##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549
  FORM 10-Q  þ
    
    QUARTERLY REPORT UNDER SECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTER ENDED JUNE 30, 2004 Commission File Number 1-9240 INCOME OPPORTUNITY REALTY INVESTORS, INC. (Exact Name of Registrant as Specified in Its Charter)
 Nevada
    
    75-2615944(State or Other Jurisdiction of
Incorporation or Organization)
    
    (I.R.S. Employer
Identification No.)1755 Wittington Place, Suite 340, Dallas, Texas
    
    75234(Address of Principal Executive Office)
    
    (Zip Code)
 (214) 750-5800
(Registrants Telephone Number, Including Area Code) Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes o. No þ. Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes þ. No o. APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the issuers classes
of Common Stock, as of the latest practicable date. Common Stock, $.01 par value
    
    1,438,945(Class)
    
    (Outstanding at July 31, 2004)




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TABLE OF CONTENTS  PART I. FINANCIAL INFORMATIONITEM 1. FINANCIAL STATEMENTSITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES REGARDING MARKET RISKITEM 4. CONTROLS AND PROCEDURESPART II. OTHER INFORMATIONITEM 1. LEGAL PROCEEDINGSITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS, AND ISSUER PURCHASES OF EQUITY SECURITIESITEM 6. EXHIBITS AND REPORTS ON FORM 8-KSIGNATURE PAGECertification Pursuant to Section 302Certification Pursuant to Section 906    Table of Contents  
 PART I. FINANCIAL INFORMATION 
 ITEM 1. FINANCIAL STATEMENTS The accompanying Consolidated Financial Statements have not been audited by
independent certified public accountants, but in the opinion of the management
of Income Opportunity Realty Investors, Inc. (IORI), all adjustments
(consisting of normal recurring accruals) necessary for a fair presentation of
IORIs consolidated financial position, consolidated results of operations and
consolidated cash flows at the dates and for the periods indicated, have been
included. INCOME OPPORTUNITY REALTY INVESTORS, INC.
CONSOLIDATED BALANCE SHEETS June 30,
    
    December 31,2004
    
    2003(dollars in thousands,except per share)AssetsReal estate held for investment
    
    $
    41,997
    
    
    $
    56,367Lessaccumulated depreciation
    
    
    (4,903
    )
    
    
    (6,002
    )37,094
    
    
    
    50,365Notes and interest receivable
    
    
    48,838
    
    
    
    45,531Investment in real estate partnerships
    
    
    618
    
    
    
    607Cash and cash equivalents
    
    
    118
    
    
    
    58Other assets (including $3,586 in 2004 and $930 in 2003 due from affiliates)
    
    
    7,843
    
    
    
    4,583$
    94,511
    
    
    $
    101,144Liabilities and Stockholders EquityLiabilities:Notes and interest payable
    
    $
    50,391
    
    
    $
    60,825Other liabilities (including $600 in 2004 and $473 in 2003 due to affiliates)
    
    
    2,060
    
    
    
    1,23052,451
    
    
    $
    62,055Commitments and contingenciesStockholders equity:Common Stock, $.01 par value; authorized, 10,000,000 shares; issued and
outstanding 1,438,945 shares in 2004 and 2003
    
    
    14
    
    
    
    14Paid-in capital
    
    
    62,774
    
    
    
    62,774Accumulated deficit
    
    
    (20,728
    )
    
    
    (23,699
    )42,060
    
    
    
    39,089$
    94,511
    
    
    $
    101,144
 The accompanying notes are an integral part of these Consolidated Financial Statements. 2




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INCOME OPPORTUNITY REALTY INVESTORS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS For the Three Months
    
    For the Six MonthsEnded June 30,
    
    Ended June 30,(dollars in thousands, except per share)2004
    
    2003
    
    2004
    
    2003Property revenue:Rents
    
    $
    1,293
    
    
    $
    2,289
    
    
    $
    3,429
    
    
    $
    3,994Property expense:Property operations (including $78 in 2004
and $194 in 2003 to
affiliates and related parties)
    
    
    519
    
    
    
    1,240
    
    
    
    1,730
    
    
    
    2,165Operating income
    
    
    774
    
    
    
    1,049
    
    
    
    1,699
    
    
    
    1,829Other income (loss):Interest
    
    
    605
    
    
    
    614
    
    
    
    1,203
    
    
    
    614Recovery of accounts receivable written off
    
    
    
    
    
    
    1,569
    
    
    
    
    
    
    
    1,569Equity in income (loss) of equity partnerships
    
    
    11
    
    
    
    
    
    
    
    10
    
    
    
    (15
    )616
    
    
    
    2,183
    
    
    
    1,213
    
    
    
    2,168Other expense:Interest
    
    
    845
    
    
    
    1,146
    
    
    
    1,823
    
    
    
    2,096Depreciation
    
    
    188
    
    
    
    456
    
    
    
    530
    
    
    
    776Advisory fee to affiliate
    
    
    202
    
    
    
    167
    
    
    
    395
    
    
    
    334Impairment of real estate held for sale
    
    
    
    
    
    
    653
    
    
    
    
    
    
    
    653Net income fee to affiliate
    
    
    30
    
    
    
    
    
    
    
    245
    
    
    
    General and administrative (including $36 in
2004 and $132 in
2003 to affiliates and related parties)
    
    
    176
    
    
    
    114
    
    
    
    446
    
    
    
    3691,441
    
    
    
    2,536
    
    
    
    3,439
    
    
    
    4,228Net income (loss) from continuing operations
    
    
    (51
    )
    
    
    696
    
    
    
    (527
    )
    
    
    (231
    )Discontinued operations:(Loss)/Income from discontinued operations
    
    
    (48
    )
    
    
    (64
    )
    
    
    (176
    )
    
    
    (135
    )Gain on sale of operations
    
    
    417
    
    
    
    
    
    
    
    3,674
    
    
    
    369
    
    
    
    (64
    )
    
    
    3,498
    
    
    
    (135
    )Net income (loss)
    
    $
    318
    
    
    $
    632
    
    
    $
    2,971
    
    
    $
    (366
    )Earnings (loss) per share:Net loss from continuing operations
    
    $
    (0.04
    )
    
    $
    0.48
    
    
    $
    (0.37
    )
    
    $
    (0.16
    )Discontinued operations
    
    
    0.26
    
    
    
    (0.04
    )
    
    
    2.43
    
    
    
    (0.09
    )Net income (loss)
    
    $
    0.22
    
    
    $
    0.44
    
    
    $
    2.06
    
    
    $
    (0.25
    )Weighted average common shares used in computing
earnings per share
    
    
    1,438,945
    
    
    
    1,438,945
    
    
    
    1,438,945
    
    
    
    1,438,945
 The accompanying notes are an integral part of these Consolidated Financial Statements. 3




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INCOME OPPORTUNITY REALTY INVESTORS, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS EQUITY For the Six Months Ended June 30, 2004 Common StockPaid-in
    
    Accumulated
    
    Total StockholdersShares
    
    Amount
    
    Capital
    
    Deficit
    
    Equity(dollars in thousands)Balance, January 1, 2004
    
    
    1,438,945
    
    
    $
    14
    
    
    $
    62,774
    
    
    $
    (23,699
    )
    
    $
    39,089Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,971
    
    
    
    2,971Balance, June 30, 2004
    
    
    1,438,945
    
    
    $
    14
    
    
    $
    62,774
    
    
    $
    (20,728
    )
    
    $
    42,060
 The accompanying notes are an integral part of these Consolidated Financial Statements. 4




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INCOME OPPORTUNITY REALTY INVESTORS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS For the Six MonthsEnded June 30,2004
    
    2003(dollars in thousands)Cash Flows from Operating Activities:Net income/(loss)
    
    $
    2,971
    
    
    $
    (366
    )Reconciliation of net income (loss) to net cash used by operating activitiesAdjustments to reconcile net income (loss) to net cash used in operating activities:Depreciation
    
    
    636
    
    
    
    1,187Loss on impairment of fixed asset
    
    
    
    
    
    
    653Gain on sale of real estate
    
    
    (3,674
    )
    
    
    (Gain) loss on equity partnerships
    
    
    (11
    )
    
    
    15Increase in interest receivable
    
    
    (317
    )
    
    
    (85
    )Increase in other assets
    
    
    (1,876
    )
    
    
    (215
    )Decrease in interest payable
    
    
    (108
    )
    
    
    (369
    )Increase in other liabilities
    
    
    231
    
    
    
    298Net cash provided by (used in) operating activities
    
    
    (2,148
    )
    
    
    1,118Cash Flows from Investing Activities:Real estate improvements
    
    
    
    
    
    
    (362
    )Proceeds from sale of real estate
    
    
    3,444
    
    
    
    Payments to advisor
    
    
    (3,024
    )
    
    
    (14
    )Net cash provided by (used in) investing activities
    
    
    420
    
    
    
    (376
    )Cash Flows from Financing Activities:Payments on notes payable
    
    $
    (462
    )
    
    $
    (358
    )Proceeds on notes payable
    
    
    1,193
    
    
    
    Advances from (payments to) affiliates
    
    
    967
    
    
    
    Deferred financing costs
    
    
    90
    
    
    
    (120
    )Net cash provided by (used in) financing activities
    
    
    1,788
    
    
    
    (478
    )Net increase in cash and cash equivalents
    
    $
    60
    
    
    $
    264Cash and cash equivalents, beginning of period
    
    
    58
    
    
    
    10Cash and cash equivalents, end of period
    
    $
    118
    
    
    $
    274Supplemental Disclosures of Cash Flow Information:Cash paid for interest
    
    
    2,232
    
    
    
    2,496Schedule of noncash investing and financing:Note receivable from sale of real estate
    
    
    2,990
    
    
    
    
 The accompanying notes are an integral part of these Consolidated Financial Statements. 5




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INCOME OPPORTUNITY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1. BASIS OF PRESENTATION The accompanying Consolidated Financial Statements have been prepared in
accordance with generally accepted accounting principles for interim financial
information and with the instructions to Form 10-Q and Article 10 of Regulation
S-X. Accordingly, they do not include all of the information and notes
required by generally accepted accounting principles for complete financial
statements. Operating results for the six month period ended June 30, 2004,
are not necessarily indicative of the results that may be expected for the year
ending December 31, 2004. For further information, refer to the Consolidated
Financial Statements and notes thereto included in IORIs Annual Report on Form
10-K for the year ended December 31, 2003 (the 2003 Form 10-K). Dollar
amounts in tables are in thousands, except per share amounts. Certain balances for 2003 have been reclassified to conform to the 2004
presentation. NOTE 2. REAL ESTATE In 2004, IORI sold the following property: Sales
    
    Net Cash
    
    Debt
    
    GainProperty
    
    Location
    
    Units/Sq.Ft.
    
    Price
    
    Received
    
    Discharged
    
    on SaleFirst QuarterApartment BuildingTreehouse
    
    San Antonio, TX
    
    106 Units
    
    $
    5,400
    
    
    $
    1,100
    
    
    $
    3,747
    
    
    $
    3,257Second QuarterApartment BuildingTreehouse (1)
    
    Irving, TX
    
    160 Units
    
    $
    8,017
    
    
    
    ($498
    )
    
    $
    5,018
    
    
    $
    
    (2)Commercial BuildingAkard Plaza
    
    Dallas, TX
    
    42,258 Sq.Ft.
    
    $
    3,900
    
    
    $
    2,007
    
    
    $
    1,849
    
    
    $
    417
   (1)
    
    Property sold to TCI, a related party, for assumption of debt and a note
receivable, less $498,000 in cash paid.(2)
    
    Excludes a $56,000 deferred gain from a related party sale. IORI did not sell any property during the first two quarters in 2003. NOTE 3. NOTES AND INTEREST RECEIVABLE There were no new notes funded in 2004. Junior Mortgage Loans.Junior mortgage loans are loans secured by mortgages
that are subordinate to one or more prior liens either on the fee or a
leasehold interest in real estate. Recourse on the loans ordinarily includes
the real estate which secures the loan, other collateral and personal
guarantees of the borrower. On May 24, 2004, a Promissory Note in the amount of $2,990,000 given by Unified
Housing of McKinney, LLC (UHM) to Transcontinental Eldorado, Inc. was
assigned from Transcontinental Realty Investors, Inc. (TCI) to IORI as a
partial payment for TCIs repurchase of 100% of the outstanding common shares
of Transcontinental Treehouse Corporation (Treehouse-IR) from IORI. On December 30, 2003, a Promissory Note in the amount of $6,363,360 given by
Housing for Seniors of Humble (Housing), LLC to NLP Lakeshore Villas, LLC
(NLP) was assigned from American Realty Investors, Inc. (ARI) to IORI as a
paydown of certain intercompany receivables. 6




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On December 30, 2003, a Promissory Note in the amount of $2,000,000 given by
Housing to NLP was assigned from ARI to IORI as additional paydown of certain
intercompany receivables. On October 14, 2003, IORI sold and conveyed the office building known as One
Hickory Centre and 202 acres of unimproved real property known as the Travelers
Land in Dallas County, Texas to Encino Executive Plaza, Ltd. The sale price for
One Hickory Centre was $12,200,000 and Encino Executive Plaza, Ltd. executed a
wrap-around promissory note in the amount of $11,973,025 payable to the order
of IORI secured by a Deed of Trust encumbering One Hickory Centre. The note
bore interest at 5.5% per annum. As with the prior transaction, the difference
between the purchase price and the promissory note represented adjustments for
various prorations. The sale price for the Travelers Land was $25,000,000. At
closing, Encino Executive Plaza, Ltd. executed an all inclusive wrap-around
promissory note payable to the order of IORI in the principal amount of
$22,801,987 secured by a Deed of Trust covering the Travelers Land sold and
delivered cash to IORI in the amount of $1,946,715, the remaining difference of
which was as a result of prorations and various expenses paid by IORI in
connection with the closing of the transaction. The note bore interest at 5.5%
per annum. Subsequently, IORI made a loan to Encino Executive Plaza, Ltd. in
the amount of $1,567,232 payable upon demand or if no demand is made prior
thereto on June 30, 2006 with a market rate of interest. Encino Executive
Plaza, Ltd. executed and delivered a promissory note payable to the order of
IORI in the stated principal amount of $1,567,232. The note bore interest at
5.5% per annum. NOTE 4. OTHER ASSETS Related Party.From time-to-time, IORI and its affiliates and related parties
have made advances to each other to fund their respective operations, which
generally have not had specific repayment terms and have been reflected in
IORIs financial statements as other assets. IORI had receivables of $3.3
million, $-0-, and $261,000 from its advisor Syntek West, Inc. (SWI), ARI,
and TCI, respectively at June 30, 2004, and receivables of $302,000, $367,000,
and $261,000 from SWI, ARI, and TCI, respectively at December 31, 2003. NOTE 5. NOTES AND INTEREST PAYABLE In April 2002, IORI sold all of its residential properties to partnerships
controlled by Metra Capital, LLC (Metra). These properties include: the 60
unit Brighton Court, the 92 unit Del Mar, the 68 unit Enclave, the 280 unit
Meridian, the 57 unit Signature, the 114 unit Sinclair, located in Midland,
Texas and the 106 unit Treehouse, located in San Antonio, Texas. Innovo Realty,
Inc., a subsidiary of Innovo Group, Inc. (Innovo) is a limited partner in the
partnerships that purchased the properties. Joseph Mizrachi, a former director
of ARI, a related party, controls approximately 11.67% of the outstanding
common stock of Innovo. The sale constituted 23% of the total assets of IORI
as of December 31, 2001. The sales price for the properties totaled $26.2
million. IORI received $5.4 million in cash after the payoff of $16.1 million
in debt and various closing costs. Management has determined to account for
this sale as a refinancing transaction, in accordance with SFAS No. 66,
Accounting for Sales of Real Estate. IORI will continue to report the assets
and the new debt incurred by the Metra partnerships on the IORI financial
statements. The new debt on the properties totals $21.4 million, bears
interest at 7.57% per annum, requires monthly interest only payments of
$135,000 and matures in May 2012. IORI also received $5.2 million of 8%
non-recourse, non-convertible Series A Preferred Stock (Preferred Shares) of
Innovo. The dividend on the Preferred Shares will be funded entirely and solely through
member distributions from cash flows generated by the operation and subsequent
sale of the sold properties. In the event the cash flows for the properties
are insufficient to cover the 8% annual dividend, Innovo will have no
obligation to cover any shortfall. The Preferred Shares have a mandatory redemption feature and are redeemable
from the cash proceeds received by Innovo from the operation and sale of the
properties. All member distributions that are in excess of current and accrued
8% dividends must be used by Innovo to redeem the Preferred Shares. Since
redemption of these shares is subject to the above future events, management
has elected to record no basis in the Preferred Shares. As mentioned in Note 2, the Treehouse apartment property (San Antonio) was sold
for $5.4 million, the Treehouse apartment property (Irving) was sold for $8.0
million to TCI, a related party, and the Akard Plaza was sold for $3.9 million.
All the existing mortgage payable amounts were discharged at the closing. 7




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In 2004, IORI refinanced the following property: Net CashDebt
    
    Debt
    
    Received/
    
    Interest
    
    MaturityProperty
    
    Location
    
    Sq.Ft./Acrs
    
    Incurred
    
    Discharged
    
    (Paid)
    
    Rate
    
    DateFirst QuarterOffice BuildingYeager Building
    
    Chantilly, VA
    
    60,060 Sq.Ft.
    
    $5,500
    
    $
    4,307
    
    
    $
    1,179
    
    
    
    5.5
    %(1)
    
    
    12/06
   (1)
    
    Variable rate. NOTE 6. OTHER LIABILITIES Related Party.As mentioned in note 4, from time-to-time, IORI and its
affiliates and related parties have made advances to each other to fund their
respective operations, which generally have not had specific repayment terms
and have been reflected in IORIs financial statements as other liabilities.
IORI had a payable of $600,000 to Regis Realty I, LLC (RRI) at June 30, 2004,
and a payable of $473,000 to RRI at December 31, 2003. NOTE 7. RELATED PARTY TRANSACTIONS On December 18, 2003, IORI purchased 100% of the outstanding common shares of
Treehouse-IR, a wholly-owned subsidiary of TCI, a related party, for $7.5
million for a reduction of intercompany debt in the amount of $2.4 million
subject to a mortgage lien in the amount of $5.1 million. TCI repurchased 100%
of the outstanding common shares of Treehouse-IR from IORI for $8.0 million
through assumption of debt of $5.1 million plus a transfer of a promissory note
for $3.0 million on May 24, 2004. This assignment of a promissory note from
TCI to IORI was given by Unified Housing of McKinney, LLC (UHM) to
Transcontinental Eldorado, Inc. Treehouse-IR owns the 153,072 sq.ft. Treehouse
Apartments Building in Irving, Texas. On December 30, 2003, a promissory note in the amount of $6.3 million given by
Housing to NLP was assigned from ARI to IORI. On December 30, 2003, a
promissory note in the amount of $2.0 million given by Housing to NLP was
assigned from ARI to IORI. These assignments were payments on certain
intercompany receivables due to IORI. On December 18, 2003, IORI purchased 100% of the outstanding common shares of
Transcontinental Brewery Corporation (Brewery), a wholly-owned subsidiary of
TCI, a related party, for $4.0 million for a reduction of intercompany debt in
the same amount. Brewery owns 19.96 acres of land and the 133,000 sq. ft.
Eagle Crest Warehouse Building in Farmers Branch, Texas. On December 18, 2003, IORI purchased 100% of the outstanding common shares of
Transcontinental Parkway Corporation (Parkway), a wholly-owned subsidiary of
TCI, for $4.0 million for reduction of intercompany debt in the amount of $2.4
million subject to mortgage lien in the amount of $1.6 million. Parkway owns
the 28,374 sq. ft. Parkway Shopping Center in Dallas, Texas. On September 19, 2002, IORIs Board of Directors authorized the Chief Financial
Officer of the Company to advance funds either to or from the Company, through
the advisor, in an amount up to $5.0 million on the condition that such
advances shall be repaid in cash or transfers of assets within 90 days. 8




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The following table reconciles the beginning and ending balances of Accounts
Receivable/(Payables) from/to Affiliates as of June 30, 2004. SWI
    
    RRI
    
    ARI
    
    TCIBalance, December 31, 2003
    
    $
    302
    
    
    
    (473
    )
    
    $
    367
    
    
    $
    261Cash transfers
    
    
    7,331
    
    
    
    
    
    
    
    
    
    
    
    Cash repayments
    
    
    (3,568
    )
    
    
    
    
    
    
    (367
    )
    
    
    Other additions
    
    
    176
    
    
    
    
    
    
    
    
    
    
    
    Other repayments
    
    
    (916
    )
    
    
    (127
    )
    
    
    
    
    
    
    Balance, June 30, 2004
    
    
    3,325
    
    
    $
    (600
    )
    
    $
    
    
    
    $
    261
 Returns on Metra Properties.As described more fully in Note 5, IORI sold all
of its residential properties during 2002 to partnerships controlled by Metra.
The partnership agreement for each of these partnerships states that the Metra
Partners, as defined, receive cash flow distributions at least quarterly in an
amount sufficient to provide them with a fifteen percent cumulative compounded
annual rate of return on their invested capital, as well as a cumulative annual
amount of 0.50% of the average outstanding balance of the mortgage indebtedness
secured by any of these residential properties. These distributions to the
Metra Partners have priority over distributions to any of the other partners. 9




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NOTE 8. OPERATING SEGMENTS Significant differences among the accounting policies of the operating segments
as compared to the Consolidated Financial Statements principally involve the
calculation and allocation of general and administrative expenses. Management
evaluates the performance of the operating segments and allocates resources to
each of them based on their operating income and cash flow. Items of income
that are not reflected in the segments are interest, income or (loss) of equity
in partnerships, and recovery of loss provision on receivable from related
party totaling $616,000 and $1.2 million for the three and six months ended
June 30, 2004, and $2.2 million and $2.2 million for the three and six months
ended June 30, 2003. Expenses that are not reflected in the segments are
general and administrative expenses, advisory fees, impairment of real estate
held for sale, and net income fees totaling $408,000 and $1.1 million for the
three and six months ended June 30, 2004, and $934,000 and $1.4 million for the
three and six months ended June 30, 2003. Excluded from operating segment
assets are assets of $57.4 million at June 30, 2004 and $15.9 million at June
30, 2003, which are not identifiable with an operating segment. There are no
intersegment revenues and expenses and all business is conducted in the United
States. Presented below is the operating income and assets of each operating segment. Three Months Ended
    
    
    
    
    
    CommercialJune 30, 2004
    
    Land
    
    Properties
    
    Apartments
    
    TotalRents
    
    $
    
    
    
    $
    397
    
    
    $
    896
    
    
    $
    1,293Property operating expenses
    
    
    
    
    
    
    70
    
    
    
    449
    
    
    
    519Operating income (loss)
    
    $
    
    
    
    $
    327
    
    
    $
    447
    
    
    $
    774Depreciation
    
    $
    
    
    
    $
    119
    
    
    $
    69
    
    
    $
    188Interest
    
    
    244
    
    
    
    253
    
    
    
    348
    
    
    
    845Real estate improvements
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Assets
    
    
    44
    
    
    
    18,458
    
    
    
    18,592
    
    
    
    37,094Six Months EndedJune 30, 2004Rents
    
    $
    
    
    
    $
    1,119
    
    
    $
    2,310
    
    
    $
    3,429Property operating expenses
    
    
    
    
    
    
    458
    
    
    
    1,272
    
    
    
    1,730Operating income (loss)
    
    $
    
    
    
    $
    661
    
    
    $
    1,038
    
    
    $
    1,699Depreciation
    
    $
    
    
    
    $
    307
    
    
    $
    223
    
    
    $
    530Interest
    
    
    569
    
    
    
    577
    
    
    
    677
    
    
    
    1,823Real estate improvements
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Assets
    
    
    44
    
    
    
    18,458
    
    
    
    18,592
    
    
    
    37,094
 10




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##### Table of Contents



Three Months Ended
    
    
    
    
    
    CommercialJune 30, 2003
    
    Land
    
    Properties
    
    Apartments
    
    TotalRents
    
    $
    
    
    
    $
    959
    
    
    $
    1,330
    
    
    $
    2,289Property operating expenses
    
    
    80
    
    
    
    408
    
    
    
    752
    
    
    
    1,240Operating income (loss)
    
    $
    (80
    )
    
    $
    551
    
    
    $
    578
    
    
    $
    1,049Depreciation
    
    $
    
    
    
    $
    380
    
    
    $
    76
    
    
    $
    456Interest
    
    
    378
    
    
    
    268
    
    
    
    500
    
    
    
    1,146Real estate improvements
    
    
    
    
    
    
    155
    
    
    
    
    
    
    
    155Assets
    
    
    24,929
    
    
    
    27,661
    
    
    
    20,941
    
    
    
    73,531Six Months EndedJune 30, 2003Rents
    
    $
    
    
    
    $
    1,744
    
    
    $
    2,250
    
    
    $
    3,994Property operating expenses
    
    
    162
    
    
    
    771
    
    
    
    1,232
    
    
    
    2,165Operating income (loss)
    
    $
    (162
    )
    
    $
    973
    
    
    $
    1,018
    
    
    $
    1,829Depreciation
    
    $
    
    
    
    $
    602
    
    
    $
    174
    
    
    $
    776Interest
    
    
    745
    
    
    
    490
    
    
    
    861
    
    
    
    2,096Real estate improvements
    
    
    
    
    
    
    365
    
    
    
    
    
    
    
    365Assets
    
    
    24,929
    
    
    
    27,661
    
    
    
    20,941
    
    
    
    73,531
 NOTE 9. ADVISORY FEES, PROPERTY MANAGEMENT, ETC. Revenue, fees and cost reimbursements to its advisors and affiliates for the
six months ended: For the Six MonthsEnded June 30,2004
    
    2003FeesAdvisory
    
    $
    395
    
    
    $
    334Net income
    
    
    245
    
    
    
    Property and construction management and leasing commission
    
    
    78
    
    
    
    194$
    718
    
    
    $
    528Cost reimbursements
    
    $
    36
    
    
    $
    132
 11




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##### Table of Contents



NOTE 10. DISCONTINUED OPERATIONS Effective January 1, 2002, IORI adopted Financial Accounting Standards No. 144,
Accounting for the Impairment or Disposal of Long-Lived Assets (SFAS 144),
which established a single accounting model for the impairment or disposal of
long-lived assets including discontinued operations. This statement requires
that the operations related to properties that have been sold, or properties
that are intended to be sold, be presented as discontinued operations in the
statement of operations for all periods presented, and the properties intended
to be sold are to be designated as held for sale on the balance sheet. In
the event of a future asset sale, IORI is required to reclassify portions of
previously reported operations to discontinued operations within the Statements
of Operations. For the three months and six months ended June 30, 2004, income
from discontinued operations relates to three properties that IORI sold during
2004. The following table summarizes revenue and expense information for the
properties sold. For the Three Months
    
    For the Six MonthsEnded June 30,
    
    Ended June 30,2004
    
    2003
    
    2004
    
    2003RevenueRental
    
    $
    805
    
    
    $
    299
    
    
    $
    973
    
    
    $
    1,070Property Operations
    
    
    569
    
    
    
    195
    
    
    
    741
    
    
    
    648Operating income
    
    
    236
    
    
    
    104
    
    
    
    232
    
    
    
    422ExpenseInterest
    
    
    182
    
    
    
    102
    
    
    
    301
    
    
    
    404Depreciation
    
    
    102
    
    
    
    66
    
    
    
    107
    
    
    
    153Total expenses
    
    
    284
    
    
    
    168
    
    
    
    408
    
    
    
    557Net (loss) from discontinued
operations before gains on sale of
operations
    
    
    (48
    )
    
    
    (64
    )
    
    
    (176
    )
    
    
    (135
    )Gain on sale of operations
    
    
    417
    
    
    
    
    
    
    
    3,674
    
    
    
    Net income/(loss) from discontinued
operations
    
    $
    369
    
    
    $
    (64
    )
    
    $
    3,498
    
    
    $
    (135
    )
 Discontinued operations have not been segregated in the consolidated statement
of cash flows. Therefore, amounts for certain captions will not agree with
respective consolidated statements of operations. NOTE 11. COMMITMENTS AND CONTINGENCIES Liquidity.Management anticipates that IORI will generate excess cash from
operations in 2004 due to increased rental rates and occupancy at its
properties, however, such excess may not be sufficient to discharge all of
IORIs debt obligations as they mature. Management intends to selectively sell
income producing real estate, refinance real estate and incur additional
borrowings against real estate to meet its cash requirements. Other Litigation.IORI is also involved in various other lawsuits arising in
the ordinary course of business. Management is of the opinion that the outcome
of these lawsuits should have no material impact on the Companys financial
condition, results of operations or liquidity. 12




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##### Table of Contents



ITEM 2.
    MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Introduction IORI invests in equity interests in real estate through acquisitions, leases
and partnerships and also invests in mortgage loans. IORI is the successor to
a California business trust organized on December 14, 1984, which commenced
operations on April 10, 1985. Critical Accounting Policies Critical accounting policies are those that are both important to the
presentation of IORIs financial condition and results of operations and
require managements most difficult, complex or subjective judgments. IORIs
critical accounting policies relate to the evaluation of impairment of
long-lived assets and the evaluation of the collectibility of accounts and
notes receivable. If events or changes in circumstances indicate that the carrying value of a
rental property to be held and used or land held for development may be
impaired, management performs a recoverability analysis based on estimated
undiscounted cash flows to be generated from the property in the future. If
the analysis indicates that the carrying value is not recoverable from future
cash flows, the property is written down to estimated fair value and an
impairment loss is recognized. If management decides to sell rental properties
or land held for development, management evaluates the recoverability of the
carrying amounts of the assets. If the evaluation indicates that the carrying
value is not recoverable from estimated net sales proceeds, the property is
written down to estimated fair value less costs to sell and an impairment loss
is recognized within income from continuing operations. IORIs estimates of
cash flow and fair values of the properties are based on current market
conditions and consider matters such as rental rates and occupancies for
comparable properties, recent sales data for comparable properties and, where
applicable, contracts or the results of negotiations with purchasers or
prospective purchasers. IORIs estimates are subject to revision as market
conditions and IORIs assessments of them change. IORIs allowance for doubtful accounts receivable and notes receivable is
established based on analysis of the risk of loss on specific accounts. The
analysis places particular emphasis on past due accounts. Management considers
such information as the nature and age of the receivable, the payment history
of the tenant or other debtor, the financial condition of the tenant or other
debtor and IORIs assessment of its ability to meet its lease or interest
obligations. IORIs estimate of the required allowance, which is reviewed on a
quarterly basis, is subject to revision as these factors change and is
sensitive to the effects of economic and market conditions. Typically, IORIs
notes receivable are collateralized by income producing real estate. IORI had
notes receivable of $48.8 million and $45.5 million at June 30, 2004 and
December 31, 2003, respectively. Liquidity and Capital Resources Cash and cash equivalents at June 30, 2004 were $118,000, compared with $58,000
at December 31, 2003. IORIs principal sources of cash have been and will
continue to be property operations, proceeds from property sales, financings
and refinancings and partnership distributions. Management anticipates that
IORI will generate excess cash from operations in 2004 due to increased rental
receipts at its properties, however, such excess will not be sufficient to
discharge all of IORIs debt obligations as they mature. Management intends to
selectively sell income producing real estate, refinance real estate and incur
additional borrowings against real estate to meet its cash requirements. The Company reported net income of $3.0 million for the six months ended June
30, 2004, which included the following non-cash charges: depreciation of
$636,000, gain on sale of real estate of $3.7 million, gain on equity
partnership of $11,000, increase in interest receivable of $317,000, increase
in other assets of $1.9 million, decrease in interest payable of $108,000, and
increase in other liabilities of $231,000. Net cash used in operating
activities amounted to $2.2 million for the six months ended June 30, 2004.
During the six months ended June 30, 2004, the increase in other assets was
primarily due to increase in accounts receivable from affiliates and the
increase in other liabilities was primarily due to increase in accounts payable
in general. Net cash provided by investing activities of $420,000 was
comprised of proceeds from sale of real estate of $3.4 million net of payments
to SWI of $3.0 million. Net cash provided by financing activities of $1.8
million was comprised of payments on notes payable of $462,000, proceeds on
notes payable of $1.2 million, advances from affiliates of $1.0 million, and
deferred financing cost of $90,000. 13




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##### Table of Contents



Management reviews the carrying values of IORIs properties at least annually
and whenever events or a change in circumstances indicate that impairment may
exist. Impairment is considered to exist if, in the case of a property, the
future cash flow from the property (undiscounted and without interest) is less
than the carrying amount of the property. If impairment is found to exist, a
provision for loss is recorded by a charge against earnings. The property
review generally includes selective property inspections, discussions with the
manager of the property, visits to selected properties in the area and a
review of the following: (1) the propertys current rents compared to market
rents, (2) the propertys expenses, (3) the propertys maintenance requirements
and (4) the propertys cash flows. Results of Operations IORI had net income of $318,000 for the three months ended June 30 2004, and
net income of $3.0 million for the six months ended June 30, 2004, as compared
to net income of $632,000 and a net loss of $366,000 for the corresponding
periods in 2003. The net income in 2004 included gains on sale of real estate
totaling $3.7 million. Fluctuations in components of revenue and expense
between the 2004 and 2003 periods are discussed below. Rents in the three and six months ended June 30, 2004 were $1.3 million and
$3.4 million versus $2.3 million and $4.0 million in the corresponding periods
in 2003. The decreases in 2004 were primarily due to the sale of three
properties in 2004. Rental income for the remaining quarters of 2004 may be
expected to decrease if IORI selectively sells properties. Property operations expense in the three and six months ended June 30, 2004
were $519,000 and $1.7 million versus $1.2 million and $2.2 million in the
corresponding periods in 2003. The decreases in 2004 were primarily due to the
sale of three properties in 2004. Property operations expense may be expected
to decrease in the remaining quarters of 2004 if IORI selectively sells
properties. Interest income in the three and six months ended June 30, 2004 was $605,000
and $1.2 million versus $614,000 and $614,000 in the corresponding periods in
2003. The six months increase in 2004 from 2003 was due to interest income
earned from the wraparound promissory notes with Encino Executive Plaza and the
promissory notes with Housing for Seniors of Humble, LLC. Interest expense in the three and six months ended June 30, 2004 was $845,000
and $1.8 million versus $1.2 million and $2.1 million in the corresponding
periods in 2003. The decreases in 2004 from 2003 were primarily due to
repayment of mortgages from the sale of properties throughout the year.
Interest expense in 2004 is expected to remain constant or decrease if IORI
selectively sells properties. Depreciation expense in the three and six months ended June 30, 2004 was
$188,000 and $530,000 versus $456,000 and $776,000 in the corresponding periods
in 2003. The decreases in 2004 from 2003 were primarily due to the sale of
properties throughout the year and fully depreciated tenant improvements. Advisory fee to affiliate in the three and six months ended June 30, 2004 was
$202,000 and $395,000 versus $167,000 and $334,000 in the corresponding periods
in 2003. The increases in 2004 from 2003 were due to changes in gross assets,
the basis of the fee. See NOTE 8. ADVISORY FEES. Net income fee to affiliate was $245,000 for the six months ended June 30,
2004. The net income fee is based on 7.5% of IORIs net income. General and administrative expense in the three and six months ended June 30,
2004 was $176,000 and $446,000 versus $114,000 and $369,000 in the
corresponding periods in 2003. The increases in 2004 from 2003 were primarily
due to the increase in property insurance expense. Related Party Transactions Historically, IORI, ARI, RRI, and TCI have each engaged in and may continue to
engage in business transactions, including real estate partnerships with
related parties. Management believes that all of the related party
transactions represented the best investments available at the time and were at
least as advantageous to IORI, ARI, RRI, and TCI as could have been obtained
from unrelated third parties. 14




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##### Table of Contents



Taxes For the tax years prior to 2003, IORI elected and qualified to be treated as a
Real Estate Investment Trust (REIT), as defined in Sections 856 and 860 of
the Internal Revenue Code of 1986, as amended (the Code), and as such was not
taxed for federal income tax purposes on that portion of its taxable income
which is distributed to stockholders. Due to the completion of a tender offer
by ARI, an affiliate, and the resulting concentration of ownership, IORI no
longer met the requirements for tax treatment as a REIT under the Code as of
January 1, 2003, and is prohibited from re-qualifying for REIT status for at
least five years. Financial statement income varies from taxable income principally due to the
accounting for income and losses of investees, gains and losses from asset
sales, depreciation on owned properties, amortization of discounts on notes
receivable and payable and the difference in the allowance for estimated
losses. IORI had a loss for federal income tax purposes after the use of net
operating loss carryforwards in the second quarter of 2004 and a loss for
federal income tax purposes in the second quarter of 2003; therefore, it
recorded no provision for income taxes. At June 30, 2004, IORI had a net deferred tax asset of $3.2 million due to tax
deductions available to it in future years. However, as management cannot
determine that it is more likely than not that IORI will realize the benefit of
the deferred tax asset, a 100% valuation allowance has been established. Inflation The effects of inflation on IORIs operations are not quantifiable. Revenues
from apartment operations tend to fluctuate proportionately with inflationary
increases and decreases in housing costs. Fluctuations in the rate of
inflation also affect the sales value of properties and the ultimate gain to be
realized from property sales. To the extent that inflation affects interest
rates, earnings from short-term investments and the cost of new financings, as
well as the cost of variable interest rate debt, will be affected. Environmental Matters Under various federal, state and local environmental laws, ordinances and
regulations, IORI may be potentially liable for removal or remediation costs,
as well as certain other potential costs, relating to hazardous or toxic
substances (including governmental fines and injuries to persons and property)
where property-level managers have arranged for the removal, disposal or
treatment of hazardous or toxic substances. In addition, certain environmental
laws impose liability for release of asbestos-containing materials into the air
and third parties may seek recovery for personal injury associated with such
materials. Management is not aware of any environmental liability relating to the above
matters that would have a material adverse effect on IORIs business, assets or
results of operations. 
 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES REGARDING MARKET RISK At June 30, 2004, IORIs exposure to a change in interest rates on its debt is
as follows: Weighted
    
    Effect of 1%Average
    
    Increase InBalance
    
    Interest Rate
    
    Base RatesWholly-owned debt:Variable rate
    
    $
    15,304
    
    
    
    7.17
    %
    
    $
    153Total decrease in IORIs annual Net income
    
    
    
    
    
    
    
    
    
    $
    153Per share
    
    
    
    
    
    
    
    
    
    $
    0.11
 15




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##### Table of Contents



ITEM 4. CONTROLS AND PROCEDURES  (a)
    
    Within the 90 days prior to the date of this report, IORI carried out an
evaluation, under the supervision and with the participation of IORIs
management, including IORIs Acting Principal Executive Officer and
principal accounting officer, of the effectiveness of the design and
operation of IORIs disclosure controls and procedures pursuant to
Exchange Act Rule 13a-14. Based upon the evaluation, IORIs Acting
Principal Executive Officer and principal accounting officer concluded
that IORIs disclosure controls and procedures are effective in timely
alerting him to material information relating to IORI (including its
consolidated subsidiaries) required to be included in IORIs periodic SEC
filings.  (b)
    
    There have been no significant changes in IORIs internal controls or in
other factors that could significantly affect IORIs internal controls
subsequent to the date IORI carried out this evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses. 16




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##### Table of Contents



PART II. OTHER INFORMATION 
  ITEM 1.
    LEGAL PROCEEDINGS On August 10, 2004, American Realty Investors, Inc. ("ARI"),
Transcontinental Realty Investors, Inc. ("TCI") and Income
Opportunity Realty Investors, Inc. ("IOT") instituted an action in
Texas State District Court as Cause No. 2004-60231-393
styled American Realty Investors, Inc., Transcontinental Realty
Investors, Inc. and Income Opportunity Realty Investors, Inc.,
Plaintiffs v. Innovo Realty, Inc. and Innovo Group, Inc., Involuntary
Plaintiffs v. Innovo Realty, Inc., Metra Capital LLC, Innovo Group,
Inc., Joseph Mizrachi, Simon Mizrachi, Hubert Guez, Third Millennium
Partners LLC, Third Millennium Partners, Inc., Third Millennium
Group, LLC and Sunridge Management Group, Inc., Defendants.
Plaintiffs complaint alleges that Joseph Mizrachi, a former
director of ARI and others, offered a plan to the Plaintiffs to
create one more joint venture arrangements with one or more of the
Plaintiffs to pursue alternative forms of financing or refinancing
portions of Plaintiffs real estate portfolios, which entailed
the creation of 22 separate limited partnerships to acquire 28
separate apartment complexes in three states (Texas, Florida and
Louisiana), the general partners of which are affiliates of, or
controlled by, Joseph Mizrachi. Plaintiffs complaint alleges
that the overall transaction required the establishment of a sinking
fund the Defendants and the 22 limited partnerships as a trust
for the benefit of certain preferred shareholders of Innovo Group,
Inc. and the payment of certain proceeds to the Plaintiffs.
Plaintiffs assert that payments have not been made pursuant to the
agreement of the parties. Plaintiffs allege that Defendants
conduct constituted a common business enterprise, alleges breach of
contract and derivative claims on behalf of Innovo Group, Inc.
against Joseph Mizrachi and others and requests declaratory relief
involving the Plaintiffs rights in the partnerships, and
accounting of proceeds, and the creation of a constructive trust.
Plaintiffs complaint also alleges that Joseph Mizrachi engaged
in fraud, negligent misrepresentation and/or breach of fiduciary duty
and seeks unspecified damages, attorneys fees, a constructive
trust to be established, and other relief. 
  ITEM 2.
    CHANGES IN SECURITIES, USE OF PROCEEDS, AND ISSUER PURCHASES OF EQUITY SECURITIES Total Number
    
    Maximumof Shares
    
    Number ofPurchased as
    
    Shares thatPart of
    
    May Yet beTotal Number
    
    Average Price
    
    Publicly
    
    Purchasedof Shares
    
    Paid per
    
    Announced
    
    Under thePeriod
    
    Purchased
    
    Share
    
    Program
    
    Program(a)April 1-30, 2004
    
    
    
    
    
    $
    
    
    
    
    
    
    
    
    May 1-31, 2004
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    June 1-30, 2004
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total
    
    
    
    
    
    $
    
    
    
    
    
    
    
    
    206,500
  (a)
    
    On June 23, 2000, the IORI Board of Directors approved a share
repurchase program for up to 500,000 shares of our common stock. This
repurchase program has no termination date. 
 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K  (a)
    
    Exhibits: ExhibitNumber
    
    Description31.1
    
    Certification Pursuant to Rules 13a-14 and 15d-14 Under the Securities
Exchange Act of 1934, as Adopted Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002, filed herewith.32.1
    
    Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002, filed herewith.
  (b)
    
    Reports on Form 8-K:  During the quarter for which this report if filed, the following current
reports on Form 8-K were filed for events occurring on the dates indicated
below covering the items set forth below:  (i)
    
    Current Report on Form 8-K for event occurring May 31, 2004
reporting under Item 4 Changes in Registrant's Certifying
Accountant, Item 5 Other Events and Regulation FD
Disclosure, and Item 7 Financial Statements and
Exhibits.(ii)
    
    Current Report on Form 8-K for event occurring June 17, 2004
reporting under Item 4 Changes in Registrant's Certifying
Accountant and Item 7 Financial Statements and
Exhibits.(iii)
    
    Current Report on Form 8-K for event occurring July 15, 2004
reporting under Item 4 Changes in Registrant's Certifying
Accountant, Item 5 Other Events and Regulation FD
Disclosure, and Item 7 Financial Statements and
Exhibits. 17




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##### Table of Contents



SIGNATURE PAGE Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized. INCOME OPPORTUNITY REALTY INVESTORS, INC.Date: August 15, 2004
    By:
    /s/ Ken L. JoinesKen L. JoinesExecutive Vice President, Chief Financial
Officer, and Acting Principal Executive
Officer 18




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##### Table of Contents



INCOME OPPORTUNITY REALTY INVESTORS, INC.
EXHIBITS TO
QUARTERLY REPORT ON FORM 10-Q
For the Quarter ended June 30, 2004 Exhibit
    
    
    
    PageNumber
    
    Description
    
    Number31.1
    
    Certification Pursuant to Rules 13a-14 and 15d-14 Under the
Securities Exchange Act of 1934, as Adopted Pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.32.1
    
    Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.