
| ** **                                        | ** ** | ** **            | ** ** |
| Real estate                                       |       | $                     | 2,421      |   |
| Other                                             |       | 174                   |       |
| Real estate assets held for sale                  |       | $                     | 2,595      |   |
|                                              |       |                  |       |
| Note payable, net                                 |       | $                     | 1,694      |   |
| Accounts payable                                  |       | 5                     |       |
| Accrued and other liabilities                     |       | 13                    |       |
| Liabilities related to real estate held for  sale |       | $                     | 1,712      |   |

 

*Net income (loss) from discontinuedoperations.*

 

Net income from discontinued operations for the three and six monthsended June 30, 2005 includes a gain generated on the sale of Sorrento I and theproperty’s operating results through the March disposition date.

 

Net loss from discontinued operations for the three and six monthsended June 30, 2004 includes the results of operations of Sorrento I and threeproperties sold during the third quarter of 2004.

 

The condensed consolidated statements of operations of discontinuedoperations for the three and six months ended June 30, 2005 and 2004 aresummarized below (dollars in thousands):

 
| ** **                                                 | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|------------------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| **Condensed Consolidated  Statements of Operations**       | ** ** | **June 30, 2005**      | ** ** | **June 30, 2005**    | ** ** |
| Rental revenue                                             |       | $                      | —     |                 | $          | — |   |
| Total expenses                                             |       | —                 |       | 29                   |       |
| Net loss from discontinued operations  before gain on sale |       | —                 |       | (29                  | )          |
| Gain on sale of discontinued operations                    |       | —                 |       | 2,460                |       |
| Net gain from discontinued operations                      |       | $                      | —     |                 | $          | 2,431 |   |

** **
| ** **                                           | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|------------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| **Condensed Consolidated  Statements of Operations** | ** ** | **June 30, 2004**      | ** ** | **June 30, 2004**    | ** ** |
| Rental revenue                                       |       | $                      | 488        |                 | $          | 1,005 |   |
| Total expenses                                       |       | 629                    |       | 1,253                |       |
| Net loss from discontinued operations                |       | $                      | (141       | )                    | $          | (248 | ) |

 

**NOTE 5.MORTGAGE LOAN RECEIVABLE**

 

OnOctober 27, 2003, the Company acquired a note secured by a property adjacent toan office property owned by the Company. The property consists of 42,860 square feet and is located in Houston,Texas.  The purchase of this note wasfunded with a new loan to the Company from the lender that owned the note.  Loan costs of approximately $41,000 wereincurred in connection with the transaction. The note bore interest at 7.5% per annum.  On August 2, 2004 the Company acquired theproperty.  Acquisition costs ofapproximately $2,084,000 included the settlement of the note, the issuance of10,000 shares of restricted Common Stock and cash.

 

**NOTE6.  NOTES PAYABLE, NET OF PREMIUMS**

 

The Company had the following notes payable outstandingas of June 30, 2005 and December 31, 2004 (dollars in thousands):

 
| ** **                                                                                                                                                                                                                                                                                                                                                                                                                        | ** ** | **2005** | ** ** | **2004** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Secured loans with various lenders, net of  unamortized premiums of $2,122 at June 30, 2005 and $2,355 at December 31,  2004, bearing interest at fixed rates between 5.51% and 10.50% at June 30,  2005 and between 5.65% and 10.50% at December 31, 2004, with monthly  principal and interest payments ranging between $2 and $269 at June 30, 2005  and December 31, 2004, and maturing at various dates through May 1, 2015. |       | $        | 123,461    |     | $          | 131,653 |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                              |       |     |       |     |       |
| Secured loans with various banks bearing  interest at variable rates ranging between 7.00% and 8.50% at June 30, 2005,  and 5.14% and at 6.50% December 31, 2004, and maturing at various dates  through June 1, 2010.                                                                                                                                                                                                            |       | 14,069   |       | 5,165    |       |
|                                                                                                                                                                                                                                                                                                                                                                                                                              |       |     |       |     |       |
| Secured Series A & B Bonds with a fixed  interest rate of 6.39%, monthly principal and interest payments of $74,  maturing September 30, 2031.                                                                                                                                                                                                                                                                                |       | 11,295   |       | 11,377   |       |
|                                                                                                                                                                                                                                                                                                                                                                                                                              |       |     |       |     |       |
| Secured Series C Bonds with a fixed  interest rate of 9.50%, semi-annual principal and interest payments ($95 at  June 30, 2005), maturing November 1, 2006.                                                                                                                                                                                                                                                                      |       | 245      |       | 325      |       |
|                                                                                                                                                                                                                                                                                                                                                                                                                              |       |     |       |     |       |
| Unsecured loan bearing interest at prime  plus 1% maturing May 31, 2008.                                                                                                                                                                                                                                                                                                                                                          |       | 200      |       | 300      |       |
|                                                                                                                                                                                                                                                                                                                                                                                                                              |       |     |       |     |       |
| Unsecured loan bearing interest at a fixed  rate of 8.00% maturing December 15, 2005.                                                                                                                                                                                                                                                                                                                                             |       | 29       |       | 59       |       |
|                                                                                                                                                                                                                                                                                                                                                                                                                              |       |     |       |     |       |
| Unsecured loans with various lenders,  bearing interest at fixed rates between 5.45% and 7.27% at December 31, 2004.  The loans were paid in 2005.                                                                                                                                                                                                                                                                                |       | —   |       | 178      |       |
|                                                                                                                                                                                                                                                                                                                                                                                                                              |       |     |       |     |       |
| Unsecured loan from John N. Galardi, a director  and principal stockholder, with a fixed interest rate of 12.00%, due December  14, 2005. The loan was paid in April 2005.                                                                                                                                                                                                                                                        |       | —   |       | 532      |       |
|                                                                                                                                                                                                                                                                                                                                                                                                                              |       |     |       |     |       |
| Total                                                                                                                                                                                                                                                                                                                                                                                                                             |       | $        | 149,299    |     | $          | 149,589 |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                   |            |          |            |          |            |  |  |  |

 

14

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Debt premiums are amortized into interest expense over the terms of therelated mortgages using the effective interest method.  As of June 30, 2005 and December 31, 2004,the unamortized debt premiums included in the above schedule were $2,122,000and $2,355,000 respectively.

 

OnMay 11, 2005, the Company refinanced a $7,500,000 loan on Mira Mesa, one of itsoffice properties, due to mature in May 2005, and entered into a promissorynote in the amount of $9,000,000.  Thenote bears interest at prime plus 1% per annum and matures in June 2010.  Net proceeds of $1,282,000 were received as aresult of the refinancing.

 

OnApril 6, 2005, the Company refinanced a $4,574,000 loan on 8300 Bissonnet, oneof its office properties, due to mature in November 2005, and entered into afixed rate promissory note in the amount of $4,758,000.  The note bears interest at 5.51% per annumand matures in May 2015.  No proceedswere received as a result of the refinancing.

 

InFebruary 2005, the Company refinanced debt of $2,385,000 on 8100 Washington,one of its office properties, with a new loan in the amount of $2,350,000 andcash.  The new loan bears interest at afixed rate of 5.59% per annum and matures in February 2015.  No proceeds were received as a result of therefinancing.

 

InDecember 2004, the Company received a $532,000 loan from John N. Galardi.  The note, which bore interest at a fixedinterest rate of 12% per annum, was paid in April 2005.

 

InOctober 2004, in connection with the acquisition of 11500 Northwest Freeway, anoffice property in Houston, Texas, the Company assumed a loan in the amount of$4,384,000.  The loan bears interest at afixed rate of 5.93% per annum and matures in June 2014.  The Company also entered into an agreementthat provided for seller financing of $316,000, bearing interest at a fixedrate of 5.93% per annum and maturing in June 2014.

 

InOctober 2004, the Company refinanced a $1,176,000 loan on 888 Sam HoustonParkway, one of its office properties, and entered into a revolving creditpromissory note in the amount of $2,250,000, of which $1,226,000 has been drawnto cover the repayment of existing debt and financing costs.  The availability on the note as of June 30,2005 and December 31, 2004 was $1,024,000. The note bears interest at prime plus 1% per annum and matures inNovember 2006.

 

InAugust 2004, the Company refinanced a $5,350,000 loan on San Felipe, one of itsoffice properties, with a new loan agreement in the amount of $5,500,000.  The new loan bears interest at a fixed rateof 5.65% per annum and matures in August 2014.  The Company funded closing costs of approximately $178,000 and escrowed$327,000 for future capital expenditures, real estate taxes and insurancerelated to the August 2004 refinance.

 

InJuly 2004, the Company refinanced a $5,330,000 loan on Northwest CorporateCenter, one of its office properties, with a new loan agreement in the amountof $5,750,000.  The new loan bearsinterest at a fixed

 

15

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rateof 6.26% per annum and matures in August 2014. No proceeds were received directly as a result of the refinance, however$350,000 is being held in escrow by the lender to assist the funding of futurecapital expenditures at the property.

 

InMay 2004, the Company refinanced a $3,132,000 loan on Mira Mesa, one of itsoffice properties, with a new one-year loan agreement in the amount of$7,500,000.  The new loan, whichcontained two six-month extension options bore interest at a fixed rate of7.95% per annum.  Net proceeds of$3,440,000 were received as a result of the refinance.  The loan was paid in May 2005.

 

In May 2004,the Company financed insurance premiums of $373,000 on its properties andagreed to pay a service fee of $85,000 over one year.  The insurance premium note was paid infull in February 2005.  The Companyfinanced an additional insurance premium during 2004 of $133,000, withscheduled payments through June 2005. The balance was paid during the second quarter of 2005.

 

In2002, the lender under a loan agreement related to the South Carolina shoppingcenter properties notified the Company it was technically in default under itsloan agreement for non-compliance with certain covenants, including covenantsrequiring improvements to shopping center properties.  Thereafter, the lender notified the Companythat it was in default for failure to pay a matured portion of the loan, whichmatured in November 2002.  In early 2003,the lender sold the loan to the major tenant in two of the shoppingcenters.  In December 2003, the Companysold one of the shopping center properties and repaid $3,935,000, whichincluded the pay-off of the matured portion of the loan.  As of June 30, 2005, the remaining balance ofthe loan was approximately $2,756,000.  The Company continues to discuss the non-compliance matter with the newlender.  The new lender has notaccelerated the loan.

# ** **

# **NOTE 7.  NOTES PAYABLE, LITIGATION SETTLEMENT**

 

As a result of thesettlement of the Teachout litigation, which was documented in the thirdquarter of 2003, the Company reaffirmed its previously announced obligation topay the former limited partners of Sierra Pacific Development Fund II (“Fund II”)as of the date of the Consolidation, or their assignees or transferees, theloans which were made and called by the former general partner of Fund II aspart of the Consolidation.  Pursuant tothe settlement, the Company established a repayment plan and secured the debtwith a second deed of trust on an office property owned by the Company.  This repayment plan consists of a promissorynote in the amount of $8,800,000, which bears interest at 6% per annum andmatures in March 2006.  The note ispayable to the former limited partners of Fund II, each of whom has a pro-ratainterest in the note.  Interest-onlypayments, which are payable quarterly, commenced June 2, 2003.  The note may be prepaid in whole or in partat any time without penalty.

 

As part of thesettlement, the Company agreed to pay legal fees totaling $1,200,000 to theplaintiff’s counsel.  The Company made ascheduled payment of $250,000 in the third quarter of 2003 with the remaining$950,000 consisting of two promissory notes. The first note, in the amount of $700,000, bears interest at 6% perannum and matures in March 2006. Interest-only payments, which are payable quarterly, commenced June 2,2003.   The second promissory note, inthe amount of $250,000, bears no interest and matures in March 2006.  The notes, which are secured by a second deedof trust on an office property owned by the Company, may be prepaid in whole orin part at any time without penalty.

 

During the fourth quarter of 2004, the Companypurchased 2,347 of the 86,653 interests outstanding in the $8,800,000promissory note.  The Company paid$140,820 (or $60 per unit), which reduced its debt obligation related to thesettlement by $238,338.

 

## **NOTE8.  LOSS ON EARLY EXTINGUISHMENT OF DEBT**

 

In May 2004,in connection with the refinance of Mira Mesa, the Company recorded a loss onearly extinguishment of debt of $613,000 due to a prepayment penalty of$687,000, which was offset in part by the write-off of an unamortized loanpremium of $74,000.  The loss on earlyextinguishment of debt is included in other loss in the consolidated statementsof operations for the three and six months ended June 30, 2004.

 

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## **NOTE 9. MINORITY INTEREST**

 

Unit holders in theOperating Partnership (other than the Company) held a 12.82% and 12.50% limitedpartnership interest in the Operating Partnership at June 30, 2005 and December31, 2004, respectively.  Each of theholders of the interests in the Operating Partnership (other than the Company)has the option (exercisable after the first anniversary of the issuance of theOP Units) to redeem its OP Units and to receive, at the option of the Company,in exchange for each four OP Units, either (i) one share of Common Stock of theCompany, or (ii) cash equal to the value of one share of Common Stock of theCompany at the date of conversion, but no fractional shares will be issued.

 

During the six months ended June 30, 2005, a total of 1,942 OP Unitswere exchanged for 485 shares of Common Stock.

 

During the year ended December 31, 2004, a total of 35,772 OP Unitswere exchanged for 8,943 shares of Common Stock.

 

# **NOTE 10.  REDEEMABLE COMMON STOCK**

 

On October 23, 2001, theCompany issued 5,000 shares of its Common Stock, $.01 par value per share, withthe holder’s right to compel the sale of the stock back to the Company (the “Put”)at a fixed price of $60.00 per share during the period from October 31, 2002 toNovember 30, 2002.  The Put exerciseperiod was subsequently extended to November 30, 2004 through December 31,2004.  In December 2004, the Companyreceived notice that the holder exercised its right to sell the Common Stockback to the Company for $60.00 per share or a total of $300,000 andsubsequently agreed to pay the sum in twelve monthly installments of $25,000 in2005.  The balance due as of June 30,2005 was $150,000.

 

**NOTE 11.  REPURCHASE OFCOMMON STOCK**

 

On April 4, 2005 the Companyoffered to purchase up to 250,000 shares pursuant to an odd lot buy backprogram.  Shareholders who participate inthe program will receive the price-per-share equal to the average of the dailyclosing prices of the Company’s Common Stock during the week in which responsecards are received and processed. Shareholders with fewer than 100 shares are eligible toparticipate.  The offer, which was due toexpire July 1, 2005, was extend to September 30, 2005.   As of June 30, 2005, 13,828 odd lot shareshad been validly tendered at an average price of $8.32 per share.  The total cost of the stock repurchasedamounted to $116,000.

 

During the six months ended June 30, 2005,the Company repurchased a total of 33,632 shares at an average price of $8.27per share in open market transactions. The total cost of the stock repurchased amounted to $284,000.

 

On October 11, 2004 the Companyoffered to purchase up to 250,000 shares at $8.25 per share to holders of fewerthan 100 shares pursuant to an odd lot buy back program.  The offer, which expired December 1, 2004,resulted in 63,327 odd lot shares validly tendered.  The total cost of the stock repurchasedamounted to $532,000.

 

InSeptember 2004, in conjunction with a resignation agreement, an employeerelinquished 1,250 shares of restricted common stock.

 

## **NOTE 12. RELATED PARTY TRANSACTIONS**

 

InDecember 2004, the Company received a $532,000 loan from John N. Galardi, adirector and a principal stockholder of the Company.  The note, which bore interest at a fixedinterest rate of 12% per annum, was paid in April 2005.

 

InSeptember 2004, the Company began managing an apartment complex owned by anaffiliated entity of William J. Carden.  Mr.Carden is the Chief Executive Officer, a director and a principal stockholderof the Company.  During the six months ended June 30, 2005 andthe year ended December 31, 2004, the

 

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Companyreceived management fees of $16,000 and $20,000, respectively, from this entity.   In April 2005, the Company received acommission of $176,400 from this entity in connection with the sale of theapartment complex.

 

InMarch 2004, the Company paid $224,520 (“Guarantee Fee”) to Mr. Carden, Mr.Galardi and CGS Real Estate Company, Inc. (“the Guarantors”) in considerationfor their guarantees of certain obligations of the Company as of December 31,2003.    An affiliate of Mr.Carden is a principal stockholder of CGS Real Estate Company, Inc. (“CGS”).  Mr. Carden is an officer and a director ofCGS, and an affiliate of Mr. Galardi is a principal stockholder of CGS.  TheCompany has agreed to pay the Guarantors an annual guarantee fee equal tobetween .25% and .75% (depending on the nature of the guarantee) of theoutstanding balance as of December 31 of the guaranteed obligations.  The Guarantee Fee is to be paid for a maximumof three years on any particular obligation. In December 2004, the Company paid $187,944 related to the Guarantee Feepayable for the 2004 year.  The paymentswere made in the form of an offset against certain sums owed to the Company bythe Guarantors.  For the first six monthsended June 30, 2005, the Company has accrued $96,000 related to the guaranteefee payable for the 2005 year.

 

In February 2003, the Company reached an agreement with CGS Real EstateCompany, Inc. whereby CGS acknowledged that it owed the Company a net amount of$270,375 which related to several issues asserted by Mr. Carden that were owedby CGS to the Company and by the Company to CGS.    This amount is payable on March 15, 2006with interest accruing from March 15, 2003 at an annual rate of 6% and payablequarterly commencing on June 15, 2003. Mr. Carden and Mr. Galardi have agreed to guarantee this obligation ofCGS, and they have secured this guarantee with an assignment to the Company oftheir right to receive $270,375 of principal payments on the notes payable tothem and their affiliates by reason of the settlement of the Teachoutlitigation, plus all interest payable on such principal amount of notes.  In March 2004, as part of the payment of the2003 Guarantee Fee, interest due on this obligation for 2004 was paid inadvance and $26,606 was applied to the principal due on this obligation.  In December 2004, as part of the payment ofthe 2004 Guarantee Fee, interest due on this obligation for 2005 was paid inadvance.  The principal balance due as ofJune 30, 2005 was $243,858.

 

In connection with the settlement of the Teachout litigation, Mr.Galardi and Mr. Carden acknowledged that they owe the Company the sum of$1,187,695 as indemnification against a portion of the Company’s settlementobligation.  Mr. Galardi and certainaffiliates of Mr. Carden and/or Mr. Galardi are beneficiaries, in part, of thesettlement of the Teachout litigation and are owed an amount in excess of thisobligation pursuant to that settlement. Mr. Galardi and Mr. Carden have agreed to pay the Company the principalsum of this obligation, plus interest thereon at the annual rate of 6% fromMarch 15, 2003, in the form of an assignment to the Company of their right toreceive $1,187,695 of principal payments on the notes payable to them and theiraffiliates by reason of the settlement of the Teachout litigation, plus allinterest payable on such principal amount of notes.  The receivable of $1,187,695 and accruedinterest are reflected as a component of equity in the Company’s consolidatedfinancial statements.  In March 2004, aspart of the payment of the 2003 Guarantee Fee, interest due on this obligationfor 2004 was paid in advance and $116,875 was applied to the principal due onthis obligation.  In December 2004, aspart of the payment of the 2004 Guarantee Fee, interest due on this obligationfor 2005 was paid in advance and $120,340 was applied to the principal due onthis obligation.  The balance due as ofJune 30, 2005 was $950,480.

 

Forthe six months ended June 30, 2005, the Company paid $18,364 for real estaterelated services to a firm in which Patricia A. Nooney, an executive officer ofthe Company, holds an ownership interest. For the year ended December 31, 2004, the Company paid $134,890 to thisfirm.

 

For the year ended December 31, 2004, the Company incurred professionalfees of $54,505 to a law firm in which Timothy R. Brown, a director of theCompany, is a partner.  No professionalfees were incurred to this firm during the six months ended June 30, 2005.

 

**NOTE 13.  SEGMENTINFORMATION**

 

As of June 30, 2005, theCompany owned a portfolio of properties comprising office, industrial, shoppingcenter properties, and an apartment property. Each of these property types represents a reportable segment withdistinct uses and tenant types and requires the Company to employ differentmanagement strategies.  The propertiescontained in the segments are located in various regions and markets within theUnited

 

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States.  The office portfolio consists primarily ofsuburban office buildings.  Theindustrial portfolio consists of properties designed for warehouse,distribution and light manufacturing for single-tenant or multi-tenantuse.  The shopping center portfolioconsists of community shopping centers located in South Carolina.  The Company’s sole remaining apartmentproperty is located in Missouri and is rented to residential tenants on eithera month-by-month basis or for terms generally of one year or less.

 

The accounting policies ofthe segments are the same as those described in the summary of significantaccounting policies.  The Companyevaluates performance of its property types based on net operating incomederived by subtracting property operating expenses from rental revenue.  Significant information used by the Companyfor its reportable segments as of and for the three months and six months endedJune 30, 2005 and 2004 is as follows (dollars in thousands):

 
| **Three Months Ended June 30,**      | ** ** | **Office** | ** ** | **Industrial** | ** ** | **Shopping  Center** | ** ** | **Apartment** | ** ** | **Other** | ** ** | **Property  Total** | ** ** |
|--------------------------------------|------------|------------|------------|----------------|------------|----------------------|------------|---------------|------------|-----------|------------|---------------------|------------|
| **2005**                             |       |       |       |           |       |                 |       |          |       |      |       |                |       |
| Rental revenue                       |       | $          | 5,264      |           | $          | 573                  |       | $             | 207        |      | $          | 664                 |       | — |   | $ | 6,708 |   |
| Property operating expenses          |       | 2,254      |       | 149            |       | 51                   |       | 432           |       | 8         |       | 2,894               |       |
| Net operating income (NOI)           |       | $          | 3,010      |           | $          | 424                  |       | $             | 156        |      | $          | 232                 |       | $ | (8 | ) | $ | 3,814 |   |
| Real estate held for investment, net |       | $          | 132,867    |           | $          | 14,221               |       | $             | 4,872      |      | $          | 13,051              |       | $ | 37 |   | $ | 165,048 |   |
|                                 |       |       |       |           |       |                 |       |          |       |      |       |                |       |
| **2004**                             |       |       |       |           |       |                 |       |          |       |      |       |                |       |
| Rental revenue                       |       | $          | 5,090      |           | $          | 591                  |       | $             | 280        |      | $          | 670                 |       | $ | — |   | $ | 6,631 |   |
| Property operating expenses          |       | 1,915      |       | 132            |       | 87                   |       | 413           |       | 14        |       | 2,561               |       |
| Net operating income (NOI)           |       | $          | 3,175      |           | $          | 459                  |       | $             | 193        |      | $          | 257                 |       | $ | (14 | ) | $ | 4,070 |   |
| Real estate held for investment, net |       | $          | 130,482    |           | $          | 14,963               |       | $             | 5,271      |      | $          | 13,623              |       | $ | 77 |   | $ | 164,416 |   |

 
| **Six Months Ended June 30,**        | ** ** | **Office** | ** ** | **Industrial** | ** ** | **Shopping  Center** | ** ** | **Apartment** | ** ** | **Other** | ** ** | **Property  Total** | ** ** |
|--------------------------------------|------------|------------|------------|----------------|------------|----------------------|------------|---------------|------------|-----------|------------|---------------------|------------|
| **2005**                             |       |       |       |           |       |                 |       |          |       |      |       |                |       |
| Rental revenue                       |       | $          | 10,632     |           | $          | 1,150                |       | $             | 449        |      | $          | 1,335               |       | — |   | $ | 13,566 |   |
| Property operating expenses          |       | 4,506      |       | 332            |       | 100                  |       | 814           |       | 15        |       | 5,767               |       |
| Net operating income (NOI)           |       | $          | 6,126      |           | $          | 818                  |       | $             | 349        |      | $          | 521                 |       | $ | (15 | ) | $ | 7,799 |   |
| Real estate held for investment, net |       | $          | 132,867    |           | $          | 14,221               |       | $             | 4,872      |      | $          | 13,051              |       | $ | 37 |   | $ | 165,048 |   |
|                                 |       |       |       |           |       |                 |       |          |       |      |       |                |       |
| **2004**                             |       |       |       |           |       |                 |       |          |       |      |       |                |       |
| Rental revenue                       |       | $          | 10,417     |           | $          | 1,215                |       | $             | 527        |      | $          | 1,328               |       | $ | — |   | $ | 13,487 |   |
| Property operating expenses          |       | 3,815      |       | 287            |       | 139                  |       | 789           |       | 25        |       | 5,055               |       |
| Net operating income (NOI)           |       | $          | 6,602      |           | $          | 928                  |       | $             | 388        |      | $          | 539                 |       | $ | (25 | ) | $ | 8,432 |   |
| Real estate held for investment, net |       | $          | 130,482    |           | $          | 14,963               |       | $             | 5,271      |      | $          | 13,623              |       | $ | 77 |   | $ | 164,416 |   |

 

The followingis a reconciliation of segment revenues, income and assets to consolidatedrevenues, income and assets for the periods presented above (dollars inthousands):

 
| ** **                                                     | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|----------------------------------------------------------------|------------|---------------------------------|------------|-------------------------------|------------|
| ** **                                                     | ** ** | **2005**                        | ** ** | **2004**                      | ** ** | **2005** | ** ** | **2004** | ** ** |
| **REVENUES**                                                   |       |                            |       |                          |       |   |   |   |   |
| Total revenues for reportable segments                         |       | $                               | 6,708      |                          | $          | 6,631 |   | $ | 13,566 |   | $ | 13,487 |   |
| Other revenues                                                 |       | 208                             |       | 82                            |       | 257 |   | 162 |   |
| Total consolidated revenues                                    |       | $                               | 6,916      |                          | $          | 6,713 |   | $ | 13,823 |   | $ | 13,649 |   |
|                                                           |       |                            |       |                          |       |   |   |   |   |
| **NET LOSS**                                                   |       |                            |       |                          |       |   |   |   |   |
| NOI for reportable segments                                    |       | $                               | 3,814      |                          | $          | 4,070 |   | $ | 7,799 |   | $ | 8,432 |   |
| Unallocated amounts:                                           |       |                            |       |                          |       |   |   |   |   |
| Interest and other income                                      |       | 208                             |       | 82                            |       | 257 |   | 162 |   |
| Corporate general and administrative  expenses                 |       | (924                            | )          | (1,181                        | )          | (1,844 | ) | (2,308 | ) |
| Depreciation and amortization                                  |       | (2,812                          | )          | (2,577                        | )          | (5,604 | ) | (5,064 | ) |
| Interest expense                                               |       | (2,888                          | )          | (2,994                        | )          | (5,869 | ) | (5,803 | ) |
| Loss on extinguishment of debt                                 |       | —                          |       | (613                          | )          | — |   | (613 | ) |
| Net loss before minority interest and  discontinued operations |       | $                               | (2,602     | )                             | $          | (3,213 | ) | $ | (5,261 | ) | $ | (5,194 | ) |

 

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| ** **                                | ** ** | **June 30,** | ** ** |
|-------------------------------------------|------------|--------------|------------|
| ** **                                | ** ** | **2005**     | ** ** | **2004** | ** ** |
| **ASSETS**                                | ** ** | ** **   | ** ** | ** ** | ** ** |
| Total assets for reportable segments      |       | $            | 165,048    |   | $ | 164,416 |   |
| Real estate held for sale                 |       | —       |       | 16,874 |   |
| Cash and cash equivalents                 |       | 855          |       | 1,106 |   |
| Tenant and other receivables, net         |       | 575          |       | 474 |   |
| Deferred rent receivable                  |       | 1,677        |       | 1,689 |   |
| Mortgage loan receivable, net of discount |       | —       |       | 1,441 |   |
| Insurance proceeds receivable             |       | —       |       | 4,860 |   |
| Investment in management company          |       | 4,000        |       | 4,000 |   |
| Prepaid and other assets, net             |       | 9,949        |       | 8,950 |   |
| Total consolidated assets                 |       | $            | 182,104    |   | $ | 203,810 |   |
|                                           |            |              |            |  |  |  |  |  |  |

 

# **NOTE 14.  COMMITMENTS AND CONTINGENCIES**

 

In connection withthe acquisition of an office property in 2004, the Company entered into anagreement with the seller in which the seller will participate in any profitsgenerated from the future sale of the property or, if demanded by the Companyor seller after the third anniversary date of the agreement, a sum determinedby the property’s fair market value at that time.

 

The Company has becomeaware that three of its properties may contain hazardous substances above reportablelevels.  The Company is currentlyevaluating this situation to determine an appropriate course of action.  The Company is currently unable to determinea meaningful cost estimate, if any, which could result from this matter.  Consequently, no amounts have been accrued inthe Company’s consolidated financial statements.

 

Certain claims and lawsuitshave arisen against the Company in its normal course of business. The Companybelieves that such claims and lawsuits will not have a material adverse effecton the Company’s financial position, cash flow or results of operations.

 

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**ITEM2****.  MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

**OVERVIEW**

 

ASR is a full-service realestate corporation, which owns, manages and operates income-producingproperties.  Substantially all of theCompany’s assets are held through its Operating Partnership in which theCompany, as of June 30, 2005, held the sole general partner interest of .93%and a limited partnership interest totaling 86.25%.  As of June 30, 2005, through itsmajority-owned subsidiary, the Operating Partnership, the Company owned andoperated 24 properties, which consisted of 18 office buildings, threeindustrial properties, two shopping centers and one apartment complex.  The 24 properties are located in sevenstates.

 

During the first sixmonths of 2005, the Company sold one industrial property (“Sorrento I”) locatedin San Diego, California.  During 2004,the Company sold three properties, which consisted of one office building, anindustrial property and a parcel of undeveloped land, and acquired two officebuildings in Houston, Texas.   Most ofthe property sales are part of the Company’s strategy to sell its non-coreproperty types – apartment and shopping center properties – and to sell itsproperties located in the Midwest and Carolina’s, its non-core markets.  The Company will focus primarily on officeand industrial properties located in Texas, California and Arizona.

 

On June 30, 2005, theproperties owned by the Company were 85% occupied compared to 88% occupied onJune 30, 2004.  The June 30, 2005weighted average occupancy rate of 85% is exclusive of signed leases in whichoccupancy had not commenced as of June 30, 2005.  The Company has five leases at 7700 IrvineCenter Drive, an office property in Irvine, California, set to commence bySeptember 2005.  Commencement of theseleases is anticipated to raise the property’s square feet occupied byapproximately 21,000 square feet, increasing its occupancy from 76% to86%.  Properties held for investmentconsidered stabilized, not undergoing major redevelopment, were 86% occupied atJune 30, 2005 compared to 90% occupied at June 30, 2004, and properties underredevelopment were 78% occupied at June 30, 2005 compared to 74% at June 30,2004.  The Company continues toaggressively pursue prospective tenants to increase its occupancy, which isexpected to improve operational results.

In the accompanying consolidated statement of operations, the results ofoperations for the properties sold in 2004 and 2005 are shown in the section “Discontinuedoperations”.  The property sold in 2005is classified as “Real estate held for sale” on the December 31, 2004 balancesheet.  Therefore the revenues andexpenses reported for the periods presented reflect results from propertiescurrently owned.

 

**CRITICALACCOUNTING POLICIES**

 

The major accountingpolicies followed by the Company are listed in Note 2 – Summary of SignificantAccounting Policies – of the Notes to the Consolidated FinancialStatements.  The consolidated financialstatements of the Company are prepared in accordance with accounting principlesgenerally accepted in the United States of America, which requires managementto make estimates and assumptions that affect the reported amounts of assetsand liabilities and disclosure of contingent assets and liabilities at the dateof the financial statements and the results of operations during the reportingperiod. Actual results could differ materially from those estimates.

 

The Company believes thefollowing critical accounting policies affect its more significant judgmentsand estimates used in the preparation of its consolidated financial statements:

 

•                  Certain leases provide for tenantoccupancy during periods for which no rent is due or where minimum rentpayments increase during the term of the lease. The Company records rental income for the full term of each lease on astraight-line basis.  Accordingly, areceivable, if deemed collectible, is recorded from tenants equal to the excessof the amount that would have been collected on a straight-line basis over theamount collected and currently due (Deferred Rent Receivable).  When a property is acquired, the term ofexisting leases is considered to commence as of the acquisition date forpurposes of this calculation.

 

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•                  Many of the Company’s leases provide for Common Area Maintenance (“CAM”)/Escalations (“ESC”)as the additional tenant revenue amounts due to the Company in addition to baserent.  CAM/ESC represents increases incertain property operating expenses (as defined in each respective leaseagreement) over the actual operating expense of the property in the base year.  The base year is stated in the leaseagreement; typically, the year in which the lease commenced.  Generally, each tenant is responsible for hisprorated share of increases in operating expenses. Tenants arebilled an estimated CAM/ESC charge based on the budgeted operating expenses forthe year.  Within 90 days after the endof each fiscal year, a reconciliation and true up billing of CAM/ESC charges isperformed based on actual operating expenses.

 

•                  Rental properties are stated at cost, net ofaccumulated depreciation, unless circumstances indicate that cost, net ofaccumulated depreciation, cannot be recovered, in which case the carrying valueof the property is reduced to estimated fair value. Estimated fair value (i) isbased upon the Company’s plans for the continued operation of each property and(ii) is computed using estimated sales price, as determined by prevailingmarket values for comparable properties and/or the use of capitalization ratesmultiplied by annualized net operating income based upon the age, constructionand use of the building.  The fulfillmentof the Company’s plans related to each of its properties is dependent upon,among other things, the presence of economic conditions which will enable theCompany to continue to hold and operate the properties prior to their eventualsale. Due to uncertainties inherent in the valuation process and in theeconomy, the actual results of operating and disposing of the Company’sproperties could be materially different than current expectations.

 

•                  Gains on property sales are accounted for inaccordance with the provisions of SFAS No. 66, “Accounting for Sales of RealEstate”.  Gains are recognized in fullwhen real estate is sold, provided (i) the gain is determinable, that is, thecollectibility of the sales price is reasonably assured or the amount that willnot be collectible can be estimated, and (ii) the earnings process is virtuallycomplete, that is, the Company is not obligated to perform significantactivities after the sale to earn the gain. Losses on property sales are recognized immediately.

 

•                  Managementcontinues to consider whether it is in the best interest of the Company toelect to be treated as a real estate investment trust (or REIT), as definedunder the Internal Revenue Code of 1986, as amended.  The Company currently operates in a mannerthat will permit it to elect REIT status; however, the Company may enter intotransactions which could preclude it from electing REIT status in thefuture.  In general, a REIT is a companythat owns or provides financing for real estate and pays annual distributionsto investors of at least 90% of its taxable income.  A REIT typically is not subject to federalincome taxation on its net income, provided applicable income tax requirements aresatisfied.   For the tax year 2004, theCompany was taxed as a C corporation.  Itis anticipated that the Company will be taxed as a C corporation for the 2005tax year.

# ** **

# **RESULTS OFOPERATIONS**

 

In accordance with generallyaccepted accounting principles, the operating results of the three propertiessold in 2004 and the one property sold in 2005 are reported as discontinuedoperations in the results of operations. See Note 4 – Discontinued Operations – of the Notes to ConsolidatedFinancial Statements.  Unless otherwiseindicated, the following discussion reflects the results from continuingoperations, which include the real estate assets held for investment.

 

***Discussion of the three months ended June 30,2005 and 2004.***

 

The followingtable shows a comparison of rental revenues and certain expenses for thequarter ended June 30:

 
| ** **                           | ** ** | ** ** | ** ** | ** ** | ** ** | **Variance** | ** ** |
|--------------------------------------|------------|------------|------------|------------|------------|--------------|------------|
| ** **                           | ** ** | **2005**   | ** ** | **2004**   | ** ** | **$**        | ** ** | **%** | ** ** |
| Rental revenue                       |       | $          | 6,708,000  |       | $          | 6,631,000    |       | 77,000 |   | 1.2 | % |
| Operating expenses:                  |       |       |       |       |       |         |       |   |   |
| Property operating expenses          |       | 2,894,000  |       | 2,561,000  |       | 333,000      |       | 13.0 | % |
| Corporate general and administrative |       | 924,000    |       | 1,181,000  |       | (257,000     | )          | (21.8 | )% |
| Depreciation and amortization        |       | 2,812,000  |       | 2,577,000  |       | 235,000      |       | 9.1 | % |
| Interest expense                     |       | 2,888,000  |       | 2,994,000  |       | (106,000     | )          | (3.5 | )% |
|                                      |            |            |            |            |            |              |            |  |  |  |  |

 

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*Rentalrevenue*. Rentalrevenue increased $77,000, or 1.2%, for the three months ended June 30, 2005 incomparison to the three months ended June 30, 2004.  This increase was attributable to $311,000 inrevenue generated from two office properties acquired subsequent to the secondquarter of 2004 offset by $234,000 in fewer revenues from properties owned onJune 30, 2005 and June 30, 2004 (“Same Properties”). This decrease in SameProperties revenue was in large part due a $139,000 lease buyout at an officeproperty in California during the second quarter of 2004.  The decrease in Same Properties revenue wasalso attributable to a decrease in occupancy. Occupancy of properties held for investment, on a weighted average basis,decreased from 88% at June 30, 2004 to 85% at June 30, 2005.  Rental revenue from the acquired propertieswas included in the Company’s results since their respective dates ofacquisition.

 

*Propertyoperating expenses*.  The increase of $333,000, or 13.0%, was inlarge part due to $253,000 in expenses related to the two acquired propertiesmentioned above.  The increase was alsoattributable to higher utilities and property general and administrative costsincurred during the quarter.

 

*Corporategeneral and administrative*. The decrease of $257,000, or 21.8%, was primarily due to a decrease incompensation expense of $135,000, primarily due to an overall downsizing of corporate management.  The decrease was also attributable to a costreduction associated with the printing of the Company’s Annual Report, inaddition to other cutting measures implemented by management.  Further, non-recurring costs of approximately$27,000 related to the Company’s March 2004 reverse stock split were includedin the second quarter of 2004.

 

*Depreciationand amortization*.  The increase of $235,000, or 9.1%, was inlarge part due to the depreciation of capital improvements and amortization ofcapitalized lease costs.  During thefirst six months of 2005 and during the year ended December 31, 2004, theCompany spent $1,827,000 and $4,516,000, respectively, in capital improvementson its existing properties, primarily for renovations and tenantimprovements.  The increase was alsoattributable to depreciation and amortization of $85,000 related to the twoacquired properties mentioned above.

 

*Interest expense*.  The decrease of $106,000, or3.5%, was primarily due to refinancing activities.  Lower interest rates were obtained on severalloans refinanced subsequent to June 30, 2004. The decrease was offset in part by additional interest expense of$69,000 related to the one of the acquired properties mentioned above.

 

In July 2002, the lender under a loan agreement related to the SouthCarolina shopping center properties notified the Company it was technically indefault under its loan agreement for non-compliance with certain covenants,including covenants requiring improvements to shopping center properties.  Thereafter, the lender notified the Companythat it was in default for failure to pay a matured portion of the loan, whichmatured in November 2002.  In early 2003,the lender sold the loan to the major tenant in two of the shoppingcenters.  In December 2003, the Companysold one of the shopping center properties and repaid $3,935,000, whichincluded the pay-off of the matured portion of the loan.  As of June 30, 2005, the remaining balance ofthe loan was approximately $2,756,000.  The Company continues to discuss the non-compliance matter with the newlender.  The new lender has notaccelerated the loan.

 

*Discontinued operations*.  TheCompany recorded a loss from operations of discontinued operations of $141,000for the three months ended June 30, 2004 related to Sorrento I, a 43,036square foot industrial property located in San Diego, California that was sold in March 2005, and the threeproperties sold during 2004.  Noproperties were sold during the second quarter of 2005 and no properties wereclassified as held for sale as of June 30, 2005.  See Note 4 – Discontinued Operations – of theNotes to Consolidated Financial Statements.

 

Theloss from operations of discontinued operations is summarized below.

 

23

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| ** **                                           | ** ** | **Three Months Ended** | ** ** | **Three Months Ended** | ** ** |
|------------------------------------------------------|------------|------------------------|------------|------------------------|------------|
| **Condensed Consolidated Statements  of Operations** | ** ** | **June 30, 2005**      | ** ** | **June 30, 2004**      | ** ** |
| Rental revenue                                       |       | —                 |       | $                      | 488        |   |
| Total expenses                                       |       | $                      | —     |                   | 629        |   |
| Net loss from discontinued operations                |       | $                      | —     |                   | $          | (141 | ) |

 

***Discussion of the six months ended June 30,2005 and 2004.***

 

The followingtable shows a comparison of rental revenues and certain expenses for the sixmonths ended June 30:

 
| ** **                           | ** ** | ** ** | ** ** | ** ** | ** ** | **Variance** | ** ** |
|--------------------------------------|------------|------------|------------|------------|------------|--------------|------------|
| ** **                           | ** ** | **2005**   | ** ** | **2004**   | ** ** | **$**        | ** ** | **%** | ** ** |
| Rental revenue                       |       | $          | 13,566,000 |       | $          | 13,487,000   |       | 79,000 |   | 0.6 | % |
| Operating expenses:                  |       |       |       |       |       |         |       |   |   |
| Property operating expenses          |       | 5,767,000  |       | 5,055,000  |       | 712,000      |       | 14.1 | % |
| Corporate general and administrative |       | 1,844,000  |       | 2,308,000  |       | (464,000     | )          | (20.1 | )% |
| Depreciation and amortization        |       | 5,604,000  |       | 5,064,000  |       | 540,000      |       | 10.7 | % |
| Interest expense                     |       | 5,869,000  |       | 5,803,000  |       | 66,000       |       | 1.1 | % |
|                                      |            |            |            |            |            |              |            |  |  |  |  |

 

*Rentalrevenue*. Rentalrevenue for the six months ended June 30, 2005 increased $79,000, or 0.6%, incomparison to the six months ended June 30, 2004.  This increase was attributable to $640,000 inrevenue generated from two office properties acquired subsequent to the secondquarter of 2004 offset by $561,000 in fewer revenues from properties owned onJune 30, 2005 and June 30, 2004 (“Same Properties”).  This decrease in Same Properties revenue isprimarily due to a $196,000 payment received from the owner of a neighboringproperty for past use of common parking areas and $293,000 in lease buyoutsincurred at an office property in California during the first six months of2004.  This decrease in Same Propertiesrevenue was also attributable to a decrease in occupancy.  Occupancy of properties held for investment,on a weighted average basis, decreased from 88% at June 30, 2004 to 85% at June30, 2005.  Rental revenue from theacquired properties was included in the Company’s results since theirrespective dates of acquisition.

 

*Propertyoperating expenses*.  The increase of $712,000, or 14.1%, wasprimarily due to $461,000 in expenses related to the two acquired propertiesmentioned above.  In addition, realestate taxes increased as a result of an increase in the assessed values ofseveral properties.  The increase wasalso attributable to higher utilities and property general and administrativecosts incurred during the period.

 

*Corporategeneral and administrative*. The decrease of $464,000, or 20.1%, was in large part due to a decreasein compensation expense of $222,000, primarily due to an overall downsizing of corporate management.  Further, non-recurring costs of $132,000associated with the Company’s March 2004 reverse stock split were included induring the first six months of 2004.  Thedecrease was also attributable to a cost reduction related to the printing ofthe Company’s Annual Report, in addition to other cutting measures implementedby management.

 

*Depreciationand amortization*.  The increase of $540,000, or 10.7%, was inlarge part due to the depreciation of capital improvements and amortization ofcapitalized lease costs.  During thefirst six months of 2005 and during the year ended December 31, 2004, the Companyspent $1,827,000 and $4,516,000, respectively, in capital improvements on itsexisting properties, primarily for renovations and tenant improvements.  The increase was also attributable todepreciation and amortization of $164,000 related to the two acquiredproperties mentioned above.

 

*Interest expense*.  The increase of $66,000, or1.1%, was primarily due to interest expense of $141,000 associated with one ofthe acquired properties mentioned above, partially offset by lower interestrates obtained on several loans refinanced subsequent to June 30, 2004.

 

In July 2002, the lender under a loan agreement related to the SouthCarolina shopping center properties notified the Company it was technically indefault under its loan agreement for non-compliance with

 

24

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certain covenants, including covenants requiring improvements toshopping center properties.  Thereafter,the lender notified the Company that it was in default for failure to pay amatured portion of the loan, which matured in November 2002.  In early 2003, the lender sold the loan tothe major tenant in two of the shopping centers.  In December 2003, the Company sold one of theshopping center properties and repaid $3,935,000, which included the pay-off ofthe matured portion of the loan.  As ofJune 30, 2005, the remaining balance of the loan was approximately$2,756,000.   The Company continues todiscuss the non-compliance matter with the new lender.  The new lender has not accelerated the loan.

 

*Discontinued operations*.  TheCompany recorded a loss from operations of discontinued operations of $29,000for the six months ended June 30, 2005 related to Sorrento I, a 43,036square foot industrial property located in San Diego, California that was sold in March 2005.  The Company recorded a loss from operationsof discontinued operations of $248,000 for the six months ended June 30, 2004related to Sorrento I and the three properties sold during 2004.  No properties were classified as held forsale as of June 30, 2005.  See Note 4 –Discontinued Operations – of the Notes to Consolidated Financial Statements.

 

Theloss from operations of discontinued operations is summarized below.

 
| ** **                                           | ** ** | **Six months Ended** | ** ** | **Six months Ended** | ** ** |
|------------------------------------------------------|------------|----------------------|------------|----------------------|------------|
| **Condensed Consolidated  Statements of Operations** | ** ** | **June 30, 2005**    | ** ** | **June 30, 2004**    | ** ** |
| Rental revenue                                       |       | —               |       | $                    | 1,005      |   |
| Total expenses                                       |       | $                    | 29         |                 | 1,253      |   |
| Net loss from discontinued operations                |       | $                    | (29        | )                    | $          | (248 | ) |

 

*Gain on sale of discontinued operations*.   TheMarch 1, 2005 sale of Sorrento I generated a gain of $2,460,000 for the six monthsended June 30, 2005.  Proceeds ofapproximately $3,169,000 were received as a result of the transaction.  No properties were sold during the six monthsended June 30, 2004.

 

# **LIQUIDITY ANDCAPITAL RESOURCES**

 

Duringfirst six months of 2005, the Company derived cash from collection of rents andthe sale of Sorrento I.  Major uses ofcash included payment for capital improvements to real estate assets, primarilyfor tenant improvements, payment of operational expenses and repayment ofborrowings.

 

TheCompany reported a net loss of $2,472,000 for the six months ended June 30,2005 compared to a net loss of $4,756,000 for the six months ended June 30,2004.  These results include thefollowing non-cash items:

 
| ** **                                                          | ** ** | **Six Months Ended June 30,** | ** ** |
|---------------------------------------------------------------------|------------|-------------------------------|------------|
| ** **                                                          | ** ** | **2005**                      | ** ** | **2004** | ** ** |
| Non-Cash Charges:                                                   |       |                          |       |   |   |
| Depreciation and amortization from real  estate held for investment |       | $                             | 5,604      |   | $ | 5,064 |   |
| Deferred compensation expense                                       |       | 37                            |       | 56 |   |
| Non-Cash Items:                                                     |       |                          |       |   |   |
| Deferred rental income                                              |       | (111                          | )          | (396 | ) |
| Minority interest                                                   |       | (358                          | )          | (686 | ) |
| Interest on receivable from principal  stockholders                 |       | (26                           | )          | (34 | ) |
| Amortization of loan premiums                                       |       | (233                          | )          | (263 | ) |
| Amortization of note receivable discount                            |       | —                        |       | (50 | ) |
| Mark-to-market adjustments on interest rate  protection agreements  |       | —                        |       | (67 | ) |
|                                                                     |            |                               |            |  |  |  |  |

 

Net cash provided by investing activities for six months ended June 30,2005 amounted to $3,094,000.  This amountwas primarily attributable to proceeds received from the sale of Sorrento Iduring the period.    During the sixmonths ended June 30, 2005, funds of $1,827,000 were used for capitalexpenditures, primarily for tenant improvements.  Net cash used in investing activities for thesix months ended June 30, 2004 was $3,275,000 primarily attributable to thefunding of capital expenditures of $3,303,000.

 

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Net cash used byfinancing activities amounted to $2,032,000 for the six months ended June 30,2005.  In March 2005, borrowings of$1,574,000 were paid in connection with the sale of Sorrento I.  Repurchases of common stock through openmarket transactions and an odd lot buy back program totaled $400,000 for thesix months ended June 30, 2005. Scheduled principal payments for the six months ended June 30, 2005amounted to $1,235,000.  In April 2005,the Company repaid a $532,000 loan from John N. Galardi, a director andprincipal stockholder.  Proceeds fromborrowings of $16,168,000 and repayment of borrowings in connection withrefinances of $14,459,000 for the six months ended June 30, 2005 are discussedbelow.  Net cash provided by financingactivities amounted to $2,664,000 for the six months ended June 30, 2004.  Proceeds from borrowings totaled $7,958,000for the six months ended June 30, 2004, which was used in part for therepayment of borrowings related to refinances of $3,820,000 and for scheduledprincipal payments of $1,474,000.

 

InMay 2005, the Company refinanced a $7,500,000 loan on Mira Mesa, one of itsoffice properties due to mature in May 2005, and entered into a promissory notein the amount of $9,000,000.  The notebears interest at prime plus 1% per annum and matures in June 2010.  Net proceeds of $1,282,000 were received as aresult of the refinancing.

 

InApril 2005, the Company refinanced a $4,574,000 loan on 8300 Bissonnet, one ofits office properties, due to mature in November 2005, and entered into a fixedrate promissory note in the amount of $4,758,000.  The note bears interest at 5.51% per annumand matures in May 2015.  No proceedswere received as a result of the refinancing.

 

In April 2005, theCompany drew down $60,000 from the $400,000 unfunded principal available to payfor capital expenditures on 800 Sam Houston, one of the Company’s officeproperties.

 

InFebruary 2005, the Company refinanced two loans of $1,684,000 and $701,000 on 8100Washington, one of its office properties, due to mature in July 2005 andNovember 2006, and entered into a fixed rate note in the amount of $2,350,000which bears interest at 5.59% per annum and matures in February 2015.

 

InOctober 2004, in connection with the acquisition of 11500 Northwest Freeway, anoffice property in Houston, Texas, the Company assumed a loan in the amount of$4,384,000.  The loan bears interest at afixed rate of 5.93% per annum and matures in June 2014.  The Company also entered into an agreementthat provided for seller financing of $316,000, bearing interest at a fixedrate of 5.93% per annum and maturing in June 2014.

 

InOctober 2004, the Company refinanced a $1,176,000 loan on 888 Sam HoustonParkway, one of its office properties, and entered into a revolving creditpromissory note in the amount of $2,250,000, of which $1,226,000 has been drawnto cover the repayment of existing debt and financing costs.  The availability on the note as of June 30,2005 and December 31, 2004 was $1,024,000. The note bears interest at prime plus 1% per annum and matures inNovember 2006.

 

InAugust 2004, the Company refinanced a $5,350,000 loan on San Felipe, one of itsoffice properties, with a new loan agreement in the amount of $5,500,000.  The new loan bears interest at a fixed rate of5.65% per annum and matures in August 2014. The Company funded closing costs of approximately $178,000 and escrowed$327,000 for future capital expenditures, real estate taxes and insurancerelated to the August 2004 refinance.

 

InJuly 2004, the Company refinanced a $5,330,000 loan on Northwest CorporateCenter, one of its office properties, with a new loan agreement in the amountof $5,750,000.  The new loan bearsinterest at a fixed rate of 6.26% per annum and matures in August 2014.  No proceeds were received directly as aresult of the refinance, however $350,000 is being held in escrow by the lenderto assist the funding of future capital expenditures at the property.

 

InMay 2004, the Company refinanced a $3,132,000 loan on Mira Mesa, one of itsoffice properties, with a new one-year loan agreement in the amount of$7,500,000.  The new loan, whichcontained two six-month extension options, bore interest at a fixed rate of7.95% per annum.  Net proceeds of$3,440,000 were received as a result of the refinance.  The loan was paid in May 2005.

 

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In May 2004, the Companyfinanced insurance premiums of $373,000 on its properties and agreed to pay aservice fee of $85,000 over one year. The balance was paid during the second quarter of 2005.

 

TheCompany expects to meet its short-term liquidity requirements for normalproperty operating expenses and general and administrative expenses from cashgenerated by operations and cash currently held.  In addition, the Company anticipates capitalcosts to be incurred related to re-leasing space and improvements toproperties, litigation settlement costs and other fees for professionalservices.  The funds to meet these obligationswill be obtained from proceeds of the sale of assets, refinancing activity andthe use of lender held funds.  There canbe no assurance, however, that these activities will occur and that substantialcash will be generated.  If theseactivities do not occur, the Company will not have sufficient cash to meet itsobligations if all leasing projections are met.

 

TheCompany has successfully refinanced or extended substantially all debt comingdue in 2005, with the exception of scheduled principal payments.  During the six months ended June 30, 2005,debt of $14,459,000 was refinanced and $1,023,000 was extended.  The Company has substantial debt coming duein 2006.  The Company believes it will beable to obtain funds necessary for the refinancing of these maturing debts aswell.  Based on the Company’s historicallosses and current debt level, there can be no assurances as to the Company’sability to obtain funds necessary for the refinancing of these maturingdebts.  If refinancing transactions are notconsummated, the Company will seek extensions and/or modifications from theexisting lenders.  If these refinancingsor extensions do not occur, the Company will not have sufficient cash to meetits debt obligations.

 

**CONTRACTUALOBLIGATIONS AND COMMITMENTS**

 

Thefollowing table aggregates the Company’s contractual obligations subsequent toJune 30, 2005 (dollars in thousands):

 
| ** **                     | ** ** | **2005** | ** ** | **2006** | ** ** | **2007** | ** ** | **2008** | ** ** | **2009** | ** ** | **Thereafter** | ** ** | **Total** | ** ** |
|--------------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------------|------------|-----------|------------|
| Long-term debt (1)             |       | $        | 1,152      |     | $          | 10,589   |       | $        | 1,857      |     | $          | 5,400          |       | $         | 8,661      |   | $ | 119,518 |   | $ | 147,177 |   |
| Litigation settlement (2)      |       | —   |       | 9,512    |       | —   |       | —   |       | —   |       | —         |       | 9,512     |       |
| Capital lease expenditures (3) |       | 1,724    |       | —   |       | —   |       | —   |       | —   |       | —         |       | 1,724     |       |
| Employee obligations (4)       |       | 67       |       | —   |       | —   |       | —   |       | —   |       | —         |       | 67        |       |
| Total                          |       | $        | 2,943      |     | $          | 20,101   |       | $        | 1,857      |     | $          | 5,400          |       | $         | 8,661      |   | $ | 119,518 |   | $ | 158,480 |   |
|                                |            |          |            |          |            |          |            |          |            |          |            |                |            |           |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

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(1)          SeeNote 6 – Notes Payable – in the accompanying consolidated financial statementsof the Company.  The Company refinancedor extended substantially all debt coming due in 2005, with the exception ofrecurring scheduled principal payments. During the six months ended June 30, 2005, debt of $14,459,000 wasrefinanced and $1,023,000 was extended. The debt obligations do not include interest associated with the debt.

(2)          Representsobligations related to the settlement of the Teachout litigation.  See Note 7 – Notes Payable, LitigationSettlement – in the accompanying consolidated financial statements of theCompany.

(3)          Representscommitments for tenant improvements and lease commissions related to theleasing of space to new or renewing tenants for leases which have beenexecuted.

(4)          Representsemployment agreement commitments for officers of the Company.

 

**INFLATION**

 

Substantially all of theleases at the industrial and retail properties provide for pass-through totenants of certain operating costs, including real estate taxes, common areamaintenance expenses, and insurance. Leases at the apartment property generallyprovide for an initial term of one month to one year and allow for rentadjustments at the time of renewal. Leases at the office properties typically provide for rent adjustmentsand pass-through of increases in operating expenses during the term of thelease.  All of these provisions maypermit the Company to increase rental rates or other charges to tenants inresponse to rising prices and, therefore, serve to reduce the Company’sexposure to the adverse effects of inflation.

 

27

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**FORWARD-LOOKINGSTATEMENTS**

 

This Report on Form 10-Q contains forward-looking statements within themeaning of Section 27A of the Securities Act of 1933 and Section 21E of theSecurities and Exchange Act of 1934. These forward-looking statements are based on management’s beliefs andexpectations, which may not be correct. Important factors that could cause actual results to differ materiallyfrom the expectations reflected in these forward-looking statements include thefollowing: the Company’s level of indebtedness and ability to refinance itsdebt; the fact that the Company’s predecessors have had a history of losses inthe past; unforeseen liabilities which could arise as a result of the prioroperations of companies acquired in the 2001 consolidation transaction; risksinherent in the Company’s acquisition and development of properties in thefuture, including risks associated with the Company’s strategy of investing inunder-valued assets; general economic, business and market conditions,including the impact of the current economic downturn; changes in federal andlocal laws, and regulations; increased competitive pressures; and otherfactors, including the factors set forth below, as well as factors set forthelsewhere in this Report on Form 10-Q.

 

**RISKFACTORS**

 

Stockholders or potentialstockholders should read the “Risk Factors” section of the Company’s latestannual report on Form 10-K filed with the Securities and Exchange Commission inconjunction with this quarterly report on Form 10-Q to better understand thefactors affecting the Company’s financial condition and results of operations.

 

**ITEM 3****.  QUANTITATIVEAND QUALITATIVE DISCLOSURE ABOUT MARKET RISK**

 

**INTERESTRATES**

 

One of the Company’s primarymarket risk exposures is to changes in interest rates on its borrowings.

 

It is the Company’spolicy to manage its exposure to fluctuations in market interest rates for itsborrowings through the use of fixed rate debt instruments to the extent thatreasonably favorable rates are obtainable with such arrangements.  In order to maximize financial flexibilitywhen selling properties and minimize potential prepayment penalties on fixedrate loans, the Company has also entered into variable rate debt arrangements.

 

At June 30, 2005, theCompany’s total indebtedness included fixed-rate debt of approximately$142,420,000 and floating-rate indebtedness of approximately $14,269,000. TheCompany continually reviews the portfolio’s interest rate exposure in an effortto minimize the risk of interest rate fluctuations.  The Company does not have any other materialmarket-sensitive financial instruments.

 

A change of 1.00% in theindex rate to which the Company’s variable rate debt is tied would change theannual interest incurred by the Company by approximately $142,690, or $0.10 pershare, based upon the balances outstanding on variable rate instruments at June30, 2005.

 

**ITEM 4****.  CONTROLS ANDPROCEDURES**

 

Management, including theCompany’s Chief Executive Officer and Acting Chief Financial Officer, haveevaluated the effectiveness of the Company’s disclosure controls and proceduresas of the end of the quarter covered by this report.  Based on, and as of the date of, thatevaluation, the Chief Executive Officer and Acting Chief Financial Officerconcluded that the disclosure controls and procedures were effective, in allmaterial respects, to ensure that information required to be disclosed in thereports the Company files and submits under the Exchange Act is recorded,processed, summarized and reported as and when required.

 

There have been nosignificant changes in the Company’s internal controls or in other factors thatcould significantly affect internal controls subsequent to the date of theevaluation referred to above.

 

28

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**PART II****.  OTHERINFORMATION**

 

**ITEM 1****.  LEGALPROCEEDINGS**

 

Certain claims and lawsuitshave arisen against the Company in its normal course of business. The Companybelieves that such claims and lawsuits will not have a material adverse effecton the Company’s financial position, cash flow or results of operations.

 

**ITEM 2****.  UNREGISTEREDSALES OF EQUITY SECURITIES AND USE OF PROCEEDS**

 

**CompanyPurchases of Equity Securities**

 
| **Period**       | ** ** | **(1) Total  Number of  Shares  Purchased** | ** ** | **Average Price  Paid per Share** | ** ** | **(2) Total Number of  Shares Purchased as  Part of Publicly  Announced Plans or  Programs** | ** ** | **(2) Maximum Number  of Shares that May Yet  Be Purchased Under the  Plans or Programs** | ** ** |
|------------------|------------|---------------------------------------------|------------|-----------------------------------|------------|----------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------|------------|
|             |       |                                        |       |                              |       |                                                                                         |       |                                                                                      |       |
| April 1-30, 2005 |       | 1,960                                       |       | $                                 | 8.69       |                                                                                         | 1,960      |                                                                                      | 248,040    |   |
| May 1-31, 2005   |       | 18,143                                      |       | 8.41                              |       | 993                                                                                          |       | 247,047                                                                                   |       |
| June 1-30, 2005  |       | 24,757                                      |       | 8.17                              |       | 10,875                                                                                       |       | 236,172                                                                                   |       |
|             |       |                                        |       |                              |       |                                                                                         |       |                                                                                      |       |
| Total            |       | 44,860                                      |       | $                                 | 8.29       |                                                                                         | 13,828     |                                                                                      | 236,172    |   |

 

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(1)          Represents 31,032 sharespurchased in open market transactions and 13,828 shares purchased pursuant toan odd lot buy back program (see footnote 2).

 

(2)          OnApril 4, 2005 the Company offered to purchase up to 250,000 sharespursuant to an odd lot buy back program. Shareholders who participate in the program will receive theprice-per-share equal to the average of the daily closing prices of the Company’sCommon Stock during the week in which response cards are received andprocessed.  Shareholders with fewer than100 shares are eligible to participate. The offer, which was due to expire July 1, 2005, was extended toSeptember 30, 2005.  As of June 30, 2005,13,828 odd lot shares had been validly tendered at an average price of $8.32per share.

 

**ITEM 4****.  SUBMISSION OFMATTERS TO A VOTE OF SECURITY HOLDERS**

 

The 2005 annual meeting ofstockholders was held on May 6, 2005. The matters on which the stockholders voted, in person or by proxy, were(i) to elect six directors to serve until the Company’s next annual meeting ofstockholders and until their successors are duly elected and qualified, and(ii) to ratify the selection of BDO Seidman, LLP, as the Company’s independentauditors for the fiscal year ended December 31, 2005.   The results of the voting are shown below:

 

Election of directors:

 
| **Name of**           | ** ** | **Number of** | ** ** | **Number of**      |
|-----------------------|------------|---------------|------------|--------------------|
| **Nominee**           | ** ** | **Votes For** | ** ** | **Votes Withheld** |
| Timothy R. Brown      |       | 890,205       |       | 62,333             |
| William J. Carden     |       | 889,379       |       | 63,159             |
| Lawrence E. Fiedler   |       | 891,090       |       | 61,448             |
| John N. Galardi       |       | 890,532       |       | 62,006             |
| William W. Geary, Jr. |       | 891,171       |       | 61,367             |
| John F. Itzel         |       | 891,029       |       | 61,509             |

 

Ratify the selection of BDOSeidman, LLP as independent auditors:

 
| **Number of** | ** ** | **Number of**     | ** ** | **Number of**        |
|---------------|------------|-------------------|------------|----------------------|
| **Votes For** | ** ** | **Votes Against** | ** ** | **Votes Abstaining** |
| 945,361       |       | 3,453             |       | 3,723                |

 

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**ITEM 6****.  EXHIBITS ANDREPORTS ON FORM 8-K**

 

(a)  Exhibits:

 

The Exhibit Indexattached hereto is hereby incorporated by reference this item.

 

(b)  Reports on Form 8-K:

 

On June 29, 2005, areport on Form 8-K was filed with respect to Item 8.01.

On May 9, 2005, a reporton Form 8-K was filed with respect to Item 2.02.

On April 4, 2005, areport on Form 8-K was filed with respect to Item 8.01.

 

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**SIGNATURES**

 

Pursuant to the requirementsof Section l3 or l5(d) of the Securities Exchange Act of l934, the Registranthas duly caused this report to be signed on its behalf by the undersigned,thereunto duly authorized.

 

**AMERICAN SPECTRUM REALTY, INC.**

 

 
| *Date: August 8, 2005* | * * | * *                                        |
|------------------------|----------|-------------------------------------------------|
| * *               | By:      | */s/ William J. Carden*                         |   |
| * *               |     | William J. Carden                               |   |
|                   |     | Chairman of the Board, President,               |
|                   |     | Chief Executive Officer  and Acting             |
|                   |     | Chief Financial Officer                         |
|                   |     |                                            |
| *Date: August 8, 2005* | * * | * *                                        |
| * *               | By:      | */s/ Patricia A. Nooney*                        |   |
| * *               |     | Patricia A. Nooney                              |   |
|                   |     | Senior Vice President, Chief Operating Officer, |
|                   |     | Secretary and Director of Accounting            |
|                   |     | (Principal Accounting  Officer)                 |

 

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**EXHIBIT INDEX**

 
| **Exhibit No.** | ** ** | **Exhibit  Title**                                                                      |
|-----------------|------------|-----------------------------------------------------------------------------------------|
|            |       |                                                                                    |
| 31              |       | Certification  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                |
|            |       |                                                                                    |
| 32              |       | Certification  pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of |
|            |       | the  Sarbanes-Oxley Act of 2002                                                         |

 

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