<PAGE>

================================================================================

                UNITED STATES SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549
                                    FORM 10-K

           X   ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
       --------          SECURITIES EXCHANGE ACT OF 1934


                     FOR FISCAL YEAR ENDED: AUGUST 31, 2000
                                       OR
               TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
       --------   SECURITIES EXCHANGE ACT OF 1934 (NO FEE  REQUIRED)

                 For the transition period from _____ to _____.

                         Commission File Number: 0-18942

                           ILM II SENIOR LIVING, INC.
             (Exact name of registrant as specified in its charter)

       VIRGINIA                                        06-1293758
-----------------------                             ----------------
(State of organization)                             (I.R.S. Employer
                                                   Identification No.)

1750 Tysons Boulevard, Suite 1200,  Tysons Corner, VA           22102
--------------------------------------------------------------------------------
(Address of principal executive office)                       (Zip Code)

Registrant's telephone number, including area code:          888-257-3550
                                                             ------------

           Securities registered pursuant to Section 12(b) of the Act:

                                                          Name of each exchange
Title of each class                                        on which registered
-------------------                                       ---------------------
       None                                                       None

           Securities registered pursuant to Section 12(g) of the Act:

                      SHARES OF COMMON STOCK $.01 PAR VALUE
                                (Title of class)

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

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

Shares of common stock outstanding as of August 31, 2000: 5,181,236. The
aggregate sales price of the shares sold was $51,812,356. This does not reflect
market value. There is no current market for these shares.

                       DOCUMENTS INCORPORATED BY REFERENCE

            DOCUMENTS                                    FORM 10-K REFERENCE
-------------------------------------                    -----------------------
Prospectus of registrant dated                           Parts II, Part IV
August 8, 1990, as supplemented
[33 Act filing #33-33857]

Current Report on Form 8-K/A                             Part IV
of registrant dated November 28, 2000

================================================================================


<PAGE>


                           ILM II SENIOR LIVING, INC.

                                 2000 FORM 10-K

                                TABLE OF CONTENTS

<TABLE>
<CAPTION>
PART I                                                                                                     PAGE
------                                                                                                     ----
<S>          <C>      <C>                                                                                  <C>
Item         1        Business.............................................................................I-1

Item         2        Properties...........................................................................I-7

Item         3        Legal Proceedings....................................................................I-7

Item         4        Submission of Matters to a Vote of Security Holders..................................I-9


PART II
-------

Item         5        Market for the Registrant's Shares and Related
                         Stockholder Matters..............................................................II-1

Item         6        Selected Financial Data.............................................................II-3

Item         7        Management's Discussion and Analysis of Financial Condition
                         and Results of Operations........................................................II-4

Item         8        Financial Statements and Supplementary Data........................................II-12

Item         9        Changes in and Disagreements with Accountants on Accounting
                         and Financial Disclosure........................................................II-12


PART III
--------

Item        10        Directors and Executive Officers of the Registrant.................................III-1

Item        11        Executive Compensation.............................................................III-2

Item        12        Security Ownership of Certain Beneficial Owners and Management.....................III-2

Item        13        Certain Relationships and Related Transactions.....................................III-3


PART IV
--------

Item        14        Exhibits, Financial Statement Schedules and Reports on Form 8-K.....................IV-1

Signatures            ....................................................................................IV-3

Index to Exhibits     ....................................................................................IV-4

Financial Statements and Supplementary Data........................................................F-1 to F-22
</TABLE>


<PAGE>

                           ILM II SENIOR LIVING, INC.

                                     PART I

ITEM 1. BUSINESS

         ILM II Senior Living, Inc. (the "Company"), formerly PaineWebber
Independent Living Mortgage Inc. II, was incorporated on February 5, 1990 under
the laws of the State of Virginia as a Virginia finite-life corporation for the
purpose of making construction and participating mortgage loans secured by
rental housing complexes for independent senior citizens ("Senior Housing
Facilities"). On September 12, 1990, the Company sold to the public in a
registered initial offering pursuant to a Registration Statement filed on Form
S-11 under the Securities Act of 1933 (Registration Statement No. 33-33857),
5,181,236 shares of common stock, $.01 par value. The Company received capital
contributions of $51,812,356, of which $200,000 represented the sale of 20,000
shares to an affiliate at that time, PaineWebber Group, Inc. ("PaineWebber").
For discussion purposes, PaineWebber will refer to PaineWebber Group, Inc., and
all affiliates that provided services to the Company in the past.

         The Company has elected to qualify and be taxed as a Real Estate
Investment Trust ("REIT") under the Internal Revenue Code of 1986, as amended,
for each taxable year of operations. As a REIT, the Company is allowed a
deduction for the amount of dividends paid to shareholders of the Company
("Shareholders"), thereby effectively subjecting the distributed net income of
the Company to taxation at the shareholder level only. In order to qualify as a
REIT, the Company must distribute at least 95% of its taxable income on an
annual basis and meet certain other requirements.

         The Company originally invested the net proceeds of the initial public
offering in six participating mortgage loans secured by senior housing
facilities located in five states ("Senior Housing Facilities"). All of the
loans made by the Company were originally to Angeles Housing Concepts, Inc.
("AHC"), a company specializing in the development, acquisition and operation of
Senior Housing Facilities, and guaranteed by AHC's corporate parent, Angeles
Corporation ("Angeles").

         During the quarter ended February 28, 1993, Angeles announced that it
was experiencing liquidity problems that resulted in the inability to meet its
obligations. Subsequent to such announcements, AHC defaulted on the regularly
scheduled mortgage loan payments due to the Company on March 1, 1993. Subsequent
to March 1993, payments toward the debt service owed on the Company's loans were
limited to the net cash flow of the operating investment properties. On May 3,
1993, Angeles filed for reorganization under a Chapter 11 Federal Bankruptcy
petition filed in the state of California. AHC did not file for reorganization.
The Company retained special counsel and held extensive discussions with AHC
concerning the default status of its loans. During the fourth quarter of fiscal
1993, a non-binding settlement agreement between the Company, AHC and Angeles
was reached whereby ownership of the properties would be transferred from AHC to
the Company or its designated affiliates. Under the terms of the settlement
agreement, the Company would release AHC and Angeles from certain obligations
under the loans. On April 27, 1994, each of the properties owned by AHC and
securing the loans was transferred (collectively, "the Transfers") to newly
created special purpose corporations affiliated with the Company (collectively,
"the Property Companies"). The Transfers had an effective date of April 1, 1994
and were made pursuant to the settlement agreement entered into on February 17,
1994 ("the Settlement Agreement") between the Company and AHC which had
previously been approved by the bankruptcy court handling the bankruptcy case of
Angeles. All of the capital stock of each Property Company was held by ILM II
Holding, Inc. ("ILM II Holding"), a Virginia corporation. In August 1995, each
of the Property Companies merged into ILM II Holding which is now a subsidiary
of the Company. As a result, ownership of the Senior Housing Facilities is now
held by ILM II Holding, and the Property Companies no longer exist as separate
legal entities.

                                      I-1

<PAGE>

                           ILM II SENIOR LIVING, INC.


Item 1.  Business (continued)

         ILM II Holding, a majority-owned subsidiary of the Company, now holds
title to the five Senior Housing Facilities, which comprise the balance of the
operating investment properties on the accompanying consolidated balance sheets,
subject to certain mortgage loans payable to the Company. Such mortgage loans
and the related interest expense are eliminated in the consolidation of the
financial statements of the Company. The capital stock of ILM II Holding was
originally owned by the Company and PaineWebber. ILM II Holding had issued 100
shares of Series A Preferred Stock to the Company in return for a capital
contribution in the amount of $495,000 and had issued 10,000 shares of common
stock to PaineWebber in return for a capital contribution in the amount of
$5,000. The common stock represented approximately 99 percent of the voting
power and 1 percent of the economic interest in ILM II Holding, while the
preferred stock represented approximately 1 percent of the voting power and 99
percent of the economic interest in ILM II Holding.

         The Company completed its restructuring plans by converting ILM II
Holding to a REIT for tax purposes effective for calendar year 1996. In
connection with these plans, on November 21, 1996 the Company requested that
PaineWebber sell all of the stock held in ILM II Holding to the Company for a
price equal to the fair market value of the 1% economic interest in ILM II
Holding represented by the common stock. On January 10, 1997, this transfer of
the common stock of ILM II Holding was completed at an agreed upon fair value of
$40,000, representing a $35,000 increase in fair value. This increase in fair
value is based on the increase in values of the Senior Housing Facilities which
occurred between April 1994 and January 1996, as supported by independent
appraisals.

         With this transfer completed, effective January 23, 1997, ILM II
Holding recapitalized its common stock and preferred stock by replacing the
outstanding shares with 50,000 shares of new common stock and 275 shares of a
new class of non-voting, 8% cumulative preferred stock issued to the Company
("the Preferred Stock"). The number of authorized shares of preferred and common
stock in ILM II Holding were also increased as part of the recapitalization.
Following the recapitalization, the Company made charitable gifts of one share
of the Preferred Stock in ILM II Holding to each of 111 charitable organizations
so that ILM II Holding would meet the stock ownership requirements of a REIT as
of January 30, 1997. The Preferred Stock has a liquidation preference of $1,000
per share plus any accrued and unpaid dividends. Dividends on the Preferred
Stock accrue at a rate of 8% per annum on the original $1,000 liquidation
preference and are cumulative from the date of issuance. Since ILM II Holding is
not expected to have sufficient cash flow in the foreseeable future to make the
required dividend payments, it is anticipated that dividends will accrue and be
paid at liquidation. The Company recorded the contribution of the Preferred
Stock in ILM II Holding to the charitable organizations at the amount of the
initial liquidation preference of $111,000. Such amount was included in general
and administrative expenses in the consolidated statement of income for the year
ended August 31, 1997. Cumulative dividends accrued as of August 31, 2000 and
1999, on the Preferred Stock in ILM II Holding totaled $32,000 and $23,000,
respectively.


                                      I-2

<PAGE>

                           ILM II SENIOR LIVING, INC.



ITEM 1.  BUSINESS (CONTINUED)

         As part of the fiscal 1994 Settlement Agreement with AHC, ILM II
Holding retained AHC as the property manager for all of the Senior Housing
Facilities pursuant to the terms of a management agreement. The management
agreement with AHC was terminated in July 1996. Subsequent to the effective date
of the Settlement Agreement with AHC, in order to maximize the potential returns
to the Company's existing Shareholders while maintaining the Company's
qualification as a REIT under the Internal Revenue Code, the Company formed a
new corporation, ILM II Lease Corporation ("Lease II"), for the purpose of
operating the Senior Housing Facilities under the terms of a facilities lease
agreement (the "Facilities Lease Agreement"). All of the shares of capital stock
of Lease II were distributed to the holders of record of the Company's common
stock and the Senior Housing Facilities were leased to Lease II effective
September 1, 1995. Lease II is a public company subject to the reporting
obligations of the Securities and Exchange Commission. All responsibility for
the day-to-day management of the Senior Housing Facilities, including
administration of the property management agreement with AHC, was transferred to
Lease II. On July 29, 1996, the management agreement with AHC was terminated and
Lease II retained Capital Senior Management 2, Inc. ("Capital") to be the new
property manager of its Senior Housing Facilities pursuant to a management
agreement (the "Management Agreement"). Lawrence A. Cohen, who, through July 28,
1998, served as President, Chief Executive Officer and Director of the Company
and a Director of Lease II, has also served in various management capacities at
Capital Senior Living Corporation ("CSLC"), an affiliate of Capital, since 1996.
Mr. Cohen currently serves as Chief Executive Officer of CSLC. As a result,
through July 28, 1998, CSLC was considered a related party.

SALE OF 75% CO-TENANCY INTEREST IN VILLA SANTA BARBARA

         On August 15, 2000, the Company caused ILM II Holding to complete the
sale of its 75% co-tenancy interest in its senior living facility located in
Santa Barbara, California ("Villa Santa Barbara"), to CSLC for $10,143,750. In
consideration for the sale, the Company received $9,543,750 in cash and CSLC
contributed $600,000 toward the Company's outstanding construction loan debt and
assumed certain then current transaction expenses of the Company in connection
with the previously announced proposed merger contemplated by the Amended and
Restated Agreement and Plan of Merger dated October 19, 1999, as amended on
April 18, 2000, by and among the Company, CSLC and CSLC's wholly-owned
acquisition subsidiary. The remaining 25% co-tenancy interest in Villa Santa
Barbara was formerly owned by ILM Holding, Inc. ("Holding I"), a subsidiary of
ILM Senior Living, Inc. ("ILM I") and was transferred to CSLC at the time the
merger between ILM I and CSLC was consummated. A gain on the sale of
approximately $6,160,000 has been recognized in the accompanying consolidated
statement of income for the year ended August 31, 2000. It is anticipated that
this gain will result in a built-in gain tax which would be reduced by available
net operating loss carryforwards from the period when the Company was a
so-called "C" Corporation (prior to the Company's conversion to a REIT for
1996).

AGREEMENT AND PLAN OF MERGER WITH CSLC

         On February 7, 1999, the Company entered into an agreement and plan of
merger, which was amended and restated on October 19, 1999, with CSLC, the
corporate parent of Capital, and certain affiliates of CSLC. On April 18, 2000,
the Company entered into a First Amendment to the Amended and Restated Agreement
and Plan of Merger dated October 19, 1999. As stated in the April 18th
amendment, if the merger is consummated, the Shareholders of the Company will
receive all-cash merger consideration of approximately $13.04 per share compared
to the previous merger consideration of $14.47 per share. In addition, the
amended agreement requires CSLC to agree to pay the Company increased
termination fees in certain circumstances. Further, the Company required CSLC to
agree to reduce the amount of fees and expenses it would receive upon
termination of the merger in certain circumstances.


                                      I-3

<PAGE>

                           ILM II SENIOR LIVING, INC.


ITEM 1.  BUSINESS (CONTINUED)

         At a special meeting of Shareholders on June 22, 2000, holders of more
than two-thirds of the outstanding shares of the Company's common stock voted in
favor of approval of the proposed Amended and Restated Agreement and Plan of
Merger dated October 19, 1999, as amended on April 18, 2000. Holders of Company
common stock will have no dissenters' rights in the merger.

         The merger was scheduled to be consummated on or prior to September 30,
2000. In July 2000, CSLC reported to the Company that it had not obtained
sufficient financing to complete the merger by September 30, 2000.

         On November 28, 2000, the Company extended until March 31, 2001 the
outside termination date of its pending merger agreement with CSLC and entered
into with CSLC a technical amendment to the merger agreement providing, among
other things, that subject to the ILM II Board's fiduciary duties to
Shareholders, CSLC will have until March 31, 2001 to obtain definitive financing
sufficient for CSLC to complete the transaction.

         In connection with the amendment, CSLC agreed, after March 31, 2001, to
a termination of all of its rights of first and last offer it may have with
respect to the sale by the Company to a third party of its common stock, its
ownership interest in ILM II Holding and/or the sale of the Company's senior
living properties and assets, and to reduce from $1,858,200 to $1,000,000 the
amount of certain termination fees payable by the Company to CSLC under certain
limited circumstances. All other terms of the merger agreement remain in effect.
The terms of the merger agreement require CSLC to pay the Company $1,540,000 if
the merger does not occur on or before March 31, 2001, if the failure to
consummate the transaction is due to CSLC's inability to obtain financing
necessary to close the transaction.

         The pending merger agreement provides for consideration of $13.04 per
share of the Company's outstanding common stock. In view of the sale in August
2000 to CSLC of the Company's interest in the Santa Barbara, California, senior
living facility, in December 2000 the Company distributed the net proceeds of
such sale on a pro rata basis in the form of a return of invested capital to
Shareholders of record as of November 1, 2000. The aggregate cash distribution
was approximately $9,800,000 and is equivalent to the payment of approximately
$1.89 per share of the $13.04 per share of merger consideration. The remaining
approximate $11.15 per share would be payable by CSLC to Shareholders of the
Company upon completion of the merger in accordance with the merger agreement.

         There can be no assurance that CSLC will be able to obtain the
requisite financing to complete the merger or, even if obtained, that the merger
otherwise will be consummated.

         In connection with the proposed merger, the Company has agreed to cause
ILM II Holding to cancel and terminate the Facilities Lease Agreement with Lease
II on the date of consummation of the merger.

         On November 13, 2000, the Company's Board of Directors voted to extend
the Facilities Lease Agreement on a month-to-month basis beyond its original
expiration date of December 31, 2000. On November 28, 2000, the Facilities Lease
Agreement was extended through the earlier of the date on which the merger of
the Company with CSLC is consummated or March 31, 2001, and on a month-to-month
basis thereafter if the merger is not consummated by that time. The Facilities
Lease Agreement was originally scheduled to expire on December 31, 2000.


                                      I-4

<PAGE>

                           ILM II SENIOR LIVING, INC.


ITEM 1. BUSINESS (CONTINUED)

         At August 31, 2000, through its consolidated subsidiary, the Company
owned five Senior Housing Facilities (six at August 31, 1999, as Villa Santa
Barbara was sold on August 15, 2000). The Company's investments as of August 31,
2000 are described below:

<TABLE>
<CAPTION>
                                                                              YEAR
PROPERTY NAME                                                   DATE OF     FACILITY    RENTABLE       RESIDENT
AND LOCATION (1)                TYPE OF PROPERTY              INVESTMENT      BUILT     UNITS (2)   CAPACITIES (2)
---------------------           ----------------              ----------      -----     ---------   --------------
<S>                             <C>                           <C>             <C>       <C>         <C>
The Palms
Fort Myers, FL                  Senior Housing Facility         7/18/90       1988         205            255

Crown Villa
Omaha, NE                       Senior Housing Facility         4/25/91       1992         73             73

Overland Park Place
Overland Park, KS               Senior Housing Facility         4/9/92        1984         141            153

Rio Las Palmas
Stockton, CA                    Senior Housing Facility         5/14/92       1988         164            190

The Villa at Riverwood
St. Louis County, MO            Senior Housing Facility         5/29/92       1986         120            140
</TABLE>


(1)      See Note 4 to the consolidated financial statements filed with this
         Annual Report for a description of the agreements through which the
         Company has acquired these real estate investments.

(2)      Rentable units represent the number of apartment units and is a measure
         commonly used in the real estate industry. Resident capacity equals the
         number of bedrooms contained within the apartment units and corresponds
         to measures commonly used in the healthcare industry.

         The Facilities Lease Agreement is a "triple-net" lease whereby the
Lessee pays all operating expenses, governmental taxes and assessments, utility
charges and insurance premiums, as well as the costs of all required
maintenance, personal property and non-structural repairs in connection with the
operation of the Senior Housing Facilities. ILM II Holding, as Lessor, is
responsible for all major capital improvements and structural repairs to the
Senior Housing Facilities. The Facilities Lease Agreement was originally
scheduled to expire on December 31, 2000, unless earlier terminated at the
election of the Lessor in connection with the sale by the Lessor of the Senior
Housing Facilities to a non-affiliated third party but on November 13, 2000, was
extended beyond its original expiration date on a month-to-month basis. On
November 28, 2000, the Facilities Lease Agreement was extended through the
earlier of the date on which the merger of the Company with CSLC is consummated
or March 31, 2001, and on a month-to-month basis thereafter if the merger is not
consummated by that time. Lease II paid annual base rent for the use of all of
the Facilities in the aggregate amount of $3,995,586 per year ($4,035,600 per
year in 1999). The reduction in base rent from the previous year is due to the
sale of Villa Santa Barbara on August 15, 2000. Beginning September 1, 2000,
annual base rent will be $3,555,427 (excluding Villa Santa Barbara). Lease II
also pays variable rent, on a quarterly basis, for each Senior Housing Facility
in an amount equal to 40% of the excess of the aggregate total revenues for the
Senior Housing Facilities, on an annualized basis, over $13,021,000. For the
years ended August 31, 2000, 1999 and 1998, variable rental income was
$1,437,000, $1,261,000, and $984,000, respectively.


                                      I-5

<PAGE>

                           ILM II SENIOR LIVING, INC.


ITEM 1.  BUSINESS (CONTINUED)

         The Senior Housing Facilities are subject to competition from similar
properties in the vicinities in which they are located. The properties are
located in areas with significant senior citizen populations and, as a result,
there are, and will likely continue to be a variety of competing projects aimed
at attracting senior residents. Such projects will generally compete on the
basis of rental rates, services, amenities and location. The Company has no real
estate investments located outside the United States. The Company is engaged
solely in the business of real estate investment. Therefore, presentation of the
information about industry segments is not applicable.

         The Company originally expected to liquidate its investments after a
period of approximately ten years, although under the terms of its
organizational documents property sales may occur at earlier or later dates. The
net proceeds of any sale transactions are expected to be distributed to the
Shareholders, so that the Company will, in effect, be self-liquidating.

         Through June 18, 1997, and subject to the supervision of the Company's
Board of Directors, assistance in the management of the business of the Company
was provided by PaineWebber. PaineWebber resigned from this position effective
as of June 18, 1997, although PaineWebber agreed to provide certain
administrative services to the Company and its affiliates through August 31,
1997. Through the date of its resignation, PaineWebber performed the day-to-day
operations of the Company and acted as the investment advisor and consultant for
the Company. PaineWebber provided cash management, accounting, tax preparation,
financial reporting, investor communications and relations as well as asset
management services to the Company. These services are now being provided to the
Company, subject to the supervision of the Company's Board of Directors, by
various companies, advisors and consultants including Cohen & Steers, Greenberg
Traurig, Fleet Bank, Ernst & Young LLP and MAVRICC Management Systems, Inc.

         There are currently three Directors of the Company, none of whom are
affiliates of PaineWebber or Capital. The Directors are subject to removal by
the vote of the holders of a majority of the outstanding shares of Company
common stock.


                                      I-6

<PAGE>

                           ILM II SENIOR LIVING, INC.


ITEM 2.  PROPERTIES

         As of August 31, 2000, the Company has interests in the five operating
properties referred to under Item 1 above (six operating properties in 1999,
prior to the sale of Villa Santa Barbara on August 15, 2000), to which reference
is made for the description, name and location of such properties.

         Average occupancy levels for each fiscal quarter during 2000, along
with an average for the year are presented below for each property:

<TABLE>
<CAPTION>
                                                                   AVERAGE QUARTERLY OCCUPANCY
                                            --------------------------------------------------------------------------
                                                                                                         FISCAL 2000
                                              11/30/99        2/29/00        5/31/00        8/31/00        AVERAGE
                                              --------        -------        -------        -------        -------
<S>                                           <C>              <C>          <C>            <C>            <C>
The Palms                                        89%              92%          92%            90%            91%

Crown Villa                                      95%              90%          89%            85%            90%

Overland Park Place                              94%              93%          92%            95%            94%

Rio Las Palmas                                   94%              92%          93%            93%            93%

The Villa at Riverwood                           88%              88%          84%            85%            86%
</TABLE>


ITEM 3.  LEGAL PROCEEDINGS

TERMINATION OF MANAGEMENT CONTRACT WITH AHC

         On July 29, 1996, Lease II and ILM II Holding (collectively for this
Item 3, the "Companies") terminated a property management agreement with AHC
covering the six Senior Housing Facilities leased by Lease II from ILM II
Holding. The management agreement was terminated for "cause" pursuant to the
contract. Simultaneously with the termination of the management agreement, the
Companies, together with certain affiliated entities, filed suit against AHC in
the United States District Court for the Eastern District of Virginia for breach
of contract, breach of fiduciary duty and fraud. The Companies alleged, among
other things, that AHC willfully performed actions specifically in violation of
the management agreement and that such actions caused damages to the Companies.

         Due to the termination of the management agreement for cause, no
termination fee was paid to AHC. Subsequent to the termination of the management
agreement, AHC filed for protection under Chapter 11 of the U.S. Bankruptcy Code
in its domestic State of California. The filing was challenged by the Companies,
and the Bankruptcy Court dismissed AHC's case effective October 15, 1996. In
November 1996, AHC filed with the Virginia District Court an answer in response
to the litigation initiated by the Companies and a counterclaim against ILM II
Holding. The counterclaim alleged that the management agreement was wrongfully
terminated for cause and requested damages which include the payment of the
termination fee in the amount of $750,000, payment of management fees pursuant
to the management agreement from August 1, 1996 through October 15, 1996, which
is the earliest date that the management agreement could have been terminated
without cause, and recovery of attorney's fees and expenses.

         The aggregate amount of damages against all parties as requested in
AHC's counterclaim exceeded $2,000,000. On June 13, 1997 and July 8, 1997, the
court issued orders to enter judgment against the Company and ILM I in the
amount of $1,000,000. The orders did not contain any findings of fact or
conclusions of law. On July 10, 1997, the Company, ILM I, Lease I and Lease II
filed a notice of appeal to the United States Court of Appeals for the Fourth
Circuit from the orders.


                                      I-7

<PAGE>

                           ILM II SENIOR LIVING, INC.

ITEM 3.  LEGAL PROCEEDINGS (CONTINUED)

         On February 4, 1997, AHC filed a complaint in the Superior Court of the
State of California against Capital, the new property manager; Lawrence A.
Cohen, who, through July 28, 1998, was President, Chief Executive Officer, and
Director of the Company; and others alleging that the defendants intentionally
interfered with AHC's property management agreement (the "California
litigation"). The complaint sought damages of at least $2,000,000. On March 4,
1997, the defendants removed the case to Federal District Court in the Central
District of California. At a Board meeting on February 26, 1997, the Company's
Board of Directors concluded that since all of Mr. Cohen's actions relating to
the California litigation were taken either on behalf of the Company under the
direction of the Board or as a PaineWebber employee, the Company or its
affiliates should indemnify Mr. Cohen with respect to any expenses arising from
the California litigation, subject to any insurance recoveries for those
expenses. Legal fees paid by Lease I and Lease II on behalf of Mr. Cohen totaled
$229,000 as of August 31, 2000. The Company's Board also concluded that, subject
to certain conditions, the Company or its affiliates should pay reasonable legal
fees and expenses incurred by Capital in the California litigation. As of August
31, 2000, the amount advanced to Capital by Lease I and Lease II for legal fees
totaled approximately $563,000. No amounts were advanced during fiscal year
2000.

         On August 18, 1998, the Company and its affiliates along with Capital
and its affiliates entered into a settlement agreement with AHC. Lease I and
Lease II agreed to pay $1,625,000 and Capital and its affiliates agreed to pay
$625,000 to AHC in settlement of all claims including those related to the
Virginia litigation and the California litigation. The Company and its
affiliates also entered into an agreement with Capital and its affiliates to
mutually release each other from all claims that any such parties may have
against each other, other than any claims under the property management
agreements. On September 4, 1998, the full settlement amounts were paid to AHC
and its affiliates with Lease I paying $975,000 and Lease II paying $650,000.

FELDMAN LITIGATION

         On May 8, 1998 Andrew A. Feldman and Jeri Feldman, as Trustees for the
Andrew A. & Jeri Feldman Revocable Trust dated September 18, 1990, commenced a
purported class action on behalf of that trust and all other shareholders of the
Company and ILM I in the Supreme Court of the State of New York, County of New
York naming the Company, ILM I and their Directors as defendants. The class
action complaint alleged that the Directors engaged in wasteful and oppressive
conduct and breached fiduciary duties in preventing the sale or liquidation of
the assets of the Company and ILM I, diverting certain of their assets. The
complaint sought compensatory damages in an unspecified amount, punitive
damages, the judicial dissolution of the Company and ILM I, an order requiring
the Directors to take all steps to maximize Shareholder value, including either
an auction or liquidation, and rescinding certain agreements, and attorney's
fees.

         On October 15, 1999, the parties entered into a Stipulation of
Settlement and filed it with the Court, which approved the settlement, by order
dated October 21, 1999. In issuing that order the Court entered a final judgment
dismissing the action and all non-derivative claims of the settlement class
against the defendants with prejudice. This litigation was settled at no cost to
the Company and ILM I. As part of the settlement, CSLC increased its proposed
merger consideration payable to the Company and ILM I shareholders and was also
responsible for a total of approximately $1.1 million in plaintiffs' attorneys
fees and expenses upon consummation of the proposed mergers. If the proposed
mergers were not consummated and if the Company or ILM I were to consummate an
extraordinary transaction with a third party, then the Company and ILM I would
be responsible for the plaintiffs' attorneys fees and expenses.

         On August 15, 2000, the merger of ILM I with CSLC was consummated. If
the proposed merger of the Company and CSLC is not consummated, and if the
Company were to consummate an extraordinary transaction with a third party, then
the Company would be responsible for the Company's share of the plaintiff's
attorney's fees and expenses.

                                      I-8

<PAGE>

                           ILM II SENIOR LIVING, INC.



ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

         At a special meeting of Shareholders on June 22, 2000, holders of more
than two-thirds of the outstanding shares of the Company's common stock voted in
favor of approval of the proposed Amended and Restated Agreement and Plan of
Merger dated October 19, 1999, as amended on April 18, 2000. Holders of Company
common stock will have no dissenters' rights in the merger.




                                      I-9

<PAGE>

                           ILM II SENIOR LIVING, INC.


                                     PART II

ITEM 5. MARKET FOR THE REGISTRANT'S SHARES AND RELATED STOCKHOLDER MATTERS

         During the public offering period, which commenced August 8, 1990 and
ended May 10, 1991, the selling price of the shares of common stock was $10 per
share. At August 31, 2000 there were 3,039 record holders of the Company's
shares. There is no public market for the resale of the shares, and it is not
anticipated that a public market will develop. While shares of the Company were
designed for long-term holding, they may possibly be traded through a secondary
market resale. The shares do not trade on an established exchange and the only
market that has developed is an informal secondary market; therefore little
resale activity occurs. Although PaineWebber and others may endeavor to assist
Shareholders desiring to sell their shares by attempting to match requests to
sell shares with requests to purchase shares, such transfers are not expected to
be frequent. In addition, the Company's Articles of Incorporation restrict
ownership of more than 9.8% of the Company's outstanding shares by one investor.
These restrictions are designed to ensure that the Company does not violate
certain share accumulation restrictions imposed by the Internal Revenue Code on
REITs.

         Through the dividend payment made on April 15, 2000, for the quarter
ended February 29, 2000, the Company made quarterly distributions, payable
within 45 days after the end of each fiscal quarter, to Shareholders of record
on the record date for such quarter as determined by the Directors. On November
13, 2000, the Company's board of directors voted to (1) reinstate the payment of
regular quarterly dividends to shareholders with the dividend for the quarter
ending November 30, 2000, which is scheduled to be paid on January 15, 2001; and
(2) distribute to shareholders the net proceeds from the sale of the Company's
75% interest in Villa Santa Barbara. The Company intends to make distributions
to Shareholders in an amount equal to at least 95% of its taxable income in
order to continue to qualify as a REIT. Reference is made to Item 6 below for
the amount of cash dividends paid per share of common stock during fiscal year
2000.

         On August 15, 2000, the Company caused ILM II Holding to complete the
sale of its 75% co-tenancy interest in its senior living facility located in
Santa Barbara, California ("Villa Santa Barbara"), to CSLC for $10,143,750. In
consideration for the sale, the Company received $9,543,750 in cash and CSLC
contributed $600,000 toward the Company's outstanding construction loan debt and
assumed certain then current transaction expenses of the Company in connection
with the previously announced proposed merger contemplated by the Amended and
Restated Agreement and Plan of Merger dated October 19, 1999, as amended on
April 18, 2000 (the "Merger Agreement"), by and among the Company, CSLC and
CSLC's wholly-owned acquisition subsidiary. The remaining 25% co-tenancy
interest in Villa Santa Barbara was formerly owned by ILM Holding, Inc.
("Holding I"), a subsidiary of ILM Senior Living, Inc. ("ILM I") and was
transferred to CSLC at the time the merger between ILM I and CSLC was
consummated. A gain on the sale of approximately $6,160,000 has been recognized
in the accompanying consolidated statement of income for the year ended August
31, 2000. It is anticipated that this gain will result in a built-in gain tax
which would be reduced by available net operating loss carryforwards from the
period when the Company was a so-called "C" Corporation (prior to the Company's
conversion to a REIT for 1996).

         On February 7, 1999, the Company entered into an agreement and plan of
merger, which was amended and restated on October 19, 1999, with CSLC, the
corporate parent of Capital, and certain affiliates of CSLC. On April 18, 2000,
the Company entered into a First Amendment to the Amended and Restated Agreement
and Plan of Merger dated October 19, 1999. As stated in the April 18th
amendment, if the merger is consummated, the Shareholders of the Company will
receive all-cash merger consideration of approximately $13.04 per share compared
to the previous merger consideration of $14.47 per share. In addition, the
amended agreement requires CSLC to agree to pay the Company increased
termination fees in certain circumstances. Further, the Company required CSLC to
agree to reduce the amount of fees and expenses it would receive upon
termination of the merger in certain circumstances.


                                      II-1

<PAGE>

                           ILM II SENIOR LIVING, INC.



ITEM 5. MARKET FOR THE REGISTRANT'S SHARES AND RELATED STOCKHOLDER MATTERS
(continued)

         At a special meeting of Shareholders on June 22, 2000, holders of more
than two-thirds of the outstanding shares of the Company's common stock voted in
favor of approval of the proposed Amended and Restated Agreement and Plan of
Merger dated October 19, 1999, as amended on April 18, 2000. Holders of Company
common stock will have no dissenters' rights in the merger.

         The merger was scheduled to be consummated on or prior to September 30,
2000. In July 2000, CSLC reported to the Company that it had not obtained
sufficient financing to complete the merger by September 30, 2000.

         On November 28, 2000, the Company extended until March 31, 2001 the
outside termination date of its pending merger agreement with CSLC and entered
into with CSLC a technical amendment to the merger agreement providing, among
other things, that subject to the ILM II Board's fiduciary duties to
Shareholders, CSLC will have until March 31, 2001 to obtain definitive financing
sufficient for CSLC to complete the transaction.

         In connection with the amendment, CSLC agreed, after March 31, 2001 to
a termination of all of its rights of first and last offer it may have with
respect to the sale by the Company to a third party of its common stock, its
ownership interest in ILM II Holding and/or the sale of the Company's senior
living properties and assets, and to reduce from $1,858,200 to $1,000,000 the
amount of certain termination fees payable by the Company to CSLC under certain
limited circumstances. All other terms of the merger agreement remain in effect.
The terms of the merger agreement require CSLC to pay the Company $1,540,000 if
the merger does not occur on or before March 31, 2001 if the failure to
consummate the transaction is due to CSLC's inability to obtain financing
necessary to close the transaction.

         The pending merger agreement provides for consideration of $13.04 per
share of the Company's outstanding common stock. In view of the sale in August
2000 to CSLC of the Company's interest in the Santa Barbara, California senior
living facility, in December 2000 the Company distributed the net proceeds of
such sale on a pro rata basis in the form of a return of invested capital to
Shareholders of record as of November 1, 2000. The aggregate cash distribution
was approximately $9,800,000 and is equivalent to the payment of approximately
$1.89 per share of the $13.04 per share of merger consideration. The remaining
approximate $11.15 per share would be payable by CSLC to Shareholders of the
Company upon completion of the merger in accordance with the merger agreement.

         There can be no assurance that CSLC will be able to obtain the
requisite financing to complete the merger or, even if obtained, that the merger
otherwise will be consummated.


                                      II-2

<PAGE>

                           ILM II SENIOR LIVING, INC.

ITEM 6.  SELECTED FINANCIAL DATA

                           ILM II SENIOR LIVING, INC.
         For the years ended August 31, 2000, 1999, 1998, 1997 and 1996
                  (Dollars in thousands, except per share data)


<TABLE>
<CAPTION>
                                                      2000         1999         1998         1997(1)        1996
                                                      ----         ----         -----        -------        ----
<S>                                                   <C>           <C>         <C>         <C>          <C>
   Revenues                                            $5,458        $5,321      $ 5,065     $  4,515     $       46

   Operating income (loss)                              2,549         1,697        2,907        2,184           (587)

   Gain on sale of Villa Santa Barbara                  6,160             -            -            -              -

   Equity in income from properties securing
     mortgage loans                                         -             -            -              -        2,674
                                                  -----------   -----------  -----------  -------------    ---------

   Net income                                          $8,709        $1,697     $  2,907     $  2,184       $  2,087
                                                       ======        ======     ========     ========       ========

   Earnings per share of common stock              $     1.68    $     0.32    $    0.56    $    0.42      $    0.40
                                                   ==========    ==========    =========    =========      =========

   Cash dividends paid per share of common stock   $     0.64    $     0.85    $    0.73    $    0.61      $    0.50
                                                   ==========    ==========    =========    =========      =========

<CAPTION>

                                                         2000          1999         1998         1997           1996
                                                         ----          ----         ----         ----           ----
<S>                                                <C>            <C>          <C>          <C>           <C>
   Total assets                                       $35,611       $31,376      $32,383      $33,355        $33,973
                                                      =======       =======      =======      =======        =======


   Shares outstanding                               5,181,236     5,181,236    5,181,236    5,181,236      5,181,236
</TABLE>


(1)      As a result of certain restructuring plans which the Company began to
         implement during fiscal 1995 (see Item 7), the financial position and
         results of operations of the combined operating investment properties
         in which the Company has invested have been presented on a consolidated
         basis in the Company's financial statements beginning in fiscal 1997.
         Prior to fiscal 1997, the Company had accounted for its interests in
         such properties under the equity method as a result of the Company not
         holding majority voting control of ILM Holding.

         The above selected financial data should be read in conjunction with
         the consolidated financial statements and related notes to the
         consolidated financial statements appearing in item 14(a) of this
         annual report.




                                      II-3

<PAGE>

                           ILM II SENIOR LIVING, INC.



ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

LIQUIDITY AND CAPITAL RESOURCES

         The Company offered shares of its common stock to the public from
September 12, 1990 to May 10, 1991 pursuant to a Registration Statement filed
under the Securities Act of 1933. Capital contributions of $51,812,356 were
received by the Company (including $200,000 contributed by PaineWebber) and,
after deducting selling expenses and offering costs and allowing for adequate
cash reserves, approximately $42.9 million was available to be invested in
participating first mortgage loans secured by Senior Housing Facilities. The
Company originally invested the net proceeds of the initial public offering in
six participating mortgage loans secured by Senior Housing Facilities located in
five states. All of the loans made by the Company were originally with AHC. As
previously reported, AHC defaulted on the regularly scheduled mortgage loan
payments due to the Company on March 1, 1993. Its parent company, Angeles,
subsequently filed for bankruptcy. In fiscal 1994, a Settlement Agreement was
executed whereby ownership of the Senior Housing Facilities was transferred from
AHC to certain designated affiliates of the Company which were majority owned by
the Company. Subsequently, these affiliates were merged into ILM II Holding
which is now a subsidiary of the Company. ILM II Holding holds title to the five
Senior Housing Facilities (six Senior Housing Facilities in 1999, prior to the
sale of Villa Santa Barbara on August 15, 2000) which comprise the balance of
operating investment properties in the accompanying consolidated balance sheets,
subject to certain mortgage loans payable to the Company. Such mortgage loans
and the related interest expense are eliminated in the consolidation of the
financial statements of the Company. As part of the fiscal 1994 Settlement
Agreement with AHC, ILM II Holding retained AHC as the property manager for all
of the Senior Housing Facilities pursuant to the terms of a management
agreement. As discussed further below, the management agreement with AHC was
terminated in July 1996.

         Subsequent to the effective date of the Settlement Agreement with AHC,
in order to maximize the potential returns to the Company's existing
Shareholders while maintaining its qualification as a REIT under the Internal
Revenue Code, the Company formed a new corporation, Lease II, for the purpose of
operating the Senior Housing Facilities under the terms of a Facilities Lease
Agreement. As of August 31, 1995, Lease II, which is taxable as a so-called "C"
corporation and not as a REIT, was a wholly-owned subsidiary of the Company. On
September 1, 1995, after the Company received the required regulatory approval,
it distributed all of the shares of capital stock of Lease II to the holders of
record of the Company's common stock. One share of common stock of Lease II was
issued for each full share of the Company's common stock held. Prior to the
distribution, the Company capitalized Lease II with $500,000 from its existing
cash reserves, which was an amount estimated to provide Lease II with necessary
working capital.

         The Facilities Lease Agreement is between the Company's consolidated
affiliate, ILM II Holding, as owner of the properties and Lessor, and Lease II
as Lessee. The facilities lease is a "triple-net" lease whereby the Lessee pays
all operating expenses, governmental taxes and assessments, utility charges and
insurance premiums, as well as the costs of all required maintenance, personal
property and non-structural repairs in connection with the operation of the
Senior Housing Facilities. ILM II Holding, as the Lessor, is responsible for all
major capital improvements and structural repairs to the Senior Housing
Facilities. The Facilities Lease Agreement was originally scheduled to expire on
December 31, 2000, unless earlier terminated at the election of the Lessor in
connection with the sale by the Lessor of the Senior Housing Facilities to a
non-affiliated third party but on November 13, 2000, was extended beyond its
original expiration date on a month-to-month basis. On November 28, 2000, the
Facilities Lease Agreement was extended through the earlier of the date on which
the merger of the Company with CSLC is consummated or March 31, 2001, and on a
month-to-month basis thereafter if the merger is not consummated by that time.
Lease II paid annual base rent for the use of all of the Facilities in the
aggregate amount of $3,995,586 per year ($4,035,600 per year in 1999). The
reduction in base rent from the previous year is due to the sale of Villa Santa
Barbara on August 15, 2000. Beginning September 1, 2000, annual base rent will
be $3,555,427 (excluding Villa Santa Barbara). Lease II also pays variable rent,
on a quarterly basis, for each Senior Housing Facility in an amount equal to 40%
of the excess, if any, of the aggregate total revenues for the Senior Housing
Facilities, on an annualized basis, over $13,021,000. Variable rental income
related to fiscal years 2000, 1999, and 1998 was $1,437,000, $1,261,000, and
$984,000, respectively.

                                      II-4

<PAGE>

                           ILM II SENIOR LIVING, INC.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)


         The assumption of ownership of the Senior Housing Facilities through
ILM II Holding, which was a so-called "C" corporation for tax purposes at the
time of the assumption, may result in a possible future tax liability which
would be payable upon the ultimate sale of the Senior Housing Facilities (the
"built-in gain tax"). The amount of such tax would be calculated based on the
lesser of the total net gain realized from the sale transaction or the portion
of the net gain realized upon a final sale which is attributable to the period
during which the Senior Housing Facilities were held by a C corporation.

         The Company completed its restructuring plans by converting ILM II
Holding to a REIT for tax purposes. In connection with these plans, on November
21, 1996, the Company requested that PaineWebber sell all of the stock held in
ILM II Holding to the Company for a price equal to the fair market value of the
1% economic interest in ILM II Holding represented by the common stock. On
January 10, 1997, this transfer of the common stock of ILM II Holding was
completed at an agreed upon fair value of $40,000. With this transfer completed,
effective January 23, 1997, ILM II Holding recapitalized its common stock and
preferred stock by replacing the outstanding shares with 50,000 shares of new
common stock and 275 shares of non-voting, 8% cumulative preferred stock issued
to the Company (the "Preferred Stock"). The number of authorized shares of
preferred stock and common stock in ILM II Holding were also increased as part
of the recapitalization. Following the recapitalization, the Company made
charitable gifts of one share of the Preferred Stock in ILM II Holding to each
of 111 charitable organizations so that ILM II Holding would meet the stock
ownership requirements of a REIT as of January 30, 1997. The Preferred Stock has
a liquidation preference of $1,000 per share plus any accrued and unpaid
dividends. Dividends on the Preferred Stock will accrue at a rate of 8% per
annum on the original $1,000 liquidation preference and are cumulative from the
date of issuance. Since ILM II Holding is not expected to have sufficient cash
flow in the foreseeable future to make the required dividend payments, it is
anticipated that dividends will accrue and be paid at liquidation. The Company
recorded the contribution of the Preferred Stock in ILM II Holding to the
charitable organizations at the amount of the initial liquidation preference of
$111,000. Such amount is included in general and administrative expense in the
accompanying consolidated statement of income for the year ended August 31,
1997. Cumulative dividends accrued as of August 31, 2000 and 1999, on the
preferred stock in ILM II Holding totaled approximately $32,000 and $23,000,
respectively.

         Any future appreciation in the value of the Senior Housing Facilities
subsequent to the conversion of ILM II Holding to a REIT would not be subject to
the built-in gain tax. The built-in gain tax would most likely not be incurred
if the properties were to be held for a period of at least ten years from the
date of the conversion of ILM II Holding to a REIT. However, since the end of
the Company's original anticipated holding period as defined in the Articles of
Incorporation is December 31, 2001, the properties may not be held for an
additional ten years. Based on management's current estimate of the increase in
the values of the Senior Housing Facilities which occurred between April 1994
and January 1996, as supported by independent appraisals, a sale of the Senior
Housing Facilities within ten years of the date of the conversion of ILM II
Holding to a REIT could result in a built-in gain tax of as much as $2.5
million, which could be reduced by approximately $270,000, using available net
operating loss carryforwards of ILM II Holding of approximately $780,000 that
were incurred prior to its conversion to REIT status. ILM II Holding also has
net operating losses that were incurred after its conversion to REIT status of
approximately $4.2 million. The sale of the Company's interest in Villa Santa
Barbara resulted in the recognition of a built-in gain of approximately
$600,000, which was offset by pre-conversion net operating losses. As of August
31, 2000, the potential built-in gain tax relating to the Senior Housing
Facilities is as much as $2.3 million, which could be further reduced by
approximately $50,000, using the remaining available pre-conversion net
operating loss


                                      II-5

<PAGE>

                           ILM II SENIOR LIVING, INC.


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)

carryforwards of ILM II Holding of approximately $150,000. To avoid this
built-in gain tax, the Directors are prepared at the appropriate time to
recommend to the Shareholders an amendment to the Articles of Incorporation to
extend the Company's scheduled liquidation date. Based upon advice from the
Company's financial advisors, commencing in 1996, the Company has acted as
though it had made an election in its 1996 tax return to allow the Company to
avoid a corporate level tax upon its conversion from a C-Corporation to a Real
Estate Investment Trust. Because proof of a formal election has not been
obtained, the Company is pursuing administrative relief with the Internal
Revenue Service to ensure the availability of the benefits of this election.
Although the Company believes that it had a legitimate basis to make this
election, in part, based upon the advice of its financial advisors, ultimate
resolution of this matter is at the discretion of the Internal Revenue Service.
If unsuccessful, the Company could be liable for up to $2.7 million of
additional penalties and interest.

         ILM II Holding has acquired the respective operating properties subject
to, and assumed the obligations under, the mortgage loans payable to the
Company, pursuant to the 1997 Settlement Agreement with AHC. The principal
balance of each loan was modified to reflect the estimated fair value of the
related operating property as of the date of the transfer of ownership. The
modified loans require interest-only payments on a monthly basis at a rate of 7%
from April 1, 1994 through December 1, 1994, 9% for the period January 1 through
December 31, 1995, 11% for the period January 1 through December 31, 1996, 12%
for the period January 1 through December 31, 1997, 13% for the period January 1
through December 31, 1998, 13.5% for the period January 1, 1999 through December
31, 1999 and 14% for the period January 1, 2000 through maturity. Since ILM II
Holding is consolidated with the Company in the accompanying consolidated
financial statements for fiscal years 2000 and 1999, the mortgage loans and
related interest expense have been eliminated in consolidation.

         Because the ownership of the assets of ILM II Holding was expected to
be transferred to the Company or its wholly-owned subsidiary, ILM II Holding was
capitalized with funds to provide it with working capital only for a limited
period of time. At the present time, ILM II Holding is not expected to have
sufficient cash flow during fiscal year 2001 to (i) meet its obligations to make
the debt service payments due under the loans and (ii) pay for capital
improvements and structural repairs in accordance with the terms of the
Facilities Lease Agreement. Although ILM II Holding is not expected to fully
fund its scheduled debt service payments to the Company, the current values of
the Senior Housing Facilities are well in excess of the mortgage principal
amounts plus accrued interest at August 31, 2000. As a result, the Company is
expected to recover the full amount that would be due under the loans upon the
sale of the Senior Housing Facilities.

         Lease II has retained Capital to be the property manager of the Senior
Housing Facilities and the Company has guaranteed payment of all fees due to
Capital pursuant to the Management Agreement which commenced on July 29, 1996.
Lawrence A. Cohen, who, through July 28, 1998, served as President, Chief
Executive Officer and Director of the Company and a Director of Lease II, has
also served in various management capacities at CSLC, an affiliate of Capital,
since 1996. Mr. Cohen currently serves as Chief Executive Officer of CSLC. As a
result, through July 28, 1998, CSLC was considered a related party. Under the
terms of the Management Agreement, Capital earns a base management fee equal to
4% of the gross operating revenues of the Senior Housing Facilities, as defined.
Capital also earns an incentive management fee equal to 25% of the amount by
which the net cash flow of the Senior Housing Facilities, as defined, exceeds a
specified base amount. Each August 31, beginning on August 31, 1997, the base
amount is increased based on the percentage increase in the Consumer Price Index
as well as 15% of Senior Housing Facility expansion costs.


                                      II-6

<PAGE>

                           ILM II SENIOR LIVING, INC.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)


         On February 4, 1997, AHC filed a complaint in the Superior Court of the
State of California against Capital, the new property manager; Lawrence A.
Cohen, who, through July 28, 1998, was President, Chief Executive Officer, and
Director of the Company; and others alleging that the defendants intentionally
interfered with AHC's property management agreement (the "California
litigation"). The complaint sought damages of at least $2,000,000. On March 4,
1997, the defendants removed the case to Federal District Court in the Central
District of California. At a Board meeting on February 26, 1997, the Company's
Board of Directors concluded that since all of Mr. Cohen's actions relating to
the California litigation were taken either on behalf of the Company under the
direction of the Board or as a PaineWebber employee, the Company or its
affiliates should indemnify Mr. Cohen with respect to any expenses arising from
the California litigation, subject to any insurance recoveries for those
expenses. Legal fees paid by Lease I and Lease II on behalf of Mr. Cohen totaled
$229,000 as of August 31, 2000. The Company's Board also concluded that, subject
to certain conditions, the Company or its affiliates should pay reasonable legal
fees and expenses incurred by Capital in the California litigation. As of August
31, 2000, the amount advanced to Capital by Lease I and Lease II for legal fees
totaled approximately $563,000. No amounts were advanced during fiscal year
2000.







                                      II-7

<PAGE>

                           ILM II SENIOR LIVING, INC.


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)


         The occupancy levels of the five Senior Housing Facilities in which the
Company has invested (six Senior Housing Facilities in 1999 prior to the sale of
Villa Santa Barbara on August 15, 2000) averaged 91% and 94% for the fiscal
years ended August 31, 2000 and 1999, respectively. The Company's net operating
cash flow is expected to be relatively stable and predictable due to the
structure of the Facilities Lease Agreement. The annual base rental payments
owed to ILM II Holding, excluding Villa Santa Barbara, will be $3,555,427
beginning September 1, 2000, and will remain at that level for the remainder of
the lease term, including any month-to-month extensions of the lease. In
addition, the Senior Housing Facilities are currently generating gross revenues
which are in excess of the specified threshold in the variable rent calculation,
as discussed further above, which became effective in January 1997. Accordingly,
ILM II Holding received variable rent payments in fiscal 2000, 1999, and 1998 in
the amounts of $1,437,000, $1,261,000, and $984,000, respectively.

         The Company has been pursuing the potential for future expansion of
several of the Senior Housing Facilities which are located in areas that have
particularly strong markets for senior housing to increase cash flow and
shareholder value. Potential expansion candidates include the facilities located
in Omaha, Nebraska; St. Louis County, Missouri; and Fort Myers, Florida. During
fiscal year 1999, approximately one acre of land located adjacent to the Omaha
facility was acquired for approximately $135,000 and during fiscal year 1998, a
one-half acre parcel of vacant land adjacent to the Stockton facility was
purchased for approximately $136,000. Also included in land on the accompanying
consolidated balance sheets are significant pre-construction design and planning
costs incurred at existing facilities for possible future expansions. Although
no expansion of the Stockton facility is being considered at this time, the
additional land is providing needed parking spaces and improved access to the
existing facility as well as future expansion potential since the completion of
the parking lot during fiscal year 2000. The Fort Myers facility includes a
vacant land parcel of approximately one and one-half acres, which could
accommodate an expansion of the existing facility. Preliminary feasibility
evaluations have been completed for all of these potential expansions and
pre-construction design and construction-cost evaluations have been completed
for expansions of the facilities located in Omaha and Fort Myers.

         To date, no construction has been started and expansion plans have been
temporarily suspended pending the expected merger of the Company and CSLC. The
Company will carefully evaluate the costs and benefits before proceeding with
the construction of any of these expansions. Depending on the extent of any
expansions deemed appropriate, such plans would result in the need for
substantial capital.

         The Company secured a construction loan facility with a major bank that
provides the Company with up to $8.8 million to fund the capital costs of the
potential expansion programs. The construction loan facility is secured by a
first mortgage of the Senior Housing Facilities and collateral assignment of the
Company's leases of such Senior Housing Facilities. The loan was scheduled to
expire on December 31, 2000, with possible extensions through September 29,
2003. Principal is due at expiration. Interest is payable at a rate equal to
LIBOR plus 1.10% or Prime plus 0.5%. Loan origination costs in connection with
this loan facility are being amortized over the life of the loan.

         On June 7, 1999, the Company borrowed approximately $1.2 million under
the construction loan facility to fund the pre-construction capital costs
incurred through April 1999, of the potential expansions of the Senior Housing
Facilities. On August 16, 2000, the Company repaid approximately $600,000 of
principal on the construction loan facility and the lender sold the loan to
CSLC. As part of the transaction, the Company agreed that the term of the loan
would not be extended beyond December 31, 2000. On November 28, 2000, the
Company and CSLC agreed that the maturity date of the loan would be extended
until the date on which the merger of the Company with CSLC is consummated or
the date on which the merger agreement is terminated, whichever occurs first.
Amounts outstanding under the loan at August 31, 2000, were approximately
$600,000 and $8.2 million of the construction loan facility is unused and
available.


                                      II-8

<PAGE>

                           ILM II SENIOR LIVING, INC.



ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)


         At August 31, 2000, the Company had cash and cash equivalents of
$11,258,000 compared to $1,913,000 at August 31, 1999. The increase in cash of
approximately $9,345,000 is due to proceeds received from the sale of the
Company's interest in Villa Santa Barbara to CSLC on August 15, 2000. Such
amounts will be used for the working capital requirements of the Company, along
with the possible investment in the properties owned by the Company's
consolidated affiliate for certain capital improvements, and for dividends to
the Shareholders. Future capital improvements could be financed from operations
or through borrowings, depending on the magnitude of the improvements, the
availability of financing and the Company's incremental borrowing rate. The
source of future liquidity and dividends to the Shareholders is expected to be
through facilities lease payments from Lease II, interest income earned on
invested cash reserves and proceeds from the future sales of the underlying
operating investment properties. Such sources of liquidity are expected to be
adequate to meet the Company's operating requirements on both a short-term and
long-term basis. The Company generally will be obligated to distribute annually
at least 95% of its taxable income to its Shareholders in order to continue to
qualify as a REIT under the Internal Revenue Code.


MARKET RISK

    The Company believes its market risk is immaterial.


                                      II-9

<PAGE>

                           ILM II SENIOR LIVING, INC.


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)


RESULTS OF OPERATIONS

2000 COMPARED TO 1999

         Net income increased $7,012,000, or 413.2%, to $8,709,000 for the
fiscal year ended August 31, 2000, compared to $1,697,000 for the fiscal year
ended August 31, 1999 due mainly to the $6,160,000 gain on sale resulting from
the Sale of Villa Santa Barbara. Total revenue was $5,458,000 for fiscal year
2000, representing an increase in revenue of $137,000, or 2.6%, compared to
total revenue of $5,321,000 for fiscal year 1999. Rental and other income
increased $136,000, or 2.6%, to $5,401,000 from $5,265,000 last year, due to
increased rental income earned pursuant to the terms of the Facilities Lease
Agreement. Interest income increased $1,000, or 1.8%, to $57,000 for the year
ended August 31, 2000, compared to $56,000 for the same period last year,
primarily due to an increase in cash and cash equivalents after the sale of the
Company's interest in Villa Santa Barbara on August 15, 2000. Total expenses
decreased $715,000, or 19.7%, to $2,909,000 for the fiscal year ended August 31,
2000, compared to $3,624,000 for the fiscal year ended August 31, 1999. This
decrease in expenses is primarily attributable to decreased professional fees of
$641,000, or 36.1%. General and administrative expenses decreased $50,000 to
$294,000, or 14.5%, for the fiscal year ended August 31, 2000, compared to
$344,000 for the same period last year, due to a variety of factors including
decreased printing costs of $68,000; decreased miscellaneous costs of $45,000 or
82.5% offset by a $47,000 or 34.75% increase in Director's & Officer's insurance
and increased postage and mailing costs of $11,000 or 41.8% due to increased
communication with Shareholders and regulatory authorities due to the proposed
merger with CSLC. Depreciation expense decreased $45,000 or 3.6% due mainly to
the Company's sale of its co-tenancy interest in Villa Santa Barbara on August
15, 2000.

1999 COMPARED TO 1998

         Net income decreased $1,210,000, or 41.6%, to $1,697,000 for the fiscal
year ended August 31, 1999, compared to $2,907,000 for the fiscal year ended
August 31, 1998. Total revenue was $5,321,000 for fiscal year 1999, representing
an increase in revenue of $256,000, or 5.1%, compared to total revenue of
$5,065,000 for fiscal year 1998. Rental and other income increased $277,000, or
5.6%, to $5,265,000 from $4,988,000 last year, due to increased rental income
earned pursuant to the terms of the Facilities Lease Agreement. Interest income
decreased $21,000, or 27.3%, to $56,000 for the year ended August 31, 1999,
compared to $77,000 for the same period last year, primarily due to a decrease
in cash and cash equivalents throughout most of fiscal year 1999. Total expenses
increased $1,466,000, or 67.9%, to $3,624,000 for the fiscal year ended August
31, 1999, compared to $2,158,000 for the fiscal year ended August 31, 1998. This
increase in expenses is primarily attributable to increased professional fees of
$1,238,000, or 229.3%, due to increased legal, financial and advisory
professionals who were engaged to assist the Company with the proposed agreement
and plan of merger with CSLC, as discussed in Note 1 to the financial
statements, and increased legal fees associated with finalizing the construction
loan facility. General and administrative expenses increased $122,000 to
$344,000, or 55.0%, for the fiscal year ended August 31, 1999, compared to
$222,000 for the same period last year, due to a variety of factors including
increased Director and Officer insurance costs of $87,000; increased printing
costs of $58,000 primarily due to the potential merger transaction with CSLC;
offset by a $58,000 decrease in postage and mailing costs and minor increases
and decreases in other general and administrative costs. Directors' compensation
decreased $28,000, or 25.2%, due to a decrease in the number of Board members.



                                      II-10

<PAGE>

                           ILM II SENIOR LIVING, INC.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)


INFLATION

         The Company completed its eighth full year of operations in fiscal
2000. The effects of inflation and changes in prices on the Company's operating
results to date have not been significant. Inflation in future periods is likely
to cause increases in the Company's expenses, which may be partially offset by
increases in revenues from the Company's investments in the Senior Housing
Facilities. Under the terms of the facilities lease, as discussed further above,
the Company, through its consolidated affiliate, ILM II Holding, earned
additional rental income based on increases in the gross revenues of the related
operating properties beginning in January 1997. Such gross revenues may tend to
rise with inflation since the rental rates on the tenant leases, which are
short-term in nature, can be adjusted to keep pace with inflation as market
conditions allow.


                                      II-11

<PAGE>

                           ILM II SENIOR LIVING, INC.


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)


FORWARD-LOOKING INFORMATION

         CERTAIN STATEMENTS INCLUDED IN THIS ANNUAL REPORT ON FORM 10-K ("ANNUAL
REPORT") CONSTITUTE "FORWARD-LOOKING STATEMENTS" INTENDED TO QUALIFY FOR THE
SAFE HARBORS FROM LIABILITY ESTABLISHED BY SECTION 27A OF THE SECURITIES ACT OF
1933, AS AMENDED (THE "SECURITIES ACT"), AND SECTION 21E OF THE SECURITIES ACT
OF 1934, AS AMENDED (THE "EXCHANGE ACT"). THESE FORWARD-LOOKING STATEMENTS
GENERALLY CAN BE IDENTIFIED AS SUCH BECAUSE THE CONTEXT OF THE STATEMENT WILL
INCLUDE WORDS SUCH AS "BELIEVES," "COULD," "MAY," "SHOULD," "ENABLE," "LIKELY,"
"PROSPECTS," "SEEK," "PREDICTS," "POSSIBLE," "FORECASTS," "PROJECTS,"
"ANTICIPATES," "EXPECTS" AND WORDS OF ANALOGOUS IMPORT AND CORRELATIVE
EXPRESSIONS THEREOF, AS WELL AS STATEMENTS PRECEDED OR OTHERWISE QUALIFIED BY:
"THERE CAN BE NO ASSURANCE" OR "NO ASSURANCE CAN BE GIVEN." SIMILARLY,
STATEMENTS THAT DESCRIBE THE COMPANY'S FUTURE PLANS, OBJECTIVES, STRATEGIES OR
GOALS ALSO ARE FORWARD-LOOKING STATEMENTS. SUCH STATEMENTS MAY ADDRESS FUTURE
EVENTS AND CONDITIONS CONCERNING, AMONG OTHER THINGS, THE COMPANY'S CASH FLOWS,
RESULTS OF OPERATIONS AND FINANCIAL CONDITION; THE CONSUMMATION OF ACQUISITION
AND FINANCING TRANSACTIONS AND THE EFFECT THEREOF ON THE COMPANY'S BUSINESS,
ANTICIPATED CAPITAL EXPENDITURES, PROPOSED OPERATING BUDGETS AND ACCOUNTING
RESERVES; LITIGATION; PROPERTY EXPANSION AND DEVELOPMENT PROGRAMS OR PLANS;
REGULATORY MATTERS; AND THE COMPANY'S PLANS, GOALS, STRATEGIES AND OBJECTIVES
FOR FUTURE OPERATIONS AND PERFORMANCE. ANY SUCH FORWARD-LOOKING STATEMENTS ARE
SUBJECT TO VARIOUS RISKS AND UNCERTAINTIES THAT COULD CAUSE ACTUAL RESULTS TO
DIFFER MATERIALLY FROM THOSE EXPRESSED OR IMPLIED IN SUCH FORWARD-LOOKING
STATEMENTS. SUCH FORWARD-LOOKING STATEMENTS ARE SUBJECT TO A NUMBER OF
ASSUMPTIONS REGARDING, AMONG OTHER THINGS, GENERAL ECONOMIC, COMPETITIVE AND
MARKET CONDITIONS. SUCH ASSUMPTIONS NECESSARILY ARE BASED ON FACTS AND
CONDITIONS AS THEY EXIST AT THE TIME SUCH STATEMENTS ARE MADE, THE PREDICTION OR
ASSESSMENT OF WHICH MAY BE DIFFICULT OR IMPOSSIBLE AND, IN ANY CASE, BEYOND THE
COMPANY'S CONTROL. FURTHER, THE COMPANY'S BUSINESS IS SUBJECT TO A NUMBER OF
RISKS THAT MAY AFFECT ANY SUCH FORWARD-LOOKING STATEMENTS AND ALSO COULD CAUSE
ACTUAL RESULTS OF THE COMPANY TO DIFFER MATERIALLY FROM THOSE PROJECTED OR
IMPLIED BY SUCH FORWARD-LOOKING STATEMENTS. ALL FORWARD-LOOKING STATEMENTS
CONTAINED IN THIS ANNUAL REPORT ARE EXPRESSLY QUALIFIED IN THEIR ENTIRETY BY THE
CAUTIONARY STATEMENTS IN THIS PARAGRAPH. MOREOVER, THE COMPANY DOES NOT INTEND
TO UPDATE OR REVISE ANY FORWARD-LOOKING STATEMENTS TO REFLECT ANY CHANGES IN
GENERAL ECONOMIC, COMPETITIVE OR MARKET CONDITIONS AND DEVELOPMENTS BEYOND ITS
CONTROL.

         READERS OF THIS ANNUAL REPORT ARE CAUTIONED NOT TO PLACE UNDUE RELIANCE
ON ANY OF THE FORWARD-LOOKING STATEMENTS SET FORTH HEREIN AND THE COMPANY MAKES
ABSOLUTELY NO PROMISES, GUARANTEES, REPRESENTATIONS OR WARRANTIES AS TO THE
ACCURACY THEREOF.


ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

         The consolidated financial statements and supplementary data are
included under Item 14 of this annual report.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE


         None.



                                      II-12

<PAGE>

                           ILM II SENIOR LIVING, INC.

                                    PART III


ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

         There are currently three Directors of the Company. The Directors are
subject to removal by the vote of the holders of a majority of the outstanding
shares. The directors are responsible for the general policies of the Company,
but they are not required to personally conduct the business of the Company in
their capacities as Directors.

         (a) and (b) The names and ages of the Directors and Executive Officers
                     of the Company during fiscal 1999 are as follows:

<TABLE>
<CAPTION>
         NAME                             OFFICE                                   AGE             DATES OF OFFICE
         ----                             ------                                   ---             ---------------
<S>                                       <C>                                     <C>              <C>
         J. William Sharman, Jr.          President and Director                  60               6/9/90** - present
         Jeffry R. Dwyer                  Secretary and Director                  54               6/9/90*   - present
         Carl J. Schramm                  Director                                54               12/5/96   - present
</TABLE>

         *        The date of incorporation of the Company.
         **       The date of incorporation of the Company as Director; July 28,
                  1998 as President.

         (c)      There is no family relationship among any of the Directors or
                  Officers. All of the Directors and Officers of the Company
                  have been elected to serve until the Company's next annual
                  meeting.

         (d)      The business experience of each of the Directors and Executive
                  Officers of the Company is as follows:

         J. WILLIAM SHARMAN, JR. has served as a Director of the Company since
its inception in 1990 and and was appointed President, succeeding Mr. Cohen, on
July 28, 1998. Mr. Sharman is the Chairman of the Board and Chief Executive
Officer of Lancaster Hotels and Resorts, Inc., a hotel management company. Mr.
Sharman served for ten years as Chairman of the Board and President of The
Lancaster Group, Inc., a real estate development firm based in Houston, Texas,
which is the predecessor of Lancaster Hotel Management, L.C. and Bayou Equities,
Inc. Mr. Sharman serves as a Director of Small Luxury Hotels, Ltd. of the United
Kingdom, an international hotel marketing and reservations firm, and also serves
on the Board of Trustees of St. Edwards University in Austin, Texas. Mr. Sharman
also presently serves as a Director of Lease I and Lease II. He has a Bachelor
of Science degree from the University of Notre Dame.


         JEFFRY R. DWYER has served as Secretary and a Director of the Company
since its inception in 1990. Mr. Dwyer has been a shareholder of the law firm of
Greenberg Traurig since June 1997. In May 1997, Greenberg Traurig began acting
as Counsel to the Company and its affiliates. From 1993 to 1997, Mr. Dwyer was a
partner with the law firm of Akin, Gump, Strauss, Hauer & Feld in the District
of Columbia. Prior to joining Akin, Gump, Strauss, Hauer & Feld, Mr. Dwyer was a
partner with the law firm of Morrison & Foerster from 1989 to 1993. Mr. Dwyer
also presently serves as President, Secretary and Director of Lease I and Lease
II. Mr. Dwyer has written several law review articles and a major treatise on
real estate financing and has taught Real Estate Planning as an Adjunct
Professor at the Georgetown University Law Center. Mr. Dwyer graduated from
Georgetown University and received his law degree from the Georgetown University
Law Center.


                                      III-1

<PAGE>

                           ILM II SENIOR LIVING, INC.


ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT (CONTINUED)

         CARL J. SCHRAMM was appointed to fill a newly created seat on the
Company's Board of Directors as of December 5, 1996. Mr. Schramm is President of
Greenspring Advisors, Inc., a consulting and investment advisory firm serving
clients in the managed care, health insurance and health information industries.
From 1993 to 1995, Mr. Schramm served as Executive Vice President of Fortis,
Inc., a diversified insurance and financial services company. From 1987 through
1992, Mr. Schramm was President of the Health Insurance Association of America,
the national trade association of commercial health underwriters. Mr. Schramm
currently serves on the boards of HCIA, Inc., the Rochdale Insurance Group,
Health Process Management and Post Acute Care, L.L.C. Mr. Schramm holds a Ph.D.
in Economics from the University of Wisconsin and received his J.D. from
Georgetown University.

         (e) None of the current Directors and Officers were involved in legal
         proceedings which are material to an evaluation of his or her ability
         or integrity as a Director or Officer except for the Feldman litigation
         described in Item 3.

         (f) Compliance With Exchange Act Filing Requirements: The Securities
         Exchange Act of 1934 requires the officers and directors of the
         Company, and persons who own more than ten percent of the Company's
         outstanding common stock, to file certain reports of ownership and
         changes in ownership with the Securities and Exchange Commission.
         Officers, directors and ten-percent beneficial holders are required by
         SEC regulations to furnish the Company with copies of all Section 16(a)
         forms they file.

         Based solely on its review of the copies of such forms received by it,
the Company believes that, during the year ended August 31, 2000, there was
compliance with all filing requirements applicable to its officers and directors
and ten-percent beneficial holders.

ITEM 11. EXECUTIVE COMPENSATION

         The Company's Directors each receive an annual fee of $12,000 (except
for J. William Sharman, Jr., President and Director, who receives $27,000) plus
$500 for attending each Board of Directors meeting and reimbursement for
expenses incurred in attending meetings and as a result of other work performed
for the Company. Officers of the Company are not compensated. Jeffry R. Dwyer is
a shareholder of and receives compensation from Greenberg Traurig, which acts as
Counsel to the Company and its affiliates. The former officers of the Company
who were also officers of PaineWebber received compensation from PaineWebber
which indirectly related to services to the Company because the Company was
required to pay certain fees to PaineWebber as described in Item 13. When
PaineWebber resigned as advisor to the Companies, the former officers resigned
effective the same date, therefore no services were provided by such persons
subsequent to June 18, 1997. Lawrence A. Cohen, who was President, Chief
Executive Officer and a Director of the Company until July 28, 1998, also
received compensation from CSLC, an affiliate of Capital, a related party
through July 28, 1998.

ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

         (a)      As of the date hereof, no person of record owns or is known by
                  the Company to own beneficially more than five percent of the
                  outstanding shares of common stock of the Company.

         (b)      The Directors and Officers of the Company do not have any
                  direct or indirect ownership of shares of

         (c)      There exists no arrangement, known to the Company, the
                  operation of which may at a subsequent date result in a change
                  in control of the Company other than the previously discussed
                  Agreement and Plan of Merger with CSLC.


                                      III-2

<PAGE>

                           ILM II SENIOR LIVING, INC.



ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

         Lease II has retained Capital to be the property manager of the Senior
Housing Facilities, and the Company has guaranteed the payment of all fees due
to Capital under the terms of the Management Agreement which commenced on July
29, 1996. Lawrence A. Cohen, who, through July 28, 1998, served as President,
Chief Executive Officer and Director of the Company and a Director of Lease II,
has also served in various management capacities at CSLC, an affiliate of
Capital, since 1996. Mr. Cohen currently serves as Chief Executive of CSLC. As a
result, through July 28, 1998, CSLC was considered a related party. For the
years ended August 31, 2000, 1999, and 1998, Capital earned property management
fees from Lease II of $903,000, $980,000 and $899,000, respectively.

         On February 4, 1997, AHC filed a complaint in the Superior Court of the
State of California against Capital, the new property manager; Lawrence A.
Cohen, who, through July 28, 1998, was President, Chief Executive Officer and
Director of the Company; and others alleging that the defendants intentionally
interfered with AHC's property management agreement (the "California
litigation"). The complaint sought damages of at least $2,000,000. On March 4,
1997, the defendants removed the case to Federal District Court in the Central
District of California. At a Board meeting on February 26, 1997, the Company's
Board of Directors concluded that since all of Mr. Cohen's actions relating to
the California litigation were taken either on behalf of the Company under the
direction of the Board or as a PaineWebber employee, the Company or its
affiliates should indemnify Mr. Cohen with respect to any expenses arising from
the California litigation, subject to any insurance recoveries for those
expenses. Legal fees paid by Lease I and Lease II on behalf of Mr. Cohen totaled
$229,000 as of August 31, 2000. The Company's Board also concluded that, subject
to certain conditions, the Company or its affiliates should pay reasonable legal
fees and expenses incurred by Capital in the California litigation. As August
31, 2000, the amount advanced to Capital by Lease I and Lease II for legal fees
totaled approximately $563,000. No amounts were advanced during fiscal year
2000.

         On September 18, 1997, Lease II entered into an agreement with Capital
Senior Development, Inc., an affiliate of Capital, to manage the development
process for the potential expansion of several of the Senior Housing Facilities.
Capital Senior Development, Inc. will receive a fee equal to 7% of the total
development costs of these expansions if they are pursued. The Company will
reimburse Lease II for all costs related to these potential expansions including
fees to Capital Senior Development, Inc. For the years ended August 31, 2000 and
1999, Capital Senior Development, Inc. earned fees from the Company of $0 and
$15,000, respectively, for managing pre-construction development activities for
potential expansions of the Senior Housing Facilities.

         Jeffry R. Dwyer, Secretary and Director of the Company, is a
shareholder of Greenberg Traurig, Counsel to the Company and its affiliates
since 1997. For the years ended August 31, 2000 and 1999, Greenberg Traurig
earned fees from the Company of $603,000 and $1,168,000, respectively.



                                      III-1

<PAGE>

                           ILM II SENIOR LIVING, INC.


                                     PART IV


ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

         (a) The following documents are filed as part of this report:

                  (1) and (2) Financial Statements and Schedules:

                           The response to this portion of Item 14 is submitted
                           as a separate section of this report. See Index to
                           Financial Statements and Financial Statement
                           Schedules at page F-1.

                  (3)      EXHIBITS:

                           The exhibits listed on the accompanying index to
                           exhibits at page IV-3 are filed as part of this
                           Report.

         (b)      Subsequent to year end, the Company filed a Current Report on
                  Form 8-K dated November 28, 2000, announcing that the Company
                  extended until March 31, 2001, the outside termination date of
                  its previously announced pending merger agreement with CSLC
                  because CSLC was unable to obtain sufficient financing to
                  complete the merger by September 30, 2000. The Company further
                  announced its intention to resume paying quarterly cash
                  dividends to holders of its common stock beginning in January
                  2001 and to distribute proceeds from the sale of the Company's
                  co-tenancy interest in Villa Santa Barbara on December 15,
                  2000.

                  Subsequent to year end, the Company amended and restated its
                  Current Report on Form 8-K originally filed with the
                  Securities and Exchange Commission on August 30, 2000 and
                  dated August 15, 2000, to clarify the transaction costs
                  assumed by CSLC in connection with the previously announced
                  proposed merger between the Company and CSLC and to file pro
                  forma financial statements showing the effect of the sale of
                  the Company's 75% co-tenancy interest in Villa Santa Barbara.

                  The Company filed a Current Report on Form 8-K dated August
                  15, 2000 announcing that it caused ILM II Holding, Inc. to
                  sell its 75% co-tenancy interest in Villa Santa Barbara, its
                  senior living facility located in Santa Barbara, California.
                  In connection with the proposed merger, the Company also
                  announced that it is in the process of seeking alternative
                  financing necessary to close the transaction.

                  The Company filed a Current Report on Form 8-K dated July 26,
                  2000 announcing that the pending merger with CSLC would not be
                  consummated because CSLC did not receive sufficient funds
                  under existing financing commitments to complete the merger at
                  this time.

                  The Company filed a Current Report on Form 8-K dated June 2,
                  2000, reporting (1) the impending termination of the
                  Facilities Lease Agreement between the Company and ILM II
                  Lease Corporation; and (2) the Board of Director's decision
                  regarding the declaration of dividends for the remainder of
                  fiscal year 2000.

                  The Company filed a Current Report on Form 8-K dated April 18,
                  2000, reporting that the Company had entered into the First
                  Amendment to the Amended and Restated Agreement and Plan of
                  Merger dated October 19, 1999, with CSLC.


                                      IV-I

<PAGE>

                           ILM II SENIOR LIVING, INC.




ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(CONTINUED)

         (c) Exhibits:

                  See (a) (3) above.

         (d) Financial Statement Schedules:

                  The response to this portion of Item 14 is submitted as a
                  separate section of this report. See Index to Financial
                  Statements and Financial Statement Schedules at page F-1.



                                      IV-2

<PAGE>

                           ILM II SENIOR LIVING, INC.


                                   SIGNATURES

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


                                    ILM II SENIOR LIVING, INC.



                                    By:  /s/ J. WILLIAM SHARMAN, JR.
                                       --------------------------------
                                         J. William Sharman, Jr.
                                         President and Chief Executive Officer







Dated:  JANUARY 26, 2001
        ------------------------------------
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Company in the
capacity and on the dates indicated.




By:   /s/ J. WILLIAM SHARMAN, JR.              Date:  JANUARY 26, 2001
      ----------------------------------             ---------------------------
      J. William Sharman, Jr.
      Director



By:    /s/ JEFFRY R.  DWYER                    Date:  JANUARY 26, 2001
      ----------------------------------             ---------------------------
      Jeffry R. Dwyer
      Director



By:   /s/ CARL J. SCHRAMM                      Date:  JANUARY 26, 2001
      ----------------------------------             ---------------------------
      Carl J. Schramm
      Director

                                      IV-3
<PAGE>

                           ILM II SENIOR LIVING, INC.

                           ANNUAL REPORT ON FORM 10-K
                                  ITEM 14(a)(3)
                           ILM II SENIOR LIVING, INC.

                                INDEX TO EXHIBITS


<TABLE>
<CAPTION>

                                                                           PAGE NUMBER IN THE REPORT OR
EXHIBIT NO.                   DESCRIPTION OF DOCUMENT                      OTHER REFERENCE
------------------            -----------------------------------------    --------------------------------------
<C>                           <C>                                          <C>
(3) and (4)                   Prospectus of the Registrant dated           Filed with the Commission pursuant to
                              August 8, 1990, as supplemented, with        Rule 424(c) and incorporated herein
                              particular reference to the Restated         by reference.
                              Certificate and Agreement of Limited
                              Partnership.

(10)                          Material contracts previously filed as       Filed with the Commission pursuant to
                              exhibits to registration statements and      Section 13 or 15(d) of the Securities
                              amendments thereto of the registrant         Exchange Act of 1934 and incorporated
                              together with all such contracts filed       herein by reference.
                              as exhibits of previously filed Forms
                              8-K and Forms 10-K are hereby
                              incorporated herein by reference.

                              Contracts regarding retention by ILM II      Filed as Exhibits 1 and 2 to the
                              Lease Corporation of Capital Senior          Current Report on Form 8-K dated July
                              Management 2, Inc., as property manager.     18, 1996 and incorporated  herein by
                                                                           reference.

(13)                          Annual Reports to Stockholders               No Annual Report for the year ended
                                                                           August 31, 2000 has been sent to the
                                                                           Stockholders. An Annual Report will
                                                                           be sent to the Stockholders subsequent
                                                                           to this filing.

</TABLE>


                                      IV-4
<PAGE>

                           ILM II SENIOR LIVING, INC.


                           ANNUAL REPORT ON FORM 10-K
                         ITEM 14(a)(1) AND (2) AND 14(d)

                           ILM II SENIOR LIVING, INC.

         INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES

<TABLE>
<CAPTION>
                                                                                                  REFERENCE
<S>                                                                                                <C>
ILM II SENIOR LIVING, INC.:
     Report of Independent Auditors                                                                  F-2

     Consolidated Balance Sheets as of August 31, 2000 and 1999                                      F-3

     Consolidated Statements of Income for the years ended August 31, 2000,
       1999 and 1998                                                                                 F-4

     Consolidated Statements of Changes in Shareholders' Equity for the years ended
       August 31, 2000, 1999 and 1998                                                                F-5

     Consolidated Statements of Cash Flows for the years ended August 31, 2000,
       1999 and 1998                                                                                 F-6

     Notes to Consolidated Financial Statements                                                      F-7

SCHEDULE:

     Schedule III - Real Estate and Accumulated Depreciation                                        F-21
</TABLE>

         Other schedules have been omitted since the required information is not
present or not present in amounts sufficient to require submission of the
schedule, or because the information required is included in the consolidated
financial statements, including the notes thereto.


                                      F-1
<PAGE>



                REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS

The Shareholders of
ILM II Senior Living, Inc.

         We have audited the accompanying consolidated balance sheets of ILM II
Senior Living, Inc. and subsidiary, as of August 31, 2000 and 1999, and the
related consolidated statements of income, shareholders' equity, and cash flows
for each of the three years in the period ended August 31, 2000. Our audits also
included the financial statement schedule listed in the Index at Item 14(a).
These financial statements and schedule are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements and schedule based on our audits.

         We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.

         In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
ILM II Senior Living, Inc. and subsidiary, at August 31, 2000, and 1999, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended August 31, 2000, in conformity with accounting
principles generally accepted in the United States. Also, in our opinion, the
related financial statement schedule, when considered in relation to the basic
financial statements taken as a whole, presents fairly in all material respects
the information set forth therein.




                                                   ERNST & YOUNG LLP



Dallas, Texas
October 24, 2000
except for Notes 1 and 7, as to which the dates are
November 28, 2000, and December 15, 2000, respectively



                                      F-2
<PAGE>

                           ILM II SENIOR LIVING, INC.



                           CONSOLIDATED BALANCE SHEETS
                            August 31, 2000 and 1999
                  (Dollars in thousands, except per share data)

<TABLE>
<CAPTION>
                                                      ASSETS

                                                                                         2000                    1999
                                                                                      ------------           -----------
<S>                                                                                   <C>                    <C>
Operating investment properties, at cost:
   Land                                                                               $  4,522               $  5,664
   Building and improvements                                                            24,190                 27,957
   Furniture, fixtures and equipment                                                     3,856                  3,815
                                                                                      ---------              ---------
                                                                                        32,568                 37,436
   Less: accumulated depreciation                                                       (8,813)                (8,834)
                                                                                      ---------              ---------
                                                                                        23,755                 28,602

Mortgage placement fees                                                                  1,247                  1,425
Less:  accumulated amortization                                                         (1,106)                (1,108)
                                                                                      ---------              ---------
                                                                                           141                    317

Loan origination fees                                                                      144                    144
Less:  accumulated amortization                                                            (84)                   (42)
                                                                                      ---------              ---------
                                                                                            60                    102

Cash and cash equivalents                                                               11,258                  1,913
Accounts receivable - related party                                                        376                    337
Prepaid expenses and other assets                                                           15                     68
Deferred rent receivable                                                                     6                     37
                                                                                      ---------              ---------
                                                                                      $ 35,611               $ 31,376
                                                                                      =========              =========

                                       LIABILITIES AND SHAREHOLDERS' EQUITY

Accounts payable and accrued expenses                                                 $    121               $    219
Accounts payable - related party                                                            40                    527
Construction loan payable                                                                  570                  1,165
Preferred shareholders' minority interest in consolidated subsidiary                       143                    134
                                                                                      ----------            ----------
               Total liabilities                                                           874                  2,045

Commitments and contingencies

Shareholders' equity:
   Common stock, $0.01 par value, 12,500,000 shares authorized,
     5,181,236 shares issued and outstanding                                                52                    52
   Additional paid-in capital                                                           44,823                44,823
   Accumulated deficit                                                                 (10,138)              (15,544)
                                                                                      --------              --------
         Total shareholders' equity                                                     34,737                29,331
                                                                                      --------              --------
                                                                                      $ 35,611              $ 31,376
                                                                                      ========              ========
</TABLE>

                             See accompanying notes.


                                      F-3
<PAGE>

                           ILM II SENIOR LIVING, INC.

                        CONSOLIDATED STATEMENTS OF INCOME
               For the years ended August 31, 2000, 1999, and 1998
                  (Dollars in thousands, except per share data)
<TABLE>
<CAPTION>
                                                                        2000              1999                 1998
                                                                      ---------         ---------           ---------
<S>                                                                   <C>               <C>                 <C>
REVENUES:
   Rental and other income                                               $5,401            $5,265              $4,988
   Interest income                                                           57                56                  77
                                                                      ---------         ---------           ---------
                                                                          5,458             5,321               5,065

EXPENSES:
   Depreciation expense                                                   1,190             1,235               1,142
   Amortization expense                                                     184               184                 143
   General and administrative                                               294               344                 222
   Professional fees                                                      1,137             1,778                 540
   Director compensation                                                    104                83                 111
                                                                      ---------         ---------           ---------
                                                                          2,909             3,624               2,158
                                                                      ---------         ---------           ---------

OPERATING INCOME                                                          2,549             1,697               2,907

Gain on sale of Villa Santa Barbara                                       6,160                 -                   -
                                                                      ---------         ---------           ---------


NET INCOME                                                               $8,709            $1,697              $2,907
                                                                      =========         =========           =========


Earnings per share of common stock                                       $ 1.68            $ 0.32               $0.56
                                                                      =========         =========           =========

Cash dividends paid per share of common stock                            $ 0.64            $ 0.85               $0.73
                                                                      =========         =========           =========
</TABLE>


         The above earnings and cash dividends paid per share of common stock
are based upon the 5,181,236 shares outstanding during the year.






                             See accompanying notes.


                                      F-4
<PAGE>

                           ILM II SENIOR LIVING, INC.


           CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
               For the years ended August 31, 2000, 1999 and 1998
                  (Dollars in thousands, except per share data)


<TABLE>
<CAPTION>
                                              COMMON STOCK
                                             $.01 PAR VALUE                ADDITIONAL
                                             --------------                 PAID-IN           ACCUMULATED
                                        SHARES            AMOUNT            CAPITAL             DEFICIT              TOTAL
                                        ------            ------            -------             -------              -----
<S>                                  <C>                  <C>               <C>                <C>                 <C>
SHAREHOLDERS' EQUITY AT
 AUGUST 31, 1997                        5,181,236               $52            $44,823            $(11,988)           $32,887

Cash dividends paid                             -                 -                  -              (3,756)           (3,756)

Net income                                      -                 -                  -                2,907             2,907
                                     --------------       -----------       ------------        -------------      -------------

SHAREHOLDERS' EQUITY AT
AUGUST 31, 1998                         5,181,236                52             44,823             (12,837)            32,038

Cash dividends paid                             -                 -                  -              (4,404)           (4,404)

Net income                                      -                 -                  -               1,697             1,697
                                     --------------       -----------       ------------        -------------      -------------

SHAREHOLDERS' EQUITY AT
AUGUST 31, 1999                         5,181,236                52             44,823             (15,544)            29,331

Cash dividends paid                             -                 -                  -              (3,303)           (3,303)

Net income                                      -                 -                  -               8,709             8,709
                                     --------------       -----------       ------------        -------------      -------------

SHAREHOLDERS' EQUITY AT
AUGUST 31, 2000                         5,181,236               $52            $44,823            $(10,138)           $34,737
                                     ==============       ===========       ============        =============      ============
</TABLE>





                             See accompanying notes.

                                      F-5
<PAGE>

                           ILM II SENIOR LIVING, INC.

                      CONSOLIDATED STATEMENTS OF CASH FLOWS
               For the years ended August 31, 2000, 1999, and 1998
                                 (In thousands)

<TABLE>
<CAPTION>
                                                                 2000              1999             1998
                                                              ------------      ------------     ------------
<S>                                                           <C>               <C>              <C>
Cash flows from operating activities:
   Net income                                                    $ 8,709           $ 1,697          $ 2,907
   Adjustments to reconcile net income to net cash provided
     by operating activities:
       Gain on Sale of Villa Santa Barbara                        (6,160)                -                -
       Depreciation and amortization                               1,374             1,419            1,285
       Charitable contribution of subsidiary's
         preferred stock and accrued dividends                         9                 9                9
       Changes in assets and liabilities:
         Accounts receivable - related party                         (39)              (64)            (122)
         Prepaid expenses and other assets                            53                86              (77)
         Deferred rent receivable                                     31                32               31
         Accounts payable - related party                           (487)              478             (205)
         Accounts payable and accrued expenses                       (98)               48               73
                                                               ----------         --------       ----------

              Net cash provided by operating activities            3,392             3,705            3,901
                                                                 -------           -------         --------

Cash flows provided by (used in) investing activities:
   Proceeds from sale of Santa Barbara                            10,144                 -                 -
   Additions to operating investment properties                     (288)             (377)            (538)
                                                                ---------         ---------        ---------
              Net cash provided by (used in) investing
                activities                                         9,856              (377)            (538)
                                                               ---------          ---------        ---------

Cash flows used in financing activities:
   Loan origination fees paid                                          -               (72)             (72)
   (Paydown of) proceeds from construction loan facility            (600)            1,165                -
   Cash dividends paid to shareholders                            (3,303)           (4,404)          (3,756)
                                                                 --------          --------         --------
              Net cash used in financing activities               (3,903)           (3,311)          (3,828)
                                                                 --------          --------         --------

Net increase (decrease) in cash and cash equivalents               9,345                17             (465)

Cash and cash equivalents, beginning of year                       1,913             1,896            2,361
                                                                 -------           -------         --------

Cash and cash equivalents, end of year                          $ 11,258           $ 1,913          $ 1,896
                                                                ========           =======          =======

Cash paid for state income taxes                               $      17         $      42       $        4
                                                               =========         =========       ==========

Cash paid for interest                                         $      60         $      11       $        -
                                                               =========         =========       ==========
</TABLE>

                             See accompanying notes.



                                      F-6
<PAGE>

                           ILM II SENIOR LIVING, INC.
                          Notes to Financial Statements

1. NATURE OF OPERATIONS, RESTRUCTURING, AND PROPOSED MERGER

         ILM II Senior Living, Inc. (the "Company), formerly PaineWebber
Independent Living Mortgage, Inc. II, was organized as a corporation on February
5, 1990, under the laws of the State of Virginia. On September 12, 1990, the
Company commenced a public offering of up to 10,000,000 shares of its common
stock at $10 per share, pursuant to the final prospectus, as amended,
incorporated into a Registration Statement filed on Form S-11 under the
Securities Act of 1933 (Registration Statement No. 33-33857), (the
"Prospectus"). The public offering terminated on May 10, 1991 with a total of
5,181,236 shares issued. The Company received capital contributions of
$51,812,356, of which $200,000 represented the sale of 20,000 shares to an
affiliate at that time, PaineWebber Group, Inc. ("PaineWebber"). For discussion
purposes, PaineWebber will refer to PaineWebber Group, Inc. and all affiliates
that provided services to the Company in the past.

         The Company has elected to qualify and be taxed as a Real Estate
Investment Trust ("REIT") under the Internal Revenue Code of 1986, as amended,
for each taxable year of operations (see Note 2).

         The Company originally invested the net proceeds of the initial public
offering in six participating mortgage loans secured by senior housing
facilities ("Senior Housing Facilities") located in five states. All of the
loans made by the Company were originally to Angeles Housing Concepts, Inc.
("AHC"), a company specializing in the development, acquisition and operation of
senior housing facilities and guaranteed by AHC's corporate parent, Angeles
Corporation ("Angeles").

         During the quarter ended February 28, 1993, Angeles announced that it
was experiencing liquidity problems that resulted in the inability to meet its
obligations. Subsequent to such announcements, AHC defaulted on the regularly
scheduled mortgage loan payments due to the Company on March 1, 1993. Subsequent
to March 1993, payments toward the debt service owed on the Company's loans were
limited to the net cash flow of the operating investment properties. On May 3,
1993, Angeles filed for reorganization under a Chapter 11 Federal Bankruptcy
petition filed in the state of California. AHC did not file for reorganization.
The Company retained special counsel and held extensive discussions with AHC
concerning the default status of its loans. During the fourth quarter of fiscal
1993, a non-binding Settlement Agreement between the Company, AHC and Angeles
was reached whereby ownership of the Senior Housing Facilities would be
transferred from AHC to the Company or its designated affiliates. Under the
terms of the Settlement Agreement, the Company would release AHC and Angeles
from certain obligations under the loans. On April 27, 1994, each of the Senior
Housing Facilities owned by AHC and securing the loans was transferred
(collectively, "the Transfers") to newly-created special purpose corporations
affiliated with the Company (collectively, "the Property Companies"). The
Transfers had an effective date of April 1, 1994 and were made pursuant to the
Settlement Agreement entered into on February 17, 1994 ("the Settlement
Agreement") between the Company and AHC which had previously been approved by
the bankruptcy court handling the bankruptcy case of Angeles. All of the capital
stock of each Property Company was held by ILM II Holding, Inc. ("ILM II
Holding"), a Virginia corporation. In August 1995, each of the Property
Companies merged into ILM II Holding which is now a subsidiary of the Company.
As a result, ownership of the Senior Housing Facilities is now held by ILM II
Holding, and the Property Companies no longer exist as separate legal entities.



                                      F-7
<PAGE>

                           ILM II SENIOR LIVING, INC.
                          Notes to Financial Statements




1.   NATURE OF OPERATIONS, RESTRUCTURING, AND PROPOSED MERGER (continued)

         ILM II Holding now holds title to the five remaining Senior Housing
Facilities which comprise the balance of operating investment properties on the
accompanying consolidated balance sheets, subject to certain mortgage loans
payable to the Company. Such mortgage loans and the related interest expense are
eliminated in the consolidation of the financial statements of the Company. The
capital stock of ILM II Holding was originally owned by the Company and
PaineWebber. ILM II Holding had issued 100 shares of Series A Preferred Stock to
the Company in return for a capital contribution in the amount of $495,000 and
had issued 10,000 shares of common stock to PaineWebber in return for a capital
contribution in the amount of $5,000. The common stock represented approximately
99 percent of the voting power and 1 percent of the economic interest in ILM II
Holding, while the preferred stock represented approximately 1 percent of the
voting power and 99 percent of the economic interest in ILM II Holding.

         The Company completed its restructuring plans by converting ILM II
Holding to a REIT for tax purposes. In connection with these plans, on November
21, 1996, the Company requested that PaineWebber sell all of the stock held in
ILM II Holding to the Company for a price equal to the fair market value of the
1% economic interest in ILM II Holding represented by the common stock. On
January 10, 1997, this transfer of the common stock of ILM II Holding was
completed at an agreed upon fair value of $40,000, representing a $35,000
increase in fair value. This increase in fair value is based on the increase in
values of the Senior Housing Facilities which occurred between April 1994 and
January 1996, as supported by independent appraisals.

         With this transfer completed, effective January 23, 1997, ILM II
Holding recapitalized its common stock and preferred stock by replacing the
outstanding shares with 50,000 shares of new common stock and 275 shares of a
new class of nonvoting, 8% cumulative preferred stock issued to the Company
(the "Preferred Stock"). The number of authorized shares of preferred and
common stock in ILM II Holding were also increased as part of the
recapitalization. Following the recapitalization, the Company made charitable
gifts of one share of the Preferred Stock in ILM II Holding to each of 111
charitable organizations so that ILM II Holding would meet the stock
ownership requirements of a REIT as of January 30, 1997. The Preferred Stock
has a liquidation preference of $1,000 per share plus any accrued and unpaid
dividends. Dividends on the Preferred Stock will accrue at a rate of 8% per
annum on the original $1,000 liquidation preference and will be cumulative
from the date of issuance. Since ILM II Holding is not expected to have
sufficient cash flow in the foreseeable future to make the required dividend
payments, it is anticipated that dividends will accrue and be paid at
liquidation. The Company recorded the contribution of the Preferred Stock in
ILM II Holding to the charitable organizations at the amount of the initial
liquidation preference of $111,000. Such amount is included in general and
administrative expense on the accompanying income statement for the year
ended August 31, 1997. Cumulative dividends accrued as of August 31, 2000 and
1999, on the preferred stock in ILM II Holding totaled approximately $32,000
and $23,000, respectively.

         As part of the fiscal 1994 Settlement Agreement with AHC, ILM II
Holding retained AHC as the property manager for all of the Senior Housing
Facilities pursuant to the terms of a management agreement. As discussed further
in Note 5, the management agreement with AHC was terminated in July 1996.
Subsequent to the effective date of the Settlement Agreement with AHC,
management investigated and evaluated the available options for structuring the
ownership of the properties in order to maximize the potential returns to the
existing shareholders while maintaining the Company's qualification as a REIT
under the Internal Revenue Code (see Note 2). As discussed further in Note 4, on
September 12, 1994, the Company formed a new subsidiary, ILM II Lease
Corporation ("Lease II"), for the purpose of operating the Senior Housing
Facilities. On September 1, 1995, after the Company received the required
regulatory approval, the Company distributed all of the shares of capital stock
of Lease II to the holders of record of the Company's common stock. The Senior
Housing Facilities were leased to Lease II effective September 1, 1995 (see Note
4 for a description of the Facilities Lease Agreement). Lease II is a public
company subject to the reporting obligations of the Securities and Exchange
Commission.



                                      F-8
<PAGE>


                           ILM II SENIOR LIVING, INC.
                    Notes to Financial Statements (continued)



1.       NATURE OF OPERATIONS, RESTRUCTURING, AND PROPOSED MERGER (CONTINUED)

         On August 15, 2000, the Company caused ILM II Holding to complete the
sale of its 75% co-tenancy interest in its senior living facility located in
Santa Barbara, California ("Villa Santa Barbara"), to Capital Senior Living
Corporation ("CSLC") for $10,143,750. In consideration for the sale, the Company
received $9,543,750 in cash and CSLC contributed $600,000 toward the Company's
outstanding construction loan debt and assumed certain then current transaction
expenses of the Company in connection with the previously announced proposed
merger contemplated by the Amended and Restated Agreement and Plan of Merger
dated October 19, 1999, as amended on April 18, 2000 (the "Merger Agreement"),
by and among the Company, CSLC and CSLC's wholly-owned acquisition subsidiary.
The remaining 25% co-tenancy interest in Villa Santa Barbara was formerly owned
by ILM Holding, Inc. ("Holding I"), a subsidiary of ILM Senior Living, Inc.
("ILM I") and was transferred to CSLC at the time the merger between ILM I and
CSLC was consummated. A gain on the sale of approximately $6,160,000 has been
recognized in the accompanying consolidated statement of income for the year
ended August 31, 2000. It is anticipated that this gain will result in a
built-in gain tax which would be reduced by available net operating loss
carryforwards from the period when the Company was a so-called "C" Corporation
(prior to the Company's conversion to a Real Estate Investment Trust [REIT] for
1996).

         On February 7, 1999, the Company entered into an agreement and plan of
merger, which was amended and restated on October 19, 1999, with CSLC, the
corporate parent of Capital, and certain affiliates of CSLC. On April 18, 2000,
the Company entered into a First Amendment to the Amended and Restated Agreement
and Plan of Merger dated October 19, 1999. As stated in the April 18th
amendment, if the merger is consummated, the Shareholders of the Company will
receive all-cash merger consideration of approximately $13.04 per share compared
to the previous merger consideration of $14.47 per share. In addition, the
amended agreement requires CSLC to agree to pay the Company increased
termination fees in certain circumstances. Further, the Company required CSLC to
agree to reduce the amount of fees and expenses it would receive upon
termination of the merger in certain circumstances.

         At a special meeting of Shareholders on June 22, 2000, holders of more
than two-thirds of the outstanding shares of the Company's common stock voted in
favor of approval of the proposed Amended and Restated Agreement and Plan of
Merger dated October 19, 1999, as amended on April 18, 2000. Holders of Company
common stock will have no dissenters' rights in the merger.

         The merger was scheduled to be consummated on or prior to September 30,
2000. In July 2000, CSLC reported to the Company that it had not obtained
sufficient financing to complete the merger by September 30, 2000.

         On November 28, 2000, the Company extended until March 31, 2001 the
outside termination date of its pending merger agreement with CSLC and entered
into with CSLC a technical amendment to the merger agreement providing, among
other things, that subject to the ILM II Board's fiduciary duties to
Shareholders, CSLC will have until March 31, 2001 to obtain definitive financing
sufficient for CSLC to complete the transaction.




                                      F-9
<PAGE>


                           ILM II SENIOR LIVING, INC.
                    Notes to Financial Statements (continued)


1.    NATURE OF OPERATIONS, RESTRUCTURING, AND PROPOSED MERGER (CONTINUED)

         In connection with the amendment, CSLC agreed, after March 31, 2001 to
a termination of all of its rights of first and last offer it may have with
respect to the sale by the Company to a third party of its common stock, its
ownership interest in ILM II Holding and/or the sale of the Company's senior
living properties and assets, and to reduce from $1,858,200 to $1,000,000 the
amount of certain termination fees payable by the Company to CSLC under certain
limited circumstances. All other terms of the merger agreement remain in effect.
The terms of the merger agreement require CSLC to pay the Company $1,540,000 if
the merger does not occur on or before March 31, 2001 if the failure to
consummate the transaction is due to CSLC's inability to obtain financing
necessary to close the transaction.

         The pending merger agreement provides for consideration of $13.04 per
share of the Company's outstanding common stock. In view of the sale in August
2000 to CSLC of the Company's interest in the Santa Barbara, California senior
living facility, in December 2000 the Company distributed the net proceeds of
such sale on a pro rata basis in the form of a return of invested capital to
Shareholders of record as of November 1, 2000. The aggregate cash distribution
was approximately $9,800,000 and is equivalent to the payment of approximately
$1.89 per share of the $13.04 per share of merger consideration. The remaining
approximate $11.15 per share would be payable by CSLC to Shareholders of the
Company upon completion of the merger in accordance with the merger agreement.

         There can be no assurance that CSLC will be able to obtain the
requisite financing to complete the merger or, even if obtained, that the merger
otherwise will be consummated.

         In connection with the proposed merger, the Company has agreed to cause
ILM II Holding to cancel and terminate the Facilities Lease Agreement with Lease
II on the date of consummation of the merger. As noted above, the Facilities
Lease Agreement was scheduled to expire on December 31, 2000.

         On November 13, 2000, the Company's Board of Directors voted to extend
the Facilities Lease Agreement on a month-to-month basis beyond its original
expiration date of December 31, 2000. On November 28, 2000, the Facilities Lease
Agreement was extended through the earlier of the date on which the merger of
the Company with CSLC is consummated or March 31, 2001, and on a month-to-month
basis thereafter if the merger is not consummated by that time.

2.    USE OF ESTIMATES AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

         The accompanying consolidated financial statements have been prepared
on the accrual basis of accounting in accordance with generally accepted
accounting principles which requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosures of contingent assets and liabilities as of August 31, 2000 and 1999
and revenues and expenses for each of the three years in the period ended August
31, 2000. Actual results could differ from the estimates and assumptions used.

         The Company's significant accounting policies are summarized as
follows:

A.   BASIS OF PRESENTATION

         The operating cycle in the real estate industry is longer than one year
and the distinction between current and non-current is of little relevance.
Accordingly, the accompanying consolidated balance sheets are presented in an
unclassified format.


                                      F-10
<PAGE>


                           ILM II SENIOR LIVING, INC.
                    Notes to Financial Statements (continued)


2. USE OF ESTIMATES AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)


The accompanying financial statements include the financial statements of the
Company and ILM II Holding. All intercompany balances and transactions have been
eliminated in consolidation.

B.   INCOME TAXES

The Company has elected to qualify and to be taxed as a REIT under the Internal
Revenue Code of 1986, as amended, for each taxable year of operations. As a
REIT, the Company is allowed a deduction for the amount of dividends paid to its
shareholders, thereby effectively subjecting the distributed net taxable income
of the Company to taxation at the shareholder level only, provided it
distributes at least 95% of its taxable income and meets certain other
requirements for qualifying as a real estate investment trust. In connection
with the settlement agreement described in Note 1, the Company, through ILM II
Holding, obtained title to the Senior Housing Facilities securing its mortgage
loan investments. To retain REIT status, the Company must ensure that 75% of its
annual gross income is received from qualified sources. Under the original
investment structure, interest income from the Company's mortgage loans was a
qualified source. The Senior Housing Facilities that are now owned by a
subsidiary of the Company provide residents with more services, such as meals,
activities, assisted living, etc., than are customary for ordinary residential
apartment properties. As a result, a significant portion of the rents paid by
the residents includes income for the increased level of services received by
them. Consequently, the rents paid by the residents likely would not be
qualified rents for REIT qualification purposes if received directly by the
Company. Therefore, if the Company received such rents directly, it could lose
REIT status and be taxed as a regular corporation. After extensive review, the
Board of Directors determined that it would be in the best interests of the
Shareholders for the Company to retain REIT status and facilities lease the
properties to a shareholder-owned operating company. As discussed further in
Note 4, on September 12, 1994 the Company formed a new subsidiary, Lease II, for
the purpose of operating the Senior Housing Facilities. The Senior Housing
Facilities were leased to Lease II effective September 1, 1995 (see Note 4 for a
description of the Facilities Lease Agreement).

The assumption of ownership of the Senior Housing Facilities through ILM II
Holding, which was organized as a so-called "C" corporation for tax purposes,
has resulted in a possible future tax liability which would be payable upon the
ultimate sale of the Senior Housing Facilities (the "built-in gain tax"). The
amount of such tax would be calculated based on the lesser of the total net gain
realized from the sale transaction or the portion of the net gain realized upon
a final sale which is attributable to the period during which the Senior Housing
Facilities were held by a C corporation. The Company completed its restructuring
plans by converting ILM II Holding to a REIT for tax purposes effective for
calendar year 1996.

Any future appreciation in the value of the Senior Housing Facilities subsequent
to the conversion of ILM II Holding to a REIT would not be subject to the
built-in gain tax. The built-in gain tax would most likely not be incurred if
the properties were to be held for a period of at least 10 years from the date
of the conversion of ILM II Holding to a REIT. However, since the end of the
Company's original anticipated holding period as defined in the Articles of
Incorporation is December 31, 2001, the Senior Housing Facilities might not be
held for an additional 10 years. Based on management's estimate of the increase
in the values of the Senior Housing Facilities which occurred between April 1994
and January 1996, as supported by independent appraisals, a sale of the Senior
Housing Facilities within ten years of the the date of the conversion of ILM II
Holding to a REIT could result in a built-in gain tax of as much as $2.5
million, which could be reduced by approximately $270,000, using available net
operating loss carryforwards of ILM II Holding of approximately $780,000 that
were incurred prior to its conversion to REIT status. ILM II Holding also has
net operating losses that were incurred after its conversion to REIT status of
approximately $4.2 million. The sale of the Company's interest in Villa Santa
Barbara resulted in the recognition of a built-in gain of approximately
$600,000, which was offset by pre-conversion net operating losses. As of August
31, 2000, the potential built-in gain tax relating to the Senior Housing
Facilities is as much as $2.3 million, which could be further reduced by
approximately


                                      F-11
<PAGE>


                           ILM II SENIOR LIVING, INC.
                    Notes to Financial Statements (continued)



2. USE OF ESTIMATES AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)


$50,000, using the remaining available pre-conversion net operating loss
carryforwards of ILM II Holding of approximately $150,000. To avoid this
built-in gain tax, the Directors are prepared at the appropriate time to
recommend to the Shareholders an amendment to the Articles of Incorporation to
extend the Company's scheduled liquidation date. Based upon advice from the
Company's financial advisors, commencing in 1996, the Company has acted as
though it had made an election in its 1996 tax return to allow the Company to
avoid a corporate level tax upon its conversion from a C-Corporation to a Real
Estate Investment Trust. Because proof of a formal election has not been
obtained, the Company is pursuing administrative relief with the Internal
Revenue Service to ensure the availability of the benefits of this election.
Although the Company believes that it had a legitimate basis to make this
election, in part, based upon the advice of its financial advisors, ultimate
resolution of this matter is at the discretion of the Internal Revenue Service.
If unsuccessful, the Company could be liable for up to $2.7 million of
additional penalties and interest.

The Company's consolidated subsidiary, ILM II Holding, has incurred losses for
tax purposes since inception. Neither the Company nor ILM II Holding is likely
to be able to use these losses to offset future tax liabilities other than the
built-in gain tax above. Accordingly, no income tax benefit is reflected in
these consolidated financial statements.

The Company reports on a calendar year basis for income tax purposes. All
distributions during calendar years 2000, 1999 and 1998 were ordinary taxable
dividends except that 14.01% of distributions for 1999 represented a return of
capital.

C.   CASH AND CASH EQUIVALENTS

For purposes of reporting cash flows, cash and cash equivalents include all
highly liquid investments with original maturities of 90 days or less.

D.   OPERATING INVESTMENT PROPERTIES

Operating investment properties are carried at the lower of cost, reduced by
accumulated depreciation, or net realizable value. The net realizable value of a
property held for long-term investment purposes is measured by the
recoverability of the owner's investment through expected future cash flows on
an undiscounted basis, which may exceed the property's current market value. The
net realizable value of a property held for sale approximates its current market
value, as determined on a discounted basis. None of the operating investment
properties were held for sale as of August 31, 2000 or 1999. Depreciation
expense is provided on a straight-line basis using an estimated useful life of
40 years for the buildings and improvements and five years for the furniture,
fixtures and equipment.

The Company reviews the carrying value of a long-lived asset if facts and
circumstances suggest that it may be impaired or that the amortization period
may need to be changed. The Company considers external factors relating to the
long-lived asset, including occupancy trends, local market developments, changes
in payments, and other publicly available information. If these external factors
indicate the long-lived asset will not be recoverable, based upon undiscounted
cash flows of the long-lived asset over its remaining life, the carrying value
of the long-lived asset will be reduced by the estimated shortfall of discounted
cash flows. The Company does not believe there are any indicators that would
require an adjustment to the carrying value of its long-lived assets or their
remaining useful lives as of August 31, 2000.




                                      F-12
<PAGE>


                           ILM II SENIOR LIVING, INC.
                    Notes to Financial Statements (continued)



2. USE OF ESTIMATES AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

Mortgage placement fees at August 31, 2000 of $1,247,000 ($1,425,000 at August
31, 1999) were incurred by the Company and these fees are included in the
accompanying consolidated balance sheets. The $178,000 reduction in mortgage
placement fees at August 31, 2000 is due to the sale of Villa Santa Barbara on
August 15, 2000, as more fully explained in Footnote 1. Accumulated amortization
of mortgage placement fees at August 31, 2000 and 1999 was $1,106,000 and
$1,108,000, respectively. At August 31, 2000 and 1999, loan origination fees of
$144,000 relating to the construction loan facility (see Note 6) are included on
the accompanying consolidated balance sheet. These fees are being amortized to
expense on a straight-line basis over the term of the loan. Accumulated
amortization of loan origination fees at August 31, 2000 and 1999 was $84,000
and $42,000, respectively. Capitalized interest at August 31, 2000 and 1999 was
$79,000 and $17,000, respectively.

E. RENTAL REVENUES

In fiscal years 2000, 1999 and 1998, rental revenues consist of payments due
from Lease II under the terms of the Facilities Lease Agreement described in
Note 4. Base rental income under the facilities lease is recognized on a
straight-line basis over the term of the lease. Deferred rent receivable on the
balance sheet as of August 31, 2000 and 1999 represents the difference between
rental income on a straight-line basis and rental income received under the
terms of the facilities lease.

F. FAIR VALUE DISCLOSURES

FASB Statement No. 107, "Disclosures about Fair Value of Financial Instruments"
("SFAS 107"), requires disclosure of fair value information about financial
instruments, whether or not recognized in the balance sheet, for which it is
practicable to estimate that value. In cases where quoted market prices are not
available, fair values are based on estimates using present value or other
valuation techniques. SFAS 107 excludes certain financial instruments and all
nonfinancial instruments from its disclosure requirements. Accordingly, the
aggregate fair value amounts presented do not represent the underlying value of
the Company.

The following methods and assumptions were used by the Company in estimating its
fair value disclosures for financial instruments:

CASH AND CASH EQUIVALENTS: The carrying amount reported on the balance sheet for
cash and cash equivalents approximates its fair value due to the short-term
maturities of such instruments.

ACCOUNTS RECEIVABLE - RELATED PARTY: The carrying amount reported on the balance
sheet for accounts receivable - related party approximates its fair value due to
the short-term maturity of such instrument.


                                      F-13
<PAGE>


                           ILM II SENIOR LIVING, INC.
                    Notes to Financial Statements (continued)


3. RELATED PARTY TRANSACTIONS

Lease II has retained Capital to be the property manager of the Senior Housing
Facilities and the Company has guaranteed the payment of all fees due to Capital
pursuant to a Management Agreement which commenced on July 29, 1996. Lawrence A.
Cohen, who, through July 28, 1998, served as President, Chief Executive Officer
and Director of the Company and a Director of Lease II, has also served in
various management capacities at CSLC, an affiliate of Capital, since 1996. Mr.
Cohen currently serves as Chief Executive Officer of CSLC. As a result, through
July 28, 1998, CSLC was considered a related party. For the years ended August
31, 2000, 1999, and 1998, Capital earned property management fees from Lease II
of $903,000, $980,000 and $899,000, respectively.

On February 4, 1997, AHC filed a complaint in the Superior Court of the State of
California against Capital, the new property manager; Lawrence A. Cohen, who,
through July 28, 1998, was President, Chief Executive Officer, and Director of
the Company; and others alleging that the defendants intentionally interfered
with AHC's property management agreement (the "California litigation"). The
complaint sought damages of at least $2,000,000. On March 4, 1997, the
defendants removed the case to Federal District Court in the Central District of
California. At a Board meeting on February 26, 1997, the Company's Board of
Directors concluded that since all of Mr. Cohen's actions relating to the
California litigation were taken either on behalf of the Company under the
direction of the Board or as a PaineWebber employee, the Company or its
affiliates should indemnify Mr. Cohen with respect to any expenses arising from
the California litigation, subject to any insurance recoveries for those
expenses. Legal fees paid by Lease I and Lease II on behalf of Mr. Cohen totaled
$229,000 as of August 31, 2000. The Company's Board also concluded that, subject
to certain conditions, the Company or its affiliates should pay reasonable legal
fees and expenses incurred by Capital in the California litigation. As of August
31, 2000 the amount advanced to Capital by Lease I and Lease II for legal fees
totaled approximately $563,000. No amounts were advanced during fiscal year
2000.

On September 18, 1997, Lease II entered into an agreement with Capital Senior
Development, Inc., an affiliate of Capital, to manage the development process
for the potential expansion of several of the Senior Housing Facilities. Capital
Senior Development, Inc. will receive a fee equal to 7% of the total development
costs of these expansions if they are pursued. The Company will reimburse Lease
II for all costs related to these potential expansions including fees to Capital
Senior Development, Inc. For the years ended August 31, 2000 and 1999, Capital
Senior Development, Inc. earned fees from the Company of $0 and $15,000,
respectively, for managing pre-construction development activities for potential
expansions of the Senior Housing Facilities.

Jeffry R. Dwyer, Secretary and Director of the Company, is a shareholder of
Greenberg Traurig, Counsel to the Company and its affiliates since 1997. For the
years ended August 31, 2000 and 1999, Greenberg Traurig received fees from the
Company of $603,000 and $1,168,000, respectively.

ACCOUNTS RECEIVABLE - RELATED PARTY at August 31, 2000 and 1999 represents
amounts due from an affiliated company, Lease II, for variable rent. ACCOUNTS
PAYABLE - RELATED PARTY at August 31, 2000, includes $40,000 in expense
reimbursements payable to Lease II. ACCOUNTS PAYABLE - RELATED PARTY at August
31, 1999, includes $50,000 of expense reimbursements payable to Lease II;
$194,000 in variable rent received from Lease II in advance; and $283,000 in
unbilled legal fees due to Greenberg Traurig, counsel to the Company and its
affiliates and a related party, as described above.


                                      F-14
<PAGE>


                           ILM II SENIOR LIVING, INC.
                    Notes to Financial Statements (continued)


4. OPERATING INVESTMENT PROPERTIES SUBJECT TO FACILITIES LEASE

         As of August 31, 2000, the Company, through its consolidated affiliate,
owned five Senior Housing Facilities (six Senior Housing Facilities at August
31, 1999) due to the sale of Villa Santa Barbara on August 15, 2000 (see Note
1). The name, location and size of the properties and the date that the Company
made its initial investment in such assets are as set forth below:

<TABLE>
<CAPTION>
                                                                                           YEAR
                                                             RENTABLE      RESIDENT      FACILITY   DATE OF
     NAME                         LOCATION                  UNITS (2)    CAPACITIES(2)     BUILT    INVESTMENT (1)
     ----                         --------                  ---------    -------------     -----    --------------
<S>                               <C>                       <C>          <C>             <C>        <C>
     The Palms                    Fort Myers, FL               205            255          1988         7/18/90

     Crown Villa                  Omaha, NE                     73            73           1992         4/25/91

     Overland Park Place          Overland Park, KS            141            153          1984          4/9/92

     Rio Las Palmas               Stockton, CA                 164            190          1988         5/14/92

     The Villa at Riverwood       St. Louis County, MO         120            140          1986         5/29/92
</TABLE>


(1)      Represents the date of the Company's original mortgage loan to Angeles
         Housing Concepts, Inc. (see Note 1).

(2)      Rentable units represent the number of apartment units and is a measure
         commonly used in the real estate industry. Resident capacity equals the
         number of bedrooms contained within the apartment units and corresponds
         to measures commonly used in the healthcare industry.

         The cost basis of the operating investment properties reflects amounts
funded under the Company's participating mortgage loans less certain guaranty
payments received from AHC in excess of the net cash flow of the Senior Housing
Facilities under the terms of the Exclusivity Agreement with the Company. The
transfer of ownership of the Senior Housing Facilities from AHC in fiscal 1994
resulted in no gain or loss recognition by the Company for financial reporting
purposes. In accordance with generally accepted accounting principles, the
Company had always accounted for its investments in acquisition and construction
loans under the equity method, as if such investments were equity interests in a
joint venture. Accordingly, the carrying values of such investments were reduced
from inception by non-cash depreciation charges and by payments from AHC, prior
to the default in fiscal 1993, in excess of the net cash flow generated by the
Senior Housing Facilities received pursuant to the guaranty agreement between
the Company and AHC. As a result of this accounting treatment, the carrying
values of the Company's investments had been reduced below management's estimate
of the fair market value of the Senior Housing Facilities as of the effective
date of the transfer of ownership. For federal income tax purposes, the
investments had always been carried at the contractually stated principal
balances of the participating mortgage loans. For tax purposes only, a loss was
recognized by the Company in 1994 in the amount by which the stated principal
balances of the loans were reduced as of the date of the transfer of ownership.

                                      F-15
<PAGE>


                           ILM II SENIOR LIVING, INC.
                    Notes to Financial Statements (continued)



4.  OPERATING INVESTMENT PROPERTIES SUBJECT TO FACILITIES LEASE (CONTINUED)

         As discussed in Note 1, effective April 1, 1994 each Property Company
acquired the respective operating property subject to, and assumed the
obligations, under the mortgage loan payable to the Company, pursuant to the
Settlement Agreement with AHC. The principal balance on each loan was modified
to reflect the estimated fair value of the related operating property as of the
date of the transfer of ownership. The modified loans require interest-only
payments on a monthly basis at a rate of 7% from April 1, 1994 through December
1, 1994, 9% for the period January 1 through December 31, 1995, 11% for the
period January 1 through December 31, 1996, 12% for the period January 1 through
December 31, 1997, 13% for the period January 1 through December 31, 1998, 13.5%
for the period January 1, 1999 through December 31, 1999 and 14% for the period
January 1, 2000 through maturity. In August 1995, each of the Property Companies
was merged into ILM II Holding. As a result, ownership of the Senior Housing
Facilities, as well as the obligation under the loans, is now held by ILM II
Holding, and the Property Companies no longer exist as separate legal entities.
Since ILM II Holding is consolidated with the Company in the accompanying
financial statements for fiscal 2000 and 1999, the mortgage loans and related
interest expense have been eliminated in consolidation.

         Subsequent to the effective date of the Settlement Agreement with AHC,
in order to maximize the potential returns to the existing shareholders while
maintaining the Company's qualification as a REIT under the Internal Revenue
Code, the Company formed a new corporation, Lease II, for the purpose of
operating the Senior Housing Facilities under the terms of a Facilities Lease
Agreement. As of August 31, 1995, Lease II, which is taxable as a so-called `C"
corporation and not as a REIT, was a wholly-owned subsidiary of the Company. On
September 1, 1995, after the Company received the required regulatory approval,
it distributed all of the shares of capital stock of Lease II to the holders of
record of the Company's common stock. One share of common stock of Lease II was
issued for each full share of the Company's common stock held. Prior to the
distribution, the Company capitalized Lease II with $500,000 from its existing
cash reserves, which was an amount estimated to provide Lease II with necessary
working capital.

         The Facilities Lease Agreement is between the Company's consolidated
subsidiary, ILM II Holding, as owner of the Senior Housing Facilities and
Lessor, and Lease II as Lessee. The Lessor has the right to terminate the
Facilities Lease Agreement as to any property sold by the Lessor as of the date
of such sale. The Facilities Lease Agreement is a "triple-net" lease whereby the
Lessee pays all operating expenses, governmental taxes and assessments, utility
charges and insurance premiums, as well as the costs of all required
maintenance, personal property and non-structural repairs in connection with the
operation of the Senior Housing Facilities. ILM II Holding, as Lessor, is
responsible for all major capital improvements and structural repairs to the
Senior Housing Facilities. The Facilities Lease Agreement was originally
scheduled to expire on December 31, 2000, unless earlier terminated at the
election of the Lessor in connection with the sale by the Lessor of the Senior
Housing Facilities to a non-affiliated third party, but on November 13, 2000,
was extended beyond its original expiration date on a month-to-month basis by
vote of the Board of Directors. On November 28, 2000, the Facilities Lease
Agreement was extended through the earlier of the date on which the merger of
the Company with CSLC is consummated or March 31, 2001, and on a month-to-month
basis thereafter if the merger is not consummated by that time. Lease II pays
annual base rent for the use of all of the Facilities in the aggregate amount of
$4,035,600 per year. Lease II also pays variable rent, on a quarterly basis, for
each Senior Housing Facility in an amount equal to 40% of the excess of the
aggregate total revenues for the Senior Housing Facilities, on an annualized
basis, over $13,021,000. For the years ended August 31, 2000, 1999, and 1998,
variable rental income was $1,437,000, $1,261,000, and $984,000, respectively.


                                      F-16
<PAGE>


                           ILM II SENIOR LIVING, INC.
                    Notes to Financial Statements (continued)


 4.  OPERATING INVESTMENT PROPERTIES SUBJECT TO FACILITIES LEASE (CONTINUED)


         Condensed balance sheets as of August 31, 2000, 1999, and 1998, and
condensed statements of operations for the years ended August 31, 2000, 1999,
and 1998 of Lease II are as follows (in thousands):

<TABLE>
<CAPTION>
                                                                    2000              1999              1998
                                                                 ----------       -----------      -----------
<S>                                                              <C>               <C>              <C>
         ASSETS
           Current assets                                           $2,015            $1,990           $1,896
           Furniture, fixtures, and equipment, net                     451               617              558
           Other assets                                                 21               163              279
                                                                 ----------       -----------      -----------
                                                                    $2,487            $2,770           $2,733
                                                                 ==========       ===========      ===========

         LIABILITIES AND SHAREHOLDERS' EQUITY
           Current liabilities                                      $1,476            $1,467           $1,960
           Other liabilities                                             6                37               76
           Shareholders' equity                                      1,005             1,266              697
                                                                 ----------       -----------      -----------
                                                                    $2,487            $2,770           $2,733
                                                                 ==========       ===========      ===========

         STATEMENT OF OPERATIONS
           Revenues                                               $ 16,598           $16,250          $15,524
           Operating expenses                                       16,405            15,339           15,560
           Income tax expense (benefit)                                454               342             (14)
                                                                 ----------       -----------      -----------
           Net (loss) income                                     $   (261)             $ 569           $ (22)
                                                                 ==========       ===========      ===========
</TABLE>

5.    LEGAL PROCEEDINGS AND CONTINGENCIES

      TERMINATION OF MANAGEMENT CONTRACT WITH AHC

         On July 29, 1996, Lease II and ILM II Holding (collectively for this
Item 3, the "Companies") terminated a property management agreement with AHC
covering the then six Senior Housing Facilities leased by Lease II from ILM II
Holding. The management agreement was terminated for "cause" pursuant to the
contract. Simultaneously with the termination of the management agreement, the
Companies, together with certain affiliated entities, filed suit against AHC in
the United States District Court for the Eastern District of Virginia for breach
of contract, breach of fiduciary duty and fraud. The Companies alleged, among
other things, that AHC willfully performed actions specifically in violation of
the management agreement and that such actions caused damages to the Companies.



                                      F-17
<PAGE>


                           ILM II SENIOR LIVING, INC.
                    Notes to Financial Statements (continued)


5.    LEGAL PROCEEDINGS AND CONTINGENCIES (CONTINUED)

         Due to the termination of the management agreement for cause, no
termination fee was paid to AHC. Subsequent to the termination of the management
agreement, AHC filed for protection under Chapter 11 of the U.S. Bankruptcy Code
in its domestic state of California. The filing was challenged by the Companies,
and the Bankruptcy Court dismissed AHC's case effective October 15, 1996. In
November 1996, AHC filed with the Virginia District Court an answer in response
to the litigation initiated by the Companies and a counterclaim against ILM II
Holding. The counterclaim alleged that the management agreement was wrongfully
terminated for cause and requested damages which include the payment of the
termination fee in the amount of $750,000, payment of management fees pursuant
to the agreement from August 1, 1996 through October 15, 1996, which is the
earliest date that the agreement could have been terminated without cause, and
recovery of attorney's fees and expenses.

         The aggregate amount of damages against all parties as requested in
AHC's counterclaim exceeded $2,000,000. On June 13, 1997 and July 8, 1997, the
court issued orders to enter judgment against the Company and ILM I in the
amount of $1,000,000. The orders did not contain any findings of fact or
conclusions of law. On July 10, 1997, the Company, ILM I, Lease I and Lease II
filed a notice of appeal to the United States Court of Appeals for the Fourth
Circuit from the orders.

         On February 4, 1997, AHC filed a complaint in the Superior Court of the
State of California against Capital, the new property manager; Lawrence A.
Cohen, who, through July 28, 1998, was President, Chief Executive Officer, and
Director of the Company; and others alleging that the defendants intentionally
interfered with AHC's property management agreement (the "California
litigation"). The complaint sought damages of at least $2,000,000. On March 4,
1997, the defendants removed the case to Federal District Court in the Central
District of California. At a Board meeting on February 26, 1997, the Company's
Board of Directors concluded that since all of Mr. Cohen's actions relating to
the California litigation were taken either on behalf of the Company under the
direction of the Board or as a PaineWebber employee, the Company or its
affiliates should indemnify Mr. Cohen with respect to any expenses arising from
the California litigation, subject to any insurance recoveries for those
expenses. Legal fees paid by Lease I and Lease II on behalf of Mr. Cohen totaled
$229,000 as of August 31, 2000. The Company's Board also concluded that, subject
to certain conditions, the Company or its affiliates should pay reasonable legal
fees and expenses incurred by Capital in the California litigation. As August
31, 2000, the amount advanced to Capital by Lease I and Lease II for legal fees
totaled approximately $563,000. No amounts were advanced during fiscal year
2000.

         On August 18, 1998, the Company and its affiliates along with Capital
and its affiliates entered into a settlement agreement with AHC. Lease I and
Lease II agreed to pay $1,625,000 and Capital and its affiliates agreed to pay
$625,000 to AHC in settlement of all claims including those related to the
Virginia litigation and the California litigation. The Company and its
affiliates also entered into an agreement with Capital and its affiliates to
mutually release each other from all claims that any such parties may have
against each other, other than any claims under the property management
agreements. On September 4, 1998, the full settlement amounts were paid to AHC
and its affiliates with Lease I paying $975,000 and Lease II paying $650,000.



                                      F-18
<PAGE>


                           ILM II SENIOR LIVING, INC.
                    Notes to Financial Statements (continued)


5.    LEGAL PROCEEDINGS AND CONTINGENCIES (CONTINUED)

       OTHER LITIGATION


         On May 8, 1998 Andrew A. Feldman and Jeri Feldman, as Trustees for the
Andrew A. & Jeri Feldman Revocable Trust dated September 18, 1990, commenced a
purported class action on behalf of that trust and all other shareholders of the
Company and ILM I in the Supreme Court of the State of New York, County of New
York naming the Company, ILM I and their Directors as defendants. The class
action complaint alleged that the Directors engaged in wasteful and oppressive
conduct and breached fiduciary duties in preventing the sale or liquidation of
the assets of the Company and ILM I, diverting certain of their assets. The
complaint sought compensatory damages in an unspecified amount, punitive
damages, the judicial dissolution of the Company and ILM I, an order requiring
the Directors to take all steps to maximize Shareholder value, including either
an auction or liquidation, and rescinding certain agreements, and attorney's
fees.

         On October 15, 1999, the parties entered into a Stipulation of
Settlement and filed it with the Court, which approved the settlement, by order
dated October 21, 1999. In issuing that order the Court entered a final judgment
dismissing the action and all non-derivative claims of the settlement class
against the defendants with prejudice. This litigation was settled at no cost to
the Company and ILM I. As part of the settlement, CSLC increased its proposed
merger consideration payable to the Company and ILM I shareholders and was also
responsible for a total of approximately $1.1 million in plaintiffs' attorneys
fees and expenses upon consummation of the proposed mergers. If the proposed
mergers were not consummated and if the Company or ILM I were to consummate an
extraordinary transaction with a third party, then the Company and ILM I would
be responsible for the plaintiffs' attorneys fees and expenses.

         On August 15, 2000, the merger of ILM I with CSLC was consummated. If
the proposed merger of the Company and CSLC is not consummated, and if the
Company were to consummate an extraordinary transaction with a third party, then
the Company would be responsible for the Company's share of the plaintiff's
attorney's fees and expenses.

6.       CONSTRUCTION LOAN FINANCING

         During 1999 the Company secured a construction loan facility with a
major bank that provides the Company with up to $8.8 million to fund the capital
costs of the potential expansion programs. The construction loan facility is
secured by a first mortgage of the Senior Housing Facilities and collateral
assignment of the Company's leases of such properties. The loan was scheduled to
expire on December 31, 2000, with possible extensions through September 29,
2003. Principal is due at expiration. Interest is payable monthly at a rate
equal to LIBOR plus 1.10% or Prime plus 0.5%.

         On June 7, 1999, the Company borrowed approximately $1.2 million under
the construction loan facility to fund the pre-construction capital costs
incurred through April 1999, of the potential expansions of the Senior Housing
Facilities. On August 16, 2000, the Company repaid approximately $600,000 of
principal on the construction loan facility in connection with the sale of Villa
Santa Barbara and the lender sold the remaining loan to CSLC. As part of the
transaction, the Company agreed that the term of the loan would not be extended
beyond December 31, 2000. On November 28, 2000, the Company and CSLC agreed that
the maturity date of the loan would be extended until the date on which the
merger of the Company with CSLC is consummated or the date on which the merger
agreement is terminated, whichever occurs first. Amounts outstanding under the
loan at August 31, 2000, were approximately $600,000, and $8.2 million of the
construction loan facility is unused and available.




                                      F-19
<PAGE>


                           ILM II SENIOR LIVING, INC.
                    Notes to Financial Statements (continued)


7.       DIVIDENDS

         On June 2, 2000, the Company's Board of Directors unanimously agreed
not to declare any dividends on shares of the Company's common stock for the
remainder of Fiscal Year 2000. The Board cited transaction costs previously
incurred and to be incurred through closing of the pending merger with CSLC and
the establishment of a reserve to fund the short-term operations of the
Company's senior living communities if the proposed merger with CSLC is not
consummated. The Company also announced that, should the merger not be
consummated, its Board of Directors would reevaluate its dividend policy.

         On November 13, 2000, the Company's Board of Directors voted to
reinstate the payment of regular quarterly dividends to shareholders with the
dividend for the quarter ending November 30, 2000, which is scheduled to be paid
on January 15, 2001.

         On November 13, 2000, the Company's board of directors also voted to
distribute to shareholders the net proceeds of approximately $9.8 million or
$1.89 per share from the sale of the Company's 75% interest in Villa Santa
Barbara.

         On December 15, 2000, the Company's Board of Directors declared a
quarterly dividend to distribute the net proceeds from the sale of the Company's
investment in Villa Santa Barbara. A dividend of $1.89 per share of common
stock, totaling approximately $9,792,000, was paid as of December 15, 2000, to
Shareholders of record as of November 1, 2000.

         Also on December 15, 2000, the Company's Board of Directors declared a
quarterly dividend of $0.1622 per share of common stock for the three-month
period ended November 30, 2000, payable to Shareholders of record at the close
of business on December 15, 2000.










                                      F-20
<PAGE>


                           ILM II SENIOR LIVING, INC.
                    Notes to Financial Statements (continued)



SCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION
                             ILM II SENIOR LIVING, INC.
          CONSOLIDATED SCHEDULE OF REAL ESTATE AND ACCUMULATED DEPRECIATION
                                   August 31, 2000
                                (Amounts in thousands)

<TABLE>
<CAPTION>
                                   INITIAL COST TO                            GROSS AMOUNT AT WHICH CARRIED AT
                                   THE COMPANY (2)                                        END OF YEAR
                                 -------------------         COSTS         --------------------------------------
                                                          CAPITALIZED
                                                           (REMOVED
                                                         SUBSEQUENT TO)
                                                         ACQUISITION OF
                                         BUILDINGS &       BUILDINGS &              BUILDINGS &     UNAMORTIZED
 DESCRIPTION   ENCUMBRANCES(1)   LAND   IMPROVEMENTS   IMPROVEMENTS (3)    LAND   IMPROVEMENTS(5) MORTGAGE FEES (5)
------------   ---------------   ----   ------------   ----------------    ----   --------------  -----------------
<S>            <C>              <C>     <C>            <C>                 <C>    <C>             <C>
CONGREGATE CARE FACILITIES:
Fort Myers,          $ 8,700    $1,075      $11,233          $(3,268)      $1,319      $ 7,863          $ 412
Florida

Omaha,
Nebraska               4,950       400        5,043           (1,054)         579        3,873            183


Overland Park,
Kansas                 7,850       672        6,787               22          656        6,679            251


Stockton,
California             5,700     1,507        5,628             (443)       1,670        5,195            240


St. Louis
County,                5,850       292        4,488               74          298        4,436            161
Missouri

Santa Barbara,
California             5,094     1,160        4,322             (197)           0            0              0
                  ----------    ------    ---------     -------------    --------    ----------      ---------
                     $38,144    $5,106      $37,501          $(4,866)      $4,522      $28,046         $1,247
                  ==========    ======    =========     =============    ========    ==========      =========
</TABLE>


<TABLE>
<CAPTION>
                                                                                          DEPRECIABLE
                               ACCUMULATED       ACCUMULATED       DATE OF      DATE          LIFE
                     TOTAL   DEPRECIATION(5)   AMORTIZATION(5)  CONSTRUCTION  ACQUIRED     OF ASSETS
                     -----   ---------------   ---------------  ------------  --------    -----------
<S>                 <C>      <C>               <C>              <C>           <C>         <C>
CONGREGATE CARE FACILITIES:
Fort Myers,        $ 9,594     $(2,500)            $(407)          1988       7/18/90      5-40 yrs.
Florida

Omaha,
Nebraska             4,635      (1,343)             (156)          1992       4/25/91      5-40 yrs.


Overland Park,
Kansas               7,586      (1,984)             (211)          1984        4/9/92      5-40 yrs.


Stockton,
California           7,105      (1,610)             (199)          1988       5/14/92      5-40 yrs.


St. Louis
County,              4,895      (1,466)             (133)          1985       5/29/92      5-40 yrs.
Missouri

Santa Barbara,
California               0           0                 0           1979       7/13/92      5-40 yrs.
                 ----------   -----------     ------------
                   $33,815    $ (8,813)          $(1,106)
                 ==========   ===========     ============
</TABLE>

(1)      Encumbrances represent first mortgage loans between ILM II Holding as
         mortgagor, and the Company as mortgagee. Such loans are eliminated in
         consolidation in the accompanying Consolidated Financial Statements
         (see Note 4).

(2)      Initial cost to the Company represents the aggregate advances made by
         the Company on the loans secured by the Facilities which were made to
         AHC prior to the default and foreclosure actions described in Notes 1
         and 4 to the Consolidated Financial Statements.

(3)      Costs removed subsequent to acquisition reflect the guaranty payments
         received by the Company from AHC under the terms of the Exclusivity
         Agreement as discussed further in Notes 1 and 4 to the Consolidated
         Financial Statements and costs incurred relating to capitalized
         interest.

(4)      The aggregate cost of real estate owned at August 31, 2000 for Federal
         income tax purposes is approximately $34,789,621

(5)      The 75% co-tenancy interest in Villa Santa Barbara was sold to Capital
         Senior Living Corporation (CSLC) on August 15, 2000.

(6)      Certain numbers have been reclassified to conform to the current year's
         presentation.






                                      F-21
<PAGE>


                           ILM II SENIOR LIVING, INC.
                    Notes to Financial Statements (continued)


SCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION

                    ILM II SENIOR LIVING, INC. AND SUBSIDIARY
        SCHEDULE OF REAL ESTATE AND ACCUMULATED DEPRECIATION (continued)
                                 August 31, 2000
                             (Amounts in thousands)

<TABLE>
<CAPTION>
                                                                                    2000           1999           1998
                                                                                    ----           ----           ----
<S>                                                                                 <C>            <C>            <C>
(5)      Reconciliation of real estate owned:

         Balance at beginning of period                                                $38,861        $38,484       $37,946
              Acquisitions and improvements - year ended 8/31/00                           288
              Sale of Villa Santa Barbara on August 15, 2000                            (5,334)
              Acquisitions and improvements - year ended 8/31/99                                          377
              Acquisitions and improvements - year ended 8/31/98                                                        538
                                                                                  ------------      ----------     --------
         Balance at end of period                                                      $33,815        $38,861       $38,484
                                                                                  ============      ==========     ========

(6)      Reconciliation of accumulated depreciation and amortization:

         Balance at beginning of period                                                $ 9,942        $ 8,565      $ 7,280
              Depreciation and amortization expense - year ended 8/31/00                 1,331
              Sale of Villa Santa Barbara on August 15, 2000                            (1,354)
              Depreciation and amortization expense - year ended 8/31/99                                1,377
              Depreciation and amortization expense - year ended 8/31/98                                             1,285
                                                                                  ------------      ----------     --------
         Balance at end of period                                                     $ 9,919         $ 9,942      $ 8,565
                                                                                  ============      ==========     ========
</TABLE>



                                      F-22