<PAGE>   1
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549


                                   FORM 10-K

           [X] ANNUAL REPORT PURSUANT TO SECTIONS 13 OR 15(d) OF THE
      SECURITIES EXCHANGE ACT OF 1934 FOR THE YEAR ENDED DECEMBER 31, 1997
                                                         

                        Commission File Number 1-9525
                                               ------

                   INCOME OPPORTUNITY REALTY INVESTORS, INC.
                   -----------------------------------------

             (Exact Name of Registrant as Specified in Its Charter)

           Nevada                                                75-2615944
-------------------------------                             -------------------
(State or Other Jurisdiction of                             (I.R.S. Employer
 Incorporation or Organization)                             Identification No.)

10670 North Central Expressway, Suite 300, Dallas, Texas               75231
--------------------------------------------------------              --------
       (Address of Principal Executive Offices)                      (Zip Code)

                                 (214) 692-4700
              ----------------------------------------------------
              (Registrant's Telephone Number, Including Area Code)

          Securities Registered Pursuant to Section 12(b) of the Act:

                                                       Name of each exchange on
     Title of each class                                    which registered
----------------------------                           ------------------------

Common Stock, $.01 par value                            American Stock Exchange

          Securities Registered Pursuant to Section 12(g) of the Act:
                                      NONE

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 at least the past 90 days. Yes [X]   No [ ]

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.  Yes [X]  No [ ]

As of March 6, 1998, the Registrant had 1,519,888 shares of Common Stock
outstanding. Of the total shares outstanding 623,836 were held by other than
those who may be deemed to be affiliates, for an aggregate value of $7,174,114
based on the last trade as reported on the American Stock Exchange on March 6,
1998. The basis of this calculation does not constitute a determination by the
Registrant that all of such persons or entities are affiliates of the Registrant
as defined in Rule 405 of the Securities Act of 1933, as amended.


                      Documents Incorporated by Reference:
                                      NONE

                                       1

<PAGE>   2



                                    INDEX TO
                           ANNUAL REPORT ON FORM 10-K



                                     PART I                                 Page
                                     ------                                 ----

Item 1.     Business..................................................        3

Item 2.     Properties................................................        7

Item 3.     Legal Proceedings.........................................       15

Item 4.     Submission of Matters to a Vote of Security
               Holders.................................................      16


                                    PART II
                                    -------


Item 5.     Market for the Registrant's Common Equity
               and Related Stockholder Matters.........................      16

Item 6.     Selected Financial Data...................................       18

Item 7.     Management's Discussion and Analysis of Financial
               Condition and Results of Operations.....................      19

Item 8.     Financial Statements and Supplementary Data...............       25

Item 9.     Changes in and Disagreements with Accountants on
               Accounting and Financial Disclosure....................       50


                                    PART III
                                    --------


Item 10.    Directors, Executive Officers and Advisor of the
               Registrant.............................................       50

Item 11.    Executive Compensation....................................       60

Item 12.    Security Ownership of Certain Beneficial Owners and
               Management.............................................       62

Item 13.    Certain Relationships and Related Transactions............       63


                                    PART IV
                                    -------


Item 14.    Exhibits, Consolidated Financial Statements,
               Schedules and Reports on Form 8-K......................       66

Signature Page........................................................       68

                                       2

<PAGE>   3



                                     PART I


ITEM 1.        BUSINESS

Income Opportunity Realty Investors, Inc. (the "Company" or "Registrant"), a
Nevada corporation, is the successor to a California business trust organized
pursuant to a declaration of trust dated December 14, 1984. The Company has
elected to be treated as a Real Estate Investment Trust ("REIT") under Sections
856 through 860 of the Internal Revenue Code of 1986, as amended (the "Code").
The Company has, in the opinion of the Company's management, qualified for
federal taxation as a REIT for all periods since May 1, 1985.

The Company's real estate at December 31, 1997, consisted of fourteen
properties held for investment and an interest in a partnership which owns five
properties. Eight of the Company's properties held for investment were
purchased in 1997. The Company's mortgage notes receivable at December 31, 1997
consisted of one mortgage loan. No mortgage loans were funded during 1997. In
addition, the Company has an interest in a partnership which holds one
wraparound mortgage loan. The Company's real estate and mortgage notes
receivable portfolios are more fully discussed in ITEM 2. "PROPERTIES."

Business Plan

The Company's primary business and only industry segment is investing in equity
interests in real estate through direct equity investments and partnerships and
financing real estate and real estate related activities through investments in
mortgage loans. The Company's real estate is located in the Pacific, Southeast
and Southwest regions of the continental United States. Information regarding
the real estate and mortgage note receivable portfolios of the Company is set
forth in ITEM 2. "PROPERTIES," and in Schedules III and IV to the Consolidated
Financial Statements included at ITEM 8. "FINANCIAL STATEMENTS AND
SUPPLEMENTARY DATA."

The Company's business is not seasonal. The Company has determined to continue
to pursue a balanced investment strategy, seeking both current income and
capital appreciation. With respect to new investments, the Company's plan of
operation is to acquire higher class apartment and commercial properties in
keeping with the current class of properties in the Company's real estate
portfolio. In 1998, the Company intends to focus on apartment acquisitions in
order to maintain a balance of apartment and commercial properties in its real
estate portfolio. The Company does not expect that it will seek to fund or
acquire new mortgage loans. It may, however, originate mortgage loans in
conjunction with providing purchase money financing of a property sale. The
Company also intends to continue its strategy of maximizing each property's
operating income by aggressive property management through closely monitoring
expenses while at the same time making property renovations and/or improvements
where appropriate. While such expenditures increase the amount of revenue
required to cover operating expenses, the Company's management believes that
such expenditures are necessary to maintain or enhance the value of the
Company's properties.

                                       3

<PAGE>   4



ITEM 1.        BUSINESS (Continued)

Business Plan (Continued)

The Company's Board of Directors currently intends to continue its policy of
prohibiting the Company from incurring aggregate secured and unsecured
indebtedness in excess of 300% of the Company's net asset value (defined as the
book value of all assets of the Company minus all of its liabilities); however,
the Board of Directors may alter such policy at any time.

Management of the Company

Although the Company's Board of Directors is directly responsible for managing
the affairs of the Company and for setting the policies which guide it, the
day-to-day operations of the Company are performed by Basic Capital Management,
Inc. ("BCM" or the "Advisor"), a contractual advisor under the supervision of
the Company's Board of Directors. The duties of the Advisor include, among
other things, locating, investigating, evaluating and recommending real estate
and mortgage note investment and sales opportunities, as well as financing and
refinancing sources for the Company. The Advisor also serves as a consultant in
connection with the Company's business plan and investment decisions made by
the Company's Board of Directors.

BCM is a company owned by a trust for the benefit of the children of
Gene E. Phillips.  Mr. Phillips served as a Trustee of the Trust until
December 31, 1992.  Mr. Phillips also served as a director of BCM until
December 22, 1989, and as Chief Executive Officer of BCM until September
1, 1992.  Mr. Phillips serves as a representative of his children's
trust which owns BCM and, in such capacity, has substantial contact with
the management of BCM and input with respect to its performance of
advisory services to the Company.  BCM is more fully described in ITEM
10. "DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT - The
Advisor."

BCM has been providing advisory services to the Company since March 28,
1989.  Renewal of BCM's advisory agreement with the Company was approved
by the Company's stockholders at the Company's annual meeting of
stockholders held on May 8, 1997.  BCM also serves as advisor to
Continental Mortgage and Equity Trust ("CMET") and Transcontinental
Realty Investors, Inc. ("TCI"). The Directors of the Company are also
trustees of CMET and directors of TCI and the officers of the Company
are also officers of CMET and TCI.  Mr. Phillips is a general partner of
Syntek Asset Management, L.P. ("SAMLP"), the general partner of National
Realty, L.P. ("NRLP") and National Operating, L.P. ("NOLP"), the
operating partnership of NRLP.  BCM performs certain administrative
functions for NRLP and NOLP on a cost-reimbursement basis.  BCM also
serves as advisor to American Realty Trust, Inc. ("ART").  Mr. Phillips
served as a director and Chairman of the Board of ART until November 16,
1992.  Randall M. Paulson, President of the Company, also serves as
President of CMET, TCI and BCM, Executive Vice President of ART, and as
the President and sole director of Syntek Asset Management, Inc.
("SAMI"), the managing general partner of SAMLP.  The officers of the
Company are also officers of ART and SAMI.  As of March 6, 1998, ART and

                                       4

<PAGE>   5



ITEM 1.        BUSINESS (Continued)

Management of the Company (Continued)

TCI each owned approximately 29.7% and 22.5% of the Company's outstanding
shares of Common Stock and BCM owned approximately 39.0% of ART's outstanding
shares of common stock.

Since February 1, 1990, affiliates of BCM have provided property
management services to the Company.  Currently Carmel Realty Services,
Ltd. ("Carmel, Ltd.") provides such property management services.
Carmel, Ltd. subcontracts with other entities for the provision of
property-level management services to the Company.  The general partner
of Carmel, Ltd. is BCM.  The limited partners of Carmel, Ltd. are (i)
First Equity Properties, Inc. ("First Equity"), which is 50% owned by
BCM, (ii) Gene E. Phillips, and (iii) a trust for the benefit of the
children of Mr. Phillips.  Carmel, Ltd. subcontracts the property-level
management and leasing of nine of the Company's office buildings and the
commercial properties owned by a real estate partnership in which the
Company and TCI are partners to Carmel Realty, Inc. ("Carmel Realty"),
which is a company owned by First Equity.  Carmel Realty is entitled to
receive property and construction management fees and leasing
commissions in accordance with the terms of its property-level
management agreement with Carmel, Ltd.

Carmel Realty is also entitled to receive real estate brokerage
commissions in accordance with the terms of a nonexclusive brokerage
agreement as discussed in ITEM 10.  "DIRECTORS, EXECUTIVE OFFICERS AND
ADVISOR TO THE REGISTRANT - The Advisor."

The Company has no employees. Employees of the Advisor render services to the
Company.

Competition

The real estate business is highly competitive and the Company competes with
numerous entities engaged in real estate activities (including certain entities
described in ITEM 13. "CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - Related
Party Transactions"), some of which may have greater financial resources than
those of the Company. The Company's management believes that success against
such competition is dependent upon the geographic location of the property, the
performance of the property managers in areas such as marketing, collection and
the ability to control operating expenses, the amount of new construction in
the area and the maintenance and appearance of the property. Additional
competitive factors with respect to commercial properties are the ease of
access to the property, the adequacy of related facilities, such as parking,
and sensitivity to market conditions in setting rent levels. With respect to
apartments, competition is also based upon the design and mix of the units and
the ability to provide a community atmosphere for the tenants. The Company's
management believes that general economic circumstances and trends and new or
renovated properties in the vicinity of each of the Company's properties are
also competitive factors.

                                       5

<PAGE>   6



ITEM 1.        BUSINESS (Continued)

Competition (Continued)

To the extent that the Company seeks to sell any of its properties, the sales
prices for such properties may be affected by competition from other real
estate entities and financial institutions also attempting to sell their
properties located in areas in which the Company's properties are located.

As described above and in ITEM 13. "CERTAIN RELATIONSHIPS AND RELATED
TRANSACTIONS" - Related Party Transactions," the officers and Directors of the
Company also serve as officers, directors or trustees of certain other
entities, each of which is also advised by BCM, and each of which has business
objectives similar to those of the Company. The Company's Directors, officers
and Advisor owe fiduciary duties to such other entities as well as to the
Company under applicable law. In determining to which entity a particular
investment opportunity will be allocated, the officers, trustees or directors
and the Advisor consider the respective investment objectives of each such
entity and the appropriateness of a particular investment in light of each such
entity's existing real estate and mortgage notes receivable portfolios. To the
extent that any particular investment opportunity is appropriate to more than
one of such entities, such investment opportunity will be allocated to the
entity which has had funds available for investment for the longest period of
time or, if appropriate, the investment may be shared among all or some of such
entities.

In addition, also as described in ITEM 13. "CERTAIN RELATIONSHIPS AND RELATED
TRANSACTIONS - Certain Business Relationships," the Company also competes with
other entities which are affiliates of the Advisor and which may have
investment objectives similar to the Company's and that may compete with the
Company in the acquisition, sale, leasing and financing of real estate. In
resolving any potential conflicts of interest which may arise, the Advisor has
informed the Company that it intends to continue to exercise its best judgment
as to what is fair and reasonable under the circumstances in accordance with
applicable law.

Certain Factors Associated with Real Estate and Related Investments

The Company is subject to all the risks incident to ownership and financing of
real estate and interests therein, many of which relate to the general
illiquidity of real estate investments. These risks include, but are not
limited to, changes in general or local economic conditions, changes in
interest rates and the availability of permanent mortgage financing which may
render the acquisition, sale or refinancing of a property difficult or
unattractive and which may make debt service burdensome, changes in real estate
and zoning laws, increases in real estate taxes, federal or local economic or
rent controls, floods, earthquakes, hurricanes and other acts of God, and other
factors beyond the control of the Company's management or Advisor. Also, the
illiquidity of real estate investments may impair the ability of the Company to
respond promptly to changing circumstances. The Company's management believes
that such risks are partially mitigated by the

                                       6

<PAGE>   7



ITEM 1.        BUSINESS (Continued)

Certain Factors Associated with Real Estate and Related Investments
(Continued)

diversification by geographic region and property type of the Company's real
estate portfolio. However, to the extent property acquisitions are concentrated
in any particular geographic region or property type, the advantages of
diversification may be mitigated.


ITEM 2.        PROPERTIES

The Company's principal offices are located at 10670 North Central Expressway,
Suite 300, Dallas, Texas 75231. In the opinion of the Company's management, the
Company's offices are suitable and adequate for its present operations.

Details of the Company's real estate and mortgage notes receivable portfolios
at December 31, 1997, are set forth in Schedules III and IV, respectively, to
the Consolidated Financial Statements included at ITEM 8. "FINANCIAL STATEMENTS
AND SUPPLEMENTARY DATA." The discussions set forth below under the headings
"Real Estate" and "Mortgage Loans" provide certain summary information
concerning the Company's real estate and mortgage notes receivable portfolios.

The Company's real estate portfolio consists of properties held for investment
and an investment in a partnership. The Company holds a fee simple title to all
of the properties in its real estate portfolio. The discussion set forth below
under the heading "Real Estate" provides certain summary information concerning
the Company's real estate and further summary information with respect to the
Company's properties held for investment and its partnership investment.

The Company's real estate is geographically diverse. At December 31, 1997, the
Company held equity investments in apartments and office buildings in the
Pacific, Southwest and Southeast regions of the continental United States, as
shown more specifically in the table under "Real Estate" below. The majority of
the Company's properties are, however, located in California and Texas. At
December 31, 1997, the Company held one wraparound mortgage note receivable,
secured by a shopping center in Joliet, Illinois.

At December 31, 1997, two of the Company's properties, Renaissance Parc
Apartments and Saratoga Office Building, each exceeded 10% of the Company's
total assets. At December 31, 1997, 91% of the Company's assets consisted of
properties held for investment, 2% consisted of a mortgage note and interest
receivable and 2% consisted of investments in partnerships. The remaining 5% of
the Company's assets at December 31, 1997, were cash, cash equivalents and
other assets. The percentage of the Company's assets invested in any one
category is subject to change and no assurance can be given that the
composition of the Company's assets in the future will approximate the
percentages listed above. See ITEM 1. "BUSINESS - Business Plan."

                                       7

<PAGE>   8



ITEM 2.        PROPERTIES (Continued)


To continue to qualify for federal taxation as a REIT under the Code, the
Company is required, among other things, to hold at least 75% of the value of
its total assets in real estate assets, government securities, cash and cash
equivalents at the close of each quarter of each taxable year.


























                     [THIS SPACE INTENTIONALLY LEFT BLANK.]

                                       8

<PAGE>   9



ITEM 2.        PROPERTIES (Continued)

Geographic Regions

The Company has divided the continental United States into the following
geographic regions.

         Northeast region comprised of the states of Connecticut, Delaware,
         Maryland, Massachusetts, New Hampshire, New Jersey, New York,
         Pennsylvania, Rhode Island and Vermont, and the District of Columbia.
         The Company has no properties in this region.

         Southeast region comprised of the states of Alabama, Florida, Georgia,
         Mississippi, North Carolina, South Carolina, Tennessee and Virginia.
         The Company has 2 commercial properties in this region.

         Southwest region comprised of the states of Arizona, Arkansas,
         Louisiana, New Mexico, Oklahoma and Texas. The Company has 4
         apartments and 2 office buildings in this region.

         Midwest region comprised of the states of Illinois, Indiana, Iowa,
         Kansas, Kentucky, Michigan, Minnesota, Missouri, Nebraska, North
         Dakota, Ohio, South Dakota, West Virginia and Wisconsin. The Company
         has no properties in this region.

         Mountain region comprised of the states of Colorado, Idaho, Montana,
         Nevada, Utah and Wyoming. The Company has no properties in this
         region.

         Pacific region comprised of the states of California, Oregon and
         Washington. The Company has 6 commercial properties in this region.

Real Estate

At December 31, 1997, approximately 91% of the Company's assets were invested
in real estate, located in the Pacific, Southeast and Southwest regions of the
continental United States, either on a leveraged or nonleveraged basis. The
Company's real estate portfolio consists of properties held for investment and
an investment in a partnership.

Types of Real Estate Investments. The Company's real estate consists of
apartments and commercial properties (office buildings) or similar properties
having established income-producing capabilities. In selecting real estate for
investment, the location, age and type of property, gross rentals, lease terms,
financial and business standing of tenants, operating expenses, fixed charges,
land values and physical condition are considered. The Company may acquire
properties subject to, or assume, existing debt and may mortgage, pledge or
otherwise obtain financing for its properties. The Company's Board of Directors
may alter the types of and criteria for selecting new real estate investments
and for obtaining financing without a vote of stockholders.

                                       9

<PAGE>   10



ITEM 2.       PROPERTIES (Continued)


Real Estate (Continued)

At December 31, 1997, the Company was completing construction of Valley View
Center, a 30,000 square foot office building in Farmers Branch, Texas. The
Company expects to expend approximately $1.5 million in 1998 to complete
construction and an additional $225,000 for tenant improvements. In addition,
the Company expects that in 1998 it will expend approximately $495,000 for
capital and tenant improvements at the Olympic Office Building, an office
building the Company acquired in 1996.

The Company has typically invested in developed real estate. The Company may
also invest in new construction or development either directly or in
partnership with nonaffiliated parties or affiliates (subject to approval by
the Company's Board of Directors). To the extent that the Company invests in
construction and development projects, such as Valley View Center, the Company
will be subject to business risks, such as cost overruns and construction
delays, associated with such higher risk projects.

In the opinion of the Company's management, the properties owned by the Company
are adequately covered by insurance.

The following table sets forth the percentages, by property type and geographic
region, of the Company's real estate at December 31, 1997.

<TABLE>
<CAPTION>

                                                           Commercial
           Region                     Apartments           Properties
           ------                     ----------           ----------
<S>                                   <C>                   <C>  
           Pacific ..............            - %                73.0%
           Southwest.............         100.0                 13.0
           Southeast ............            -                  14.0
                                          -----                -----

                                          100.0%               100.0%

</TABLE>

The foregoing table is based solely on the number of apartment units and
commercial square footage owned by the Company and does not reflect the value
of the Company's investment in each region. See Schedule III to the
Consolidated Financial Statements included at ITEM 8. "FINANCIAL STATEMENTS AND
SUPPLEMENTARY DATA" for a more detailed description of the Company's real
estate.

A summary of activity in the Company's owned real estate portfolio during 1997
is as follows:

<TABLE>
<CAPTION>

           <S>                                                              <C>
           Owned properties in real estate portfolio at
             January 1, 1997.................................                 9
           Properties purchased..............................                 8
           Properties sold...................................                (3)
                                                                             --
           Owned properties in real estate portfolio at
             December 31, 1997...............................                14
                                                                             ==
</TABLE>

                                       10

<PAGE>   11



ITEM 2.           PROPERTIES (Continued)

Real Estate (Continued)

Properties Held for Investment. Set forth below are the Company's properties
held for investment and the monthly rental rate for apartments and the average
annual rental rate for office buildings and occupancy thereof at December 31,
1997, 1996 and 1995:

<TABLE>
<CAPTION>

                                                                        Rent Per Square Foot                Occupancy %
                                                       Units/          --------------------------     -----------------------
    Property                 Location              Square Footage       1997      1996      1995       1997    1996      1995
-----------------        -----------------         ---------------     ------    ------    ------     ------  ------    -----
Apartments
----------
<S>                      <C>                       <C>                 <C>       <C>       <C>         <C>     <C>      <C>   
Eastpoint                Mesquite, TX                  126 units/
                                                   113,138 sq. ft.     $   .67   $  .66    $  .62       97      97       99
LaMonte Park             Houston, TX                   128 units/
                                                   123,184 sq. ft.         .59      *         *         96      *        *
Renaissance Parc         Dallas, TX                    294 units/
                                                   293,654 sq. ft.         .80      *         *         95      *        *
Treehouse                San Antonio, TX               106 units/
                                                    88,957 sq. ft.         .76      .75       .75       98      94       94
Office Buildings
Akard Plaza              Dallas, TX                 42,895 sq. ft.       13.27      *         *         99       *        *
Chuck Yeager             Chantilly, VA              60,060 sq. ft.       13.07      *         *         93       *        *
Daley Plaza
 Corporate Center        San Diego, CA             122,795 sq. ft.       12.74    12.88       *         76       80       *
Fireside Thrift
 Building                Newark, CA                 56,120 sq. ft.       18.92      *         *         81       *        *
La Mesa Village
 Plaza                   La Mesa, CA                92,611 sq. ft.       17.15      *         *         90       *        *
Olympic                  Los Angeles, CA            46,685 sq. ft.       21.94    16.09       *         73       73       *
Saratoga                 Saratoga, CA               89,825 sq. ft.       21.27    19.42     19.07      100       98      100
Town Center              Boca Raton, FL             24,518 sq. ft.        8.86     8.21      7.77      100      100      100
Valley View Center       Farmers Branch, TX         30,000 sq. ft.         **       **        **        **       **       **
Westlake Village         Westlake Village, CA       45,500 sq. ft.       14.20      *         *         98       *        *

</TABLE>
-----------------

*  Property was purchased in 1997 or 1996.
** Property was purchased in 1997 and construction is currently being completed.

In January 1997, the Company purchased the Chuck Yeager Building, a 60,060
square foot industrial/office building in Chantilly, Virginia, for $5.1
million. The Company paid $2.0 million in cash and obtained new mortgage
financing of $3.1 million. The mortgage bears interest at a variable rate,
currently 10.75% per annum, requires monthly payments of principal and interest
of $53,276 and matures in January 1999, with an option to extend the maturity
to January 2000. The Company paid a real estate brokerage commission of
$171,000 to Carmel Realty and a real estate acquisition fee of $51,000 to BCM
based on the $5.1 million purchase price of the property.

In March 1997, the Company completed the sale of the Plumtree Apartments, a 116
unit apartment complex in Martinez, California, that was under contract for
sale at December 31, 1996, for $7.8 million in cash. The Company received net
cash of $1.6 million after the payoff of $5.7 million in existing mortgage debt
and the payment of various closing costs associated with the sale. The Company
paid a real estate sales commission of $226,000 to Carmel Realty based on the
$7.8 million sales price of the property. The Company recognized a gain of $1.8
million on the sale.

                                       11

<PAGE>   12



ITEM 2.    PROPERTIES (Continued)

Real Estate (Continued)

In May 1997, the Company purchased the La Mesa Village Plaza, a 92,611 square
foot office building in La Mesa, California, for $8.1 million. The Company paid
$2.1 million in cash and obtained new mortgage financing of $6.0 million. The
mortgage bears interest at 9.1875% per annum, requires monthly payments of
principal and interest of $51,124 and matures in June 2007. The Company paid a
real estate brokerage commission of $232,000 to Carmel Realty and a real estate
acquisition fee of $81,000 to BCM based on the $8.1 million purchase price of
the property.

In June 1997, the Company sold the Porticos Apartments, a 256 unit apartment
complex in Milwaukee, Wisconsin, for $15.2 million in cash. The Company
received net cash of $5.2 million after the payoff of $9.6 million in existing
mortgage debt and the payment of various closing costs associated with the
sale. The Company paid a real estate brokerage commission of $348,000 to Carmel
Realty based on the $15.2 million sales price of the property. The Company
recognized a gain of $1.5 million on the sale.

Also in June 1997, the Company purchased Renaissance Parc Apartments, a 294
unit apartment complex in Dallas, Texas, for $15.7 million. The Company paid
$3.2 million in cash and obtained new mortgage financing of $12.5 million. The
mortgage bears interest at 8.375% per annum, requires monthly payments of
principal and interest of $95,161 and matures in July 2007. The Company paid a
real estate brokerage commission of $355,000 to Carmel Realty and a real estate
acquisition fee of $157,000 to BCM based on the $15.7 million purchase price of
the property.

Further in June 1997, the Company purchased LaMonte Park Apartments, a 128 unit
apartment complex in Houston, Texas, for $3.7 million. The Company paid
$200,000 in cash and assumed the existing mortgage of $3.5 million. The
mortgage bears interest at a variable rate, currently 8.6% per annum, requires
monthly payments of principal and interest of $30,527 and matures in July 2001.
The Company paid a real estate brokerage commission of $132,000 to Carmel
Realty and a real estate acquisition fee of $37,000 to BCM based on the $3.7
million purchase price of the property.

In September 1997, the Company purchased Valley View Center, a partially
complete four story office building in Farmers Branch, Texas, for $565,000 in
cash. The Company paid a real estate brokerage commission of $23,000 to Carmel
Realty and a real estate acquisition fee of $6,000 to BCM based on the $565,000
purchase price of the property.

In October 1997, the Company refinanced the matured mortgage debt secured by
Daley Plaza Corporate Center in San Diego, California in the amount of $7.0
million. The Company received net cash of $3.3 million after the payoff of $3.7
million in existing mortgage debt and the payment of various closing costs
associated with the refinancing. The new mortgage bears interest at a variable
rate, currently 9.75% per

                                       12

<PAGE>   13



ITEM 2.    PROPERTIES (Continued)


Real Estate (Continued)

annum, requires monthly payments of principal and interest of $62,380 and
matures in October 2002. The Company paid a mortgage brokerage and equity
refinancing fee of $70,000 to BCM based on the new $7.0 million mortgage.

In November 1997, the Company purchased Westlake Village, a 45,500 square foot
office building in Westlake Village, California, for $3.9 million. The Company
paid $1.0 million in cash and obtained new mortgage financing of $2.9 million.
The mortgage bears interest at a variable rate, currently 9.75% per annum,
requires monthly payments of principal and interest of $26,258 and matures in
October 2002. The Company paid a real estate brokerage commission of $134,000
to Carmel Realty and a real estate acquisition fee of $39,000 to BCM based on
the $3.9 million purchase price of the property.

In December 1997, the Company purchased Akard Plaza, a 42,895 square foot
office building in Dallas, Texas, for $3.5 million. The Company paid $1.0
million in cash with the seller providing purchase money financing of the
remaining $2.5 million of the purchase price. The financing bears interest at
9% per annum, requires monthly payments of interest only and matures in June
1998. The Company paid a real estate brokerage commission of $125,000 to Carmel
Realty and a real estate acquisition fee of $35,000 to BCM based on the $3.5
million purchase price of the property.

Also in December 1997, the Company purchased Fireside Thrift, a 56,120 square
foot office building in Newark, California, for $6.0 million. The Company paid
a $1.7 million in cash and assumed the existing mortgage of $4.3 million. The
mortgage bears interest at 9.4% per annum, requires monthly payments of
principal and interest of $35,843 and matures in September 2006. The Company
paid a real estate brokerage commission of $190,000 to Carmel Realty and a real
estate acquisition fee of $60,000 to BCM based on the $6.0 million purchase
price of the property.

Further in December 1997, the Company sold the Spanish Trace Apartments, a 136
unit apartment complex in Irving, Texas, for $1.8 million in cash. The Company
had obtained the property through foreclosure in 1994. The Company received net
cash of $1.7 million after the payment of various closing costs associated with
the sale. The Company paid a real estate brokerage commission of $72,000 to
Carmel Realty based on the $1.8 million sales price of the property. The
Company recognized a gain of $631,000 on the sale.

Partnership Properties.  Set forth below are the properties owned by a
partnership in which the Company is an equity investee and the monthly

                                       13

<PAGE>   14



ITEM 2.    PROPERTIES (Continued)

Real Estate (Continued)

rental rate for apartments and the average annual rental rate for commercial
properties and occupancy thereof at December 31, 1997, 1996 and 1995:
<TABLE>
<CAPTION>

                                                                               Rent Per
                                                                              Square Foot                   Occupancy %
                                                       Units/          --------------------------     ----------------------
   Property                Location               Square Footage       1997      1996      1995        1997    1996      1995
-----------------        --------------            ---------------     ------    ------    ------     ------  ------    -----
Apartments
----------
<S>                      <C>                       <C>                 <C>       <C>       <C>       <C>    <C>       <C>   
Inwood Greens            Houston, TX                   126 units/
                                                   105,960 sq. ft.     $   .46   $  .45    $  .44       94        93       93
Oaks of Inwood           Houston, TX                   198 units/
                                                   167,872 sq. ft.         .45      .44       .43       94        93       91
Office Building
MacArthur Mills          Carrollton, TX             53,472 sq. ft.        9.35     8.38      7.60       97        94       95

Shopping Centers
Chelsea Square           Houston, TX                70,275 sq. ft.        9.21     9.32      9.51       49        69       77
Summit at
 Bridgewood              Fort Worth, TX             48,696 sq. ft.        9.48     8.67      9.27       65        62       63
</TABLE>

The Company owns a 36.3% general partner interest and TCI owns a 63.7% combined
general and limited partner interest in Tri-City Limited Partnership which in
turn owns the five properties listed above. In 1997, the Company made advances
to the partnership of $218,000 and received $218,000 in operating distributions
and $627,000 in financing distributions from the partnership.


Mortgage Loans

Prior to 1991, a substantial portion of the Company's assets had been invested
in mortgage notes receivable secured by income-producing real estate. The
Company's mortgage notes have included first mortgage loans, wraparound
mortgage loans and junior mortgage loans. The Company has determined that it
will not seek to fund or acquire new mortgage loans, other than those which it
may originate in conjunction with providing purchase money financing of a
property sale. See ITEM 1. "BUSINESS". BCM, in its capacity as a mortgage
servicer, services the Company's mortgage note receivable.

Wraparound Mortgage Loans. A wraparound mortgage loan, sometimes called an
all-inclusive loan, is a mortgage loan having an original principal amount
equal to the outstanding balance under the prior existing mortgage loan(s) plus
the amount actually advanced under the wraparound mortgage loan.

At December 31, 1997, the Company's mortgage notes receivable portfolio
consisted of one performing wraparound mortgage note, with an outstanding
principal balance of $2.0 million, secured by a shopping center in Joliet,
Illinois.

During 1997, the Company funded no new mortgage loans and made no additional
advances on its existing mortgage loan.

                                       14

<PAGE>   15



ITEM 2.    PROPERTIES (Continued)

Mortgage Loans (Continued)

Partnership mortgage loans. The Company owns a 40% general partner interest and
TCI owns a 60% general partner interest in Nakash Income Associates ("NIA").
NIA in turn owns a wraparound mortgage note receivable secured by a building
occupied by a Wal-Mart in Maulden, Missouri. In August 1997, Mountain Home
Associates, the owner of the shopping center, refinanced the matured mortgage
secured by the shopping center in the amount of $850,000. The mortgage bears
interest at a variable rate, currently 9.5% per annum, requires monthly
payments of principal and interest of $13,000 and matures in May 2005.

ITEM 3.  LEGAL PROCEEDINGS

Olive Litigation

In February 1990, the Company, together with CMET, National Income Realty Trust
and TCI, three real estate entities with, at the time, the same officers,
directors or trustees and advisor as the Company, entered into a settlement of
a class and derivative action entitled Olive et al. v. National Income Realty
Trust et al., in the United States District Court for the Northern District of
California, relating to the operation and management of each of the entities.
On April 23, 1990, the Court granted final approval of the terms of the
settlement.

On May 4, 1994, the parties entered into a Modification of Stipulation of
Settlement dated April 27, 1994 (the "Olive Modification") which settled
subsequent claims of breaches of the settlement that were asserted by the
plaintiffs and that modified certain provisions of April 1990 settlement. The
Olive Modification was preliminarily approved by the Court July 1, 1994 and
final Court approval was entered on December 12, 1994. The effective date of
the Modification was January 11, 1995.

The Court retained jurisdiction to enforce the Olive Modification, and during
August and September 1996, the Court held evidentiary hearings to assess
compliance with the terms of the Olive Modification by various parties. The
Court issued no ruling or order with respect to the matters addressed at the
hearings.

Separately, in 1996, legal counsel for the plaintiffs notified the Company's
Board of Directors that he intended to assert that certain actions taken by the
Board of Directors breached the terms of the Olive Modification. On January 27,
1997, the parties entered into an Amendment to the Olive Modification effective
January 9, 1997 (the "Olive Amendment"), which was submitted to the Court for
approval on January 29, 1997. The Olive Amendment provides for the settlement
of all matters raised at the evidentiary hearings and by plaintiffs' counsel in
his notices to the Company's Board of Directors. On May 2, 1997, a hearing was
held for the Court to consider approval of the Olive Amendment. As a result of
the hearing, the parties entered into a revised Olive Amendment. The Court
issued an order approving the Olive Amendment on July 3, 1997.

                                       15

<PAGE>   16



ITEM 3.       LEGAL PROCEEDINGS (Continued)

Olive Litigation (Continued)

The Olive Amendment provides for the addition of four new unaffiliated members
to the Company's Board of Directors and sets forth new requirements for the
approval of any transactions with certain affiliates until April 28, 1999. In
addition, the Company, CMET, TCI and their stockholders released the defendants
from any claims relating to the plaintiffs' allegations and matters which were
the subject of the evidentiary hearings. The plaintiffs' allegations of any
breaches of the Olive Modification shall be settled by mutual agreement of the
parties or, lacking such agreement, by an arbitration proceeding.

Under the Olive Amendment, all shares of the Company owned by Gene E. Phillips
or any of his affiliates shall be voted at all stockholder meetings of the
Company held until April 28, 1999 in favor of all new members of the Company's
Board of Directors added under the Olive Amendment. The Olive Amendment also
requires that, until April 28, 1999, all shares of the Company owned by Mr.
Phillips or his affiliates in excess of forty percent (40%) of the Company's
outstanding shares shall be voted in proportion to the votes cast by all
non-affiliated stockholders of the Company.

In accordance with the Olive Amendment, Richard W. Douglas, Larry E. Harley and
R. Douglas Leonhard were added to the Company's Board of Directors in January
1998 and Murray Shaw was added to the Company's Board of Directors in February
1998.

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

Not applicable.

                      ----------------------------------

                                    PART II
                                    -------


ITEM 5.        MARKET FOR THE REGISTRANT'S SHARES OF COMMON STOCK AND
               RELATED SHAREHOLDER MATTERS

The Company's Common Stock is traded on the American Stock Exchange ("AMEX")
under the symbol "IOT". The following table sets forth the high and low prices
for the Company's Common Stock as reported on the AMEX.

<TABLE>
<CAPTION>
  QUARTER ENDED                                         HIGH             LOW
  -------------                                         ----             ---

<S>                                                   <C>                <C> 
March 31, 1998 (through March 6, 1998).........       $11 7/8            $11 3/8

March 31, 1997.................................        14 5/8             11
June 30, 1997..................................        14 1/2             11 1/2
September 30, 1997.............................        16                 11
December 31, 1997..............................        12 1/2             11 1/2
</TABLE>

                                       16

<PAGE>   17



ITEM 5.          MARKET FOR THE REGISTRANT'S SHARES OF COMMON STOCK AND
                 RELATED SHAREHOLDER MATTERS (Continued)
<TABLE>
<CAPTION>

  QUARTER ENDED                                       HIGH           LOW
------------------                                -----------     ---------
<S>                                               <C>             <C>      
March 31, 1996 ..............................     $  10 2/3 *     $ 9 1/4 *
June 30, 1996 ...............................        10 1/2 *       9 3/4 *
September 30, 1996 ..........................        11             9 1/2
December 31, 1996 ...........................        11 1/2         9 5/8
</TABLE>


*  Restated for the two for one forward stock split effected June 14,
   1996.

As of March 6, 1998, the closing price of the Company's Common Stock on the
AMEX was $11.50 per share.

As of March 6, 1998, the Company's Common Stock was held by 1,856 holders of
record.

The Company paid quarterly dividends in 1997 and 1996 as follows:
<TABLE>
<CAPTION>

                                                                                                               Amount
                                                                                                                Per
  Date Declared                         Record Date                        Payable Date                        Share
------------------                  -------------------                 -------------------                   -------
<S>                                 <C>                                 <C>                                    <C> 
February 26, 1997                   March 14, 1997                      March 31, 1997                         $ .10
June 5, 1997                        June 13, 1997                       June 30, 1997                            .10
September 3, 1997                   September 15, 1997                  September 30, 1997                       .10
December 1, 1997                    December 15, 1997                   December 31, 1997                        .10

March 1, 1996                       March 15, 1996                      March 31, 1996                         $ .10*
June 3, 1996                        June 14, 1996                       June 28, 1996                            .10*
August 23, 1996                     September 13, 1996                  September 30, 1996                       .10
December 2, 1996                    December 13, 1996                   December 31, 1996                        .10

</TABLE>
---------------------

*     Restated for the two for one forward stock split effected June 14,
      1996.

The Company reported to the Internal Revenue Service that 100% of the dividends
paid in 1997 represented capital gains and 100% of the dividends paid in 1996
represented a return of capital.

On December 5, 1989, the Company's Board of Directors approved a share
repurchase program. The Company's Board of Directors authorized the Company to
repurchase a total of 200,000 shares of its Common Stock pursuant to such
program. Through December 31, 1997, the Company had repurchased a total of
198,904 shares of its Common Stock pursuant to such program at a total cost to
the Company of $1.8 million. In 1997, the Company repurchased none of its
shares of Common Stock.




                     [THIS SPACE INTENTIONALLY LEFT BLANK.]

                                       17

<PAGE>   18

ITEM 6.        SELECTED FINANCIAL DATA
<TABLE>
<CAPTION>


                                                            For the Years Ended December 31,
                                   -------------------------------------------------------------------------------
                                       1997             1996             1995             1994             1993
                                   -----------      -----------      -----------      -----------      -----------
                                                       (dollars in thousands, except per share)
<S>                                <C>              <C>              <C>              <C>              <C>        
EARNINGS DATA
Revenues .....................     $    12,487      $     9,005      $     7,919      $     6,852      $     7,113
Expenses .....................          13,175            9,658            8,081            7,225            7,247
                                   -----------      -----------      -----------      -----------      -----------

(Loss) from operations .......            (688)            (653)            (162)            (373)            (134)
Equity in income (loss)
 of partnerships .............              52               85             (744)              86              203
Gain on sale of real
   estate ....................           3,953             --               --               --               --
Extraordinary gain ...........            --               --               --               --                806
                                   -----------      -----------      -----------      -----------      -----------
Net income (loss) ............     $     3,317      $      (568)     $      (906)     $      (287)     $       875
                                   ===========      ===========      ===========      ===========      ===========

PER SHARE DATA
Income (loss) before
   extraordinary gain ........     $      2.18      $      (.37)     $      (.57)     $      (.18)     $       .04
Extraordinary gain ...........            --               --               --               --                .50
                                   -----------      -----------      -----------      -----------      -----------
Net income (loss) ............     $      2.18      $      (.37)     $      (.57)     $      (.18)     $       .54
                                   ===========      ===========      ===========      ===========      ===========

Dividends per share ..........     $       .40      $       .40      $       .30      $       .30      $       .25

Weighted average Common
   shares outstanding ........       1,519,888        1,530,008        1,582,888        1,582,888        1,609,432
</TABLE>



<TABLE>
<CAPTION>
                                                                     December 31,
                                   -------------------------------------------------------------------------------
                                       1997             1996             1995             1994             1993
                                   -----------      -----------      -----------      -----------      -----------
                                                      (dollars in thousands, except per share)

<S>                                <C>              <C>              <C>              <C>              <C>
BALANCE SHEET DATA
Notes and interest
   receivable, net ...........     $     2,010      $     1,998      $     1,986      $     1,974      $     2,983
Real estate held for
   sale, net
   Foreclosed ................            --                914              845           15,878           15,121
   Other .....................            --              5,709             --             25,157           25,710
Real estate held for
   investment, net ...........          81,914           46,693           39,480             --               --
Total assets .................          90,309           63,593           49,169           49,035           50,127
Notes and interest
   payable ...................          61,323           38,957           22,682           20,717           21,354
Stockholders' equity .........          25,131           22,381           24,191           25,572           26,334

Book value per share .........     $     16.53      $     14.63      $     15.28      $     16.16      $     16.36
</TABLE>


The Company acquired eight properties in 1997 for a total of $46.6
million and two properties in 1996 for a total of $13.1 million.  The
Company sold three properties in 1997 for a total of $24.8 million.  See
ITEM 2. "PROPERTIES - REAL ESTATE" and ITEM 8. "FINANCIAL STATEMENTS AND
SUPPLEMENTARY DATA."

Shares and per share data have been restated for the two for one forward Common
Stock split effected June 14, 1996.

                                       18

<PAGE>   19



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

Introduction

Income Opportunity Realty Investors, Inc. (the "Company") invests in equity
interests in real estate through acquisitions, leases and partnerships and in
mortgage loans on real estate, including first, wraparound and junior mortgage
loans. The Company is the successor to a California business trust organized on
December 14, 1984 which commenced operations on April 10, 1985.

Liquidity and Capital Resources

Cash and cash equivalents at December 31, 1997 aggregated $1.1 million compared
with $3.2 million at December 31, 1996. The Company's principal sources of cash
have been and will continue to be property operations, proceeds from property
sales and refinancings, collection of its mortgage note receivable and
partnership distributions. The Company anticipates that it will have sufficient
cash in 1998 to meet its various cash requirements including the payment of
dividends, debt service obligations and property development, renovation and/or
improvement costs.

The Company's cash flow from property operations (rents collected less payments
for property operating expenses) increased from $3.5 million in 1996 to $6.5
million in 1997. This increase is the result of the acquisition of eight income
producing properties in 1997 and two income producing properties in 1996 and
also to increased occupancy and rental rates, primarily at the Company's
commercial properties, and the control of operating expenses. These increases
are partially offset by a decrease of $1.2 million due to properties sold in
1997. The Company's management believes that this trend will continue,
particularly in the Company's apartments, if the economy remains stable or
improves.

Interest collected on mortgage notes receivable decreased from $327,000 in 1996
to $253,000 in 1997. This decrease is primarily due to a decrease in short term
investment income. Interest is expected to continue to decrease as a source of
cash to the Company due to the expected payoff of its one mortgage note
receivable in August 1998. The Company has determined that generally, it will
not actively seek to originate new mortgage loans, other than those resulting
from the Company's providing purchase money financing in connection with a
property sale.

Interest paid on the Company's notes payable increased from $2.3 million in
1996 to $3.9 million in 1997. This increase is primarily attributable to
interest paid on mortgages secured by two income producing properties purchased
by the Company in 1996 and eight income producing properties purchased by the
Company in 1997 and interest paid on two financings in 1996 secured by
previously unencumbered commercial properties and the refinancing of a
commercial property in 1997. The Company believes that interest paid on notes
payable will continue to increase as the Company continues to acquire
properties on a leveraged basis and/or obtain financing on its one unencumbered
property.

                                       19

<PAGE>   20



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

Liquidity and Capital Resources (Continued)

The Company was involved in significant investing activities during 1997. The
Company purchased two apartment complexes and six commercial properties during
1997, for which the Company paid a total of $46.6 million. The Company paid
$14.2 million in cash, with the remaining $34.8 million financed through new or
assumed mortgage debt. The Company also made improvements to its properties
totaling $901,000. The Company sold three apartment complexes during 1997 for
$24.8 million. The Company received net cash of $8.4 million after the payoff
of existing mortgage debt and the payment of various closing costs associated
with the sales.

During 1997, the Company refinanced the mortgage debt secured by an office
building. The Company received net cash of $3.3 million after the payoff of
$3.7 million in existing mortgage debt and the payment of various closing costs
associated with the refinancing. Also during 1997, the Company made scheduled
mortgage principal payments totaling $736,000. Scheduled principal payments on
notes payable of $3.5 million are due in 1998.

The Company owns a 36.3% general partner interest and Transcontinental Realty
Investors, Inc. ("TCI") owns a 63.7% combined general and limited partner
interest in the Tri-City Limited Partnership ("Tri-City"). In 1997, the Company
received $218,000 in distributions from Tri-City's operating cash flow,
$627,000 from its financing cash flow and made advances of $218,000 to
Tri-City. In 1997, the Company received no distributions from and made $7,000
in contributions to Nakash Income Associates ("NIA"). The Company owns a 40%
general partner interest and TCI owns a 60% general partner interest in NIA.
See NOTE 5. "INVESTMENT IN EQUITY METHOD REAL ESTATE ENTITIES."

The Company has paid quarterly dividends since the first quarter of 1993. In
1997 and 1996, the Company paid dividends to its stockholders totaling $567,000
($.40 per share) and $621,000 ($.40 per share), respectively.

The Company's management reviews the carrying values of the Company's
properties and mortgage note receivable 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. For notes receivable impairment is considered to exist
if it is probable that all amounts due under the terms of the note will not be
collected. In those instances where impairment is found to exist, a provision
for loss is recorded by a charge against earnings. The Company's mortgage note
receivable review includes an evaluation of the collateral property securing
such note. The property review generally includes selective property
inspections, a review of the property's current rents compared to market rents,
a review of the property's expenses, a review of maintenance

                                       20

<PAGE>   21



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

Liquidity and Capital Resources (Continued)

requirements, a review of the property's cash flow, discussions with the
manager of the property and a review of properties in the surrounding area.

Results of Operations

1997 COMPARED TO 1996. For the year 1997, the Company reported net income of
$3.3 million as compared with a net loss of $568,000 in 1996. The Company's
1997 net income includes gains on sale of real estate of $4.0 million, where as
its 1996 net loss includes no such gains. The primary factors contributing to
the Company's 1997 net income are discussed in the following paragraphs.

Rents in 1997, were $12.2 million compared to $8.7 million in 1996. Of this
increase, $5.4 million is attributable to the ten properties purchased in 1997
and late 1996 and $355,000 is attributable to increased occupancy and rental
rates at two of the Company's commercial properties and two of its apartment
complexes. This increase is partially offset by a decrease of $2.2 million due
to three apartment complexes being sold in 1997. Rents are expected to increase
in 1998 due to a full year of operations of the commercial properties acquired
in 1997.

Property operations expense for 1997 was $5.9 million, compared to $4.4 million
for 1996. Of the increase, $2.5 million is attributable to the ten properties
purchased in 1997 and late 1996 and $87,000 is due to increased repairs and
maintenance at one of the Company's commercial properties. This increase is
partially offset by a decrease of $1.0 million due to three apartment complexes
being sold in 1997.

Equity in income of partnerships was $52,000 in 1997 compared to $85,000 in
1996. The decrease is due to expenses relating to the refinancing of one of the
partnership's mortgage debt.

Interest income of $266,000 in 1997 decreased from the $339,000 earned in 1996.
This decrease is primarily due to a decrease in short term investment income.
Interest income is expected to decrease in 1998, as the Company's only mortgage
note receivable is scheduled to mature in August 1998.

Interest expense increased to $4.1 million in 1997 compared to $2.6 million in
1996. Of this increase $2.1 million is attributable to the purchase of ten
properties in 1997 and late 1996 and $191,000 is due to the financing of two
previously unencumbered commercial properties in late 1996 and the refinancing
of a commercial property in 1997. This increase is partially offset by a
decrease of $848,000 due to three apartment complexes being sold in 1997.
Interest expense will increase in 1998 due to a full year's affect of the 1997
transactions, described above.

                                       21

<PAGE>   22



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

Results of Operations (Continued)

Depreciation expense increased to $1.6 million in 1997 compared to $1.1 million
in 1996. Of this increase, $734,000 is due to ten properties purchased in 1997
and late 1996 partially offset by a decrease of $294,000 due to three apartment
complexes being sold in 1997. Depreciation expense will increase in 1998 due to
a full year's affect of the eight properties acquired by the Company in 1997.

Advisory fee expense increased to $343,000 in 1997 compared to $227,000 in
1996. Such increase is attributable to an increase in the Company's gross
assets, the basis for such fee. Such fee is expected to continue to increase as
the Company's assets increase.

Net income and incentive sales fees totaling $275,000 were earned by the
Company's advisor in 1997. Such fees are the result of the Company recognizing
gains totaling $4.0 million from the sale of three apartment complexes in 1997.
No such fees were earned by the Company's advisor in 1996.

General and administrative expenses for 1997 decreased to $1.0 million as
compared to $1.3 million in 1996. Of this decrease, $189,000 is attributable to
a decrease in legal fees related to the Olive litigation (see NOTE 14.
"COMMITMENTS AND CONTINGENCIES") and $248,000 is attributable to the 1996
preparation of proxy material and registration statement relating to the
Company's incorporation, which is nonrecurring in nature. These decreases are
partially offset by an increase of $73,000 in advisor cost reimbursements and
$90,000 in professional fees relating to the selection of new directors.

1996 COMPARED TO 1995. For the year 1996, the Company incurred a net loss of
$568,000 as compared with a net loss of $906,000 in 1996. The primary factor
contributing to the Company's decreased net loss in 1996 was an improvement in
equity in income (loss) of partnerships of $829,000.

Rents in 1996, were $8.7 million compared to $7.7 million in 1995. Of this
increase, $466,000 is attributable to the two commercial properties purchased
in 1996, $170,000 is attributable to a full year of operations of an apartment
complex foreclosed in 1995 and $302,000 is attributable to increased occupancy
and rental rates at one of the Company's commercial properties and two of its
apartment complexes.

Property operations expense for 1996 was $4.4 million, compared to $4.0 million
for 1995. Of the increase, $141,000 is attributable to the two commercial
properties purchased in 1996, $27,000 is attributable to a full year of
operations of an apartment complex foreclosed in 1995, and $164,000 is due to
increased repairs and maintenance at two of the Company's apartment complexes.

Equity in income (loss) of partnerships was income of $85,000 in 1996 as
compared to a loss of $744,000 in 1995. The 1995 equity loss is primarily due
to the modification of a wraparound note receivable and

                                       22

<PAGE>   23



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

Results of Operations (Continued)

underlying note payable by Nakash Income Associates ("NIA"), a partnership in
which the Company has a 40% general partner interest and to the writedown of a
wraparound mortgage note receivable to the balance of the underlying mortgage
payable also by NIA. The Company's equity share of the loss on the note
modification was $85,000 and its equity share of the note writedown was
$601,000. See NOTE 5. "INVESTMENT IN EQUITY METHOD PARTNERSHIPS." Excluding the
effect of the NIA transactions, equity earnings would have been comparable in
each year.

Interest income increased to $339,000 in 1996 from $231,000 in 1995 due to an
increase in short-term investment income.

Interest expense increased to $2.6 million in 1996 compared to $2.0 million in
1995. Of this increase, $537,000 is attributable to the refinancing of two
previously unencumbered commercial properties in March 1996 and in September
1996 and $100,000 is due to the purchase of two commercial properties in 1996.

Depreciation expense of $1.1 million in 1996 was comparable to the $1.1 million
in 1995.

Advisory fee expense decreased to $227,000 in 1996 compared to $316,000
in 1995.  Such decrease is attributable to the operating expense
limitation in the Company's Advisory Agreement.  See NOTE 9. "ADVISORY
AGREEMENT."

General and administrative expenses for 1996 increased to $1.3 million as
compared to $699,000 in 1995. Of this increase, $399,000 is attributable to an
increase in legal fees related to the Olive litigation (See NOTE 14.
"COMMITMENTS AND CONTINGENCIES."), $101,000 is attributable to consulting and
engineering fees related to potential property acquisitions and financings and
$96,000 is attributable to the preparation of proxy material and registration
statement relating to the Company's incorporation, which is nonrecurring in
nature.

Environmental Matters

Under various federal, state and local environmental laws, ordinances and
regulations, the Company 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 from the Company for personal injury
associated with such materials.

The Company's management is not aware of any environmental liability relating
to the above matters that would have a material adverse effect on the Company's
business, assets or results of operations.

                                       23

<PAGE>   24


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


Inflation

The effects of inflation on the Company's operations are not quantifiable.
Revenues from property operations fluctuate proportionately with inflationary
increases and decreases in housing costs. Fluctuations in the rate of inflation
also affect the sale values of properties and, correspondingly, the ultimate
realizable value of the Company's real estate and notes receivable portfolios.
Inflation also has an effect on the Company's earnings from short-term
investments.


Taxes

For the years 1995, 1996 and 1997, the Company elected and in the opinion of
the Company's management qualified, to be taxed as a Real Estate Investment
Trust ("REIT") as defined under Sections 856 through 860 of the Internal
Revenue Code of 1986, as amended (the "Code"). To continue to qualify for
federal taxation as a REIT under the Code, the Company is required to hold at
least 75% of the value of its total assets in real estate assets, government
securities, cash and cash equivalents at the close of each quarter of each
taxable year. The Code also requires a REIT to distribute at least 95% of its
REIT taxable income plus 95% of its net income from foreclosure property, all
as defined in Section 857 of the Code, on an annual basis to stockholders.


Year 2000

The Company's advisor has advised the Company that its current computer
software has been certified by the Information Technology Association of
America ("ITAA") as year 2000 compliant. The Company's advisor has also advised
the Company that it has recently received and plans to install in 1998 the ITAA
certified year 2000 compliant operating system for its computer hardware.

                                       24




<PAGE>   25
ITEM 8.          FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA






                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

                                                                     PAGE
                                                                    --------


Report of Independent Certified Public Accountants..............      26


Consolidated Balance Sheets -
    December 31, 1997 and 1996..................................      27


Consolidated Statements of Operations -
    Years Ended December 31, 1997, 1996 and 1995................      28


Consolidated Statements of Stockholders' Equity -
    Years Ended December 31, 1997, 1996 and 1995................      29


Consolidated Statements of Cash Flows -
    Years Ended December 31, 1997, 1996 and 1995................      30


Notes to Consolidated Financial Statements......................      32


Schedule III - Real Estate and Accumulated Depreciation.........      46


Schedule IV  - Mortgage Loans on Real Estate....................      48







All other schedules are omitted because they are not required, are not
applicable or the information required is included in the Financial Statements
or the notes thereto.



                                       25

<PAGE>   26

               REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS




Board of Directors of
Income Opportunity Realty Investors, Inc.

We have audited the accompanying consolidated balance sheets of Income
Opportunity Realty Investors, Inc. and Subsidiaries as of December 31, 1997 and
1996 and the related consolidated statements of operations, stockholders' equity
and cash flows for each of the three years in the period ended December 31,
1997. We have also audited the schedules listed in the accompanying index. These
financial statements and schedules are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements and schedules based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and schedules are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements and
schedules. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
presentation of the financial statements and schedules. We believe 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 Income
Opportunity Realty Investors, Inc. and Subsidiaries as of December 31, 1997 and
1996, and the consolidated results of their operations and their cash flows for
each of the three years in the period ended December 31, 1997, in conformity
with generally accepted accounting principles.

Also, in our opinion, the schedules referred to above present fairly, in all
material respects, the information set forth therein.






                                          BDO SEIDMAN, LLP



Dallas, Texas
March 6, 1998

                                       26

<PAGE>   27



                    INCOME OPPORTUNITY REALTY INVESTORS, INC.
                           CONSOLIDATED BALANCE SHEETS



<TABLE>
<CAPTION>

                                                             December 31,
                                                        -----------------------  
                                                           1997          1996
                                                        ----------    ---------
                                                        (dollars in thousands)
                         Assets
<S>                                                       <C>         <C>
Notes and interest receivable
   Performing .......................................     $ 2,010     $ 1,998

Foreclosed real estate held for sale, net of
   accumulated depreciation ($20 in 1996) ...........          --         914

Real estate under contract for sale, net of
   accumulated depreciation ($1,904 in 1996) ........          --       5,709

Real estate held for investment, net of accumulated
   depreciation ($5,211 in 1997 and $5,311 in 1996) .      81,914      46,693

Investment in partnerships ..........................       1,762       2,331
Cash and cash equivalents ...........................       1,145       3,186
Other assets (including $302 in 1997 and $256 in
   1996 from affiliates) ............................       3,478       2,762
                                                          -------     -------
                                                          $90,309     $63,593
                                                          =======     =======


       Liabilities and Stockholders' Equity

Liabilities
Notes and interest payable ..........................     $61,323     $38,957
Other liabilities (including $468 in 1997 to
   affiliates) ......................................       3,855       2,255
                                                          -------     -------
                                                           65,178      41,212

Commitments and contingencies


Stockholders' equity
Common Stock, $.01 par value;
   authorized 10,000,000 shares; issued and
   outstanding 1,519,888 shares in 1997 and 1996 ....          15          15
Paid-in capital .....................................      64,804      64,804
Accumulated distributions in excess of accumulated
   earnings .........................................     (39,688)    (42,438)
                                                          -------     -------
                                                           25,131      22,381
                                                          -------     -------
                                                          $90,309     $63,593
                                                          =======     =======

</TABLE>




  The accompanying notes are an integral part of these Consolidated Financial
                                  Statements.

                                       27

<PAGE>   28



                    INCOME OPPORTUNITY REALTY INVESTORS, INC.
                      CONSOLIDATED STATEMENTS OF OPERATIONS



<TABLE>
<CAPTION>

                                                 For the Years Ended December 31,
                                            ----------------------------------------
                                                1997         1996            1995
                                            -----------   -----------    -----------
                                            (dollars in thousands, except per share)
<S>                                         <C>            <C>            <C>
Revenues
   Rents ..............................     $   12,221     $    8,666     $    7,688
   Interest ...........................            266            339            231
                                            ----------     ----------     ----------

                                                12,487          9,005          7,919


Expenses
   Property operations (including $503
      in 1997, $209 in 1996 and $156 in
      1995 to affiliates) .............          5,900          4,358          4,035
   Interest ...........................          4,069          2,629          1,979
   Depreciation .......................          1,615          1,128          1,052
   Advisory fee to affiliate ..........            343            227            316
   Net income and incentive sales fee
      due to affiliate  ...............            275             --             --
   General and administrative
      (including $248 in 1997, $175 in
      1996 and $140 in 1995 to
      affiliate) ......................            973          1,316            699
                                            ----------     ----------     ----------

                                                13,175          9,658          8,081
                                            ----------     ----------     ----------

(Loss) from operations ................           (688)          (653)          (162)

Equity in income (loss) of
   partnerships .......................             52             85           (744)
Gain on sale of real estate ...........          3,953             --             --
                                            ----------     ----------     ----------
Net income (loss) .....................     $    3,317     $     (568)    $     (906)
                                            ==========     ==========     ==========
Earnings per share
Net income (loss) .....................     $     2.18     $     (.37)    $     (.57)
                                            ==========     ==========     ==========

Weighted average shares of
   Common Stock used in
   computing earnings per share .......      1,519,888      1,530,008      1,582,888
                                            ==========     ==========     ==========
</TABLE>





  The accompanying notes are an integral part of these Consolidated Financial
  Statements.

                                       28

<PAGE>   29



                    INCOME OPPORTUNITY REALTY INVESTORS, INC.
                 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY




<TABLE>
<CAPTION>

                                                                             Accumulated
                                                                             Distributions
                                  Common Stock                               in Excess of              
                              --------------------------        Paid-in      Accumulated   Stockholders'
                               Shares           Amount         Capital         Earnings        Equity
                              --------         ---------       -------       -----------   ------------  
                                                         (dollars in thousands)
<S>                           <C>            <C>             <C>             <C>             <C>       
Balance, January 1, 1995      1,582,888      $    3,347      $   62,093      $  (39,868)     $   25,572

Dividends ($.30 per
   share) ..............             --              --              --            (475)           (475)

Net (loss) .............             --              --              --            (906)           (906)
                              ---------      ----------      ----------      ----------      ----------                     

Balance, December 31,
   1995 ................      1,582,888           3,347          62,093         (41,249)         24,191


Change in par value ....             --          (3,332)          3,332              --              --

Repurchase of Common
 Stock .................        (63,000)             --            (621)             --            (621)

Dividends ($.40 per
   share) ..............             --              --              --            (621)           (621)

Net (loss) .............             --              --              --            (568)           (568)
                              ---------      ----------      ----------      ----------      ----------                     

Balance, December 31,
   1996 ................      1,519,888              15          64,804         (42,438)         22,381


Dividends ($.40 per
   share) ..............             --              --              --            (567)           (567)

Net income .............             --              --              --           3,317           3,317
                              ---------      ----------      ----------      ----------      ----------                     

Balance, December 31,
   1997 ................      1,519,888      $       15      $   64,804      $  (39,688)     $   25,131
                              =========      ==========      ==========      ==========      ========== 
</TABLE>





The accompanying notes are an integral part of these Consolidated Financial
Statements.

                                       29



<PAGE>   30



                    INCOME OPPORTUNITY REALTY INVESTORS, INC.
                      CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
                                                     For the Years Ended December 31,
                                                   ------------------------------------
                                                     1997          1996          1995
                                                   ---------    ----------    ---------    
                                                          (dollars in thousands)
<S>                                                <C>           <C>           <C>
Cash Flows from Operating Activities
   Rents collected ...........................     $ 11,772      $  8,688      $  7,685
   Interest collected ........................          253           327           219
   Interest paid .............................       (3,856)       (2,281)       (1,816)
   Payments for property operations
      (including $503 in 1997, $209 in 1996
      and $156 in 1995 to affiliate) .........       (5,295)       (5,223)       (3,776)
   Advisory and net income fee paid to
      affiliate ..............................         (567)         (386)         (316)
   General and administrative expenses paid
      (including $248 in 1997, $175 in 1996
      and $140 in 1995 to affiliates) ........       (1,081)       (1,151)         (851)
   Distributions from equity partnership's
      operating cash flow ....................          218           308           298
   Escrow funding ............................         (522)         (219)         (131)
   Other .....................................          663            88           (97)
                                                   --------      --------      --------
         Net cash provided by operating
            activities .......................        1,585           151         1,215

Cash Flows from Investing Activities
   Funding of equity partnerships ............         (224)          (82)          (20)
   Real estate improvements ..................         (901)         (290)         (341)
   Acquisition of real estate (including
      $1,826 in 1997 and $532 in 1996 to
      affiliate) .............................      (38,174)      (10,151)           --
   Proceeds from sale of real estate .........       23,593            --            --
                                                   --------      --------      --------
      Net cash (used in) investing activities       (15,706)      (10,523)         (361)

Cash Flows from Financing Activities
   Proceeds from notes payable ...............       31,565        13,011         6,300
   Payments on notes payable .................      (19,452)         (439)       (4,300)
   Deferred financing costs ..................         (250)         (488)         (294)
   Distributions from equity partnership's
      financing cash flow ....................          627            --           486
   Dividends to stockholders .................         (567)         (621)         (475)
   Repurchase of Common Stock ................           --          (621)           --
   Payments (to)/from advisor ................          157          (272)          185
                                                   --------      --------      --------
         Net cash provided by financing
            activities .......................       12,080        10,570         1,902

Net increase (decrease) in cash and
   cash equivalents ..........................       (2,041)          198         2,756
Cash and cash equivalents, beginning of year .        3,186         2,988           232
                                                   --------      --------      --------
Cash and cash equivalents, end of year .......     $  1,145      $  3,186      $  2,988
                                                   ========      ========      ========
</TABLE>

The accompanying notes are an integral part of these Consolidated Financial
Statements.

                                       30

<PAGE>   31



                    INCOME OPPORTUNITY REALTY INVESTORS, INC.
                CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)





<TABLE>
<CAPTION>
                                                       For the Years Ended December 31,
                                                      ---------------------------------- 
                                                        1997        1996          1995
                                                      ---------   ---------     -------- 
                                                           (dollars in thousands)
<S>                                                   <C>          <C>          <C>
Reconciliation of net income (loss) to net
   cash provided by operating activities
   Net income (loss) ............................     $ 3,317      $  (568)     $  (906)

   Adjustments to reconcile net income (loss)
      to net cash provided by operating
      activities
         Depreciation and amortization ..........       1,718        1,261        1,238
         Gain on sale of real estate ............      (3,953)          --           --
         Equity in loss (income) of partnerships          (52)         (85)         744
         Distributions from equity
            partnership's operating cash flow ...         218          308          298
         (Increase) in other assets .............      (1,091)        (350)        (287)
         Increase (decrease) in interest
            payable .............................          97          203          (35)
         Increase (decrease) in other
            liabilities .........................       1,331         (618)         163
                                                      -------      -------      -------
                Net cash provided by operating
                  activities ....................     $ 1,585      $   151      $ 1,215
                                                      =======      =======      =======
Schedule of noncash investing and financing
   activities


   Notes payable from purchase of
      real estate ...............................     $ 7,736      $ 3,500      $    --
</TABLE>






  The accompanying notes are an integral part of these Consolidated Financial
  Statements.

                                       31

<PAGE>   32



                    INCOME OPPORTUNITY REALTY INVESTORS, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


The accompanying Consolidated Financial Statements of Income Opportunity Realty
Investors, Inc. and consolidated entities (the "Company") have been prepared in
conformity with generally accepted accounting principles, the most significant
of which are described in NOTE 1. "SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES."
These, along with the remainder of the Notes to Consolidated Financial
Statements, are an integral part of these Consolidated Financial Statements. The
data presented in the Notes to Consolidated Financial Statements are as of
December 31 of each year and for the year then ended, unless otherwise
indicated. Dollar amounts in tables are in thousands, except per share amounts.

Certain balances for 1996 and 1995 have been reclassified to conform to the 1997
presentation. Shares and per share data have been restated for the two for one
forward Common Stock split effected June 14, 1996.

NOTE 1.        SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Organization and Company Business. Income Opportunity Realty Investors, Inc.
("IORI"), is the successor to a California business trust organized on December
14, 1984, which commenced operations on April 10, 1985. The Company may hold
interests in real estate through direct ownership, leases and partnerships and
it may also invest in mortgage loans on real estate, including first, wraparound
and junior mortgage loans.

Basis of consolidation. The Consolidated Financial Statements include the
accounts of IORI and subsidiaries and partnerships which it controls. All
intercompany transactions and balances have been eliminated.

Accounting estimates. In the preparation of the Company's Consolidated Financial
Statements in conformity with generally accepted accounting principles it was
necessary for the Company's management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the Consolidated Financial
Statements and the reported amounts of revenues and expenses for the year then
ended. Actual results could differ from these estimates.

Interest recognition on notes receivable. It is the Company's policy to cease
recognizing interest income on notes receivable that have been delinquent for 60
days or more. In addition, accrued but unpaid interest income is only recognized
to the extent that the net realizable value of the underlying collateral exceeds
the carrying value of the receivable.

Allowance for estimated losses. Valuation allowances are provided for estimated
losses on notes receivable considered to be impaired. Impairment is considered
to exist when it is probable that all amounts due under the terms of the note
will not be collected. Valuation allowances are provided for estimated losses on
notes receivable to the

                                       32

<PAGE>   33



                    INCOME OPPORTUNITY REALTY INVESTORS, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)



NOTE 1.        SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

extent that the Company's investment in the note exceeds the Company's estimate
of fair value of the collateral securing such note.

Real Estate Held for Investment and Depreciation. Real estate held for
investment is carried at cost. Statement of Financial Accounting Standards No.
121 ("SFAS No. 121") requires that a property be considered impaired, if the sum
of the expected future cash flows (undiscounted and without interest charges) is
less than the carrying amount of the property. If impairment exists, an
impairment loss is recognized, by a charge against earnings, equal to the amount
by which the carrying amount of the property exceeds the fair value of the
property. If impairment of a property is recognized, the carrying amount of the
property is reduced by the amount of the impairment, and a new cost for the
property is established. Such new cost is depreciated over the property's
remaining useful life. Depreciation is provided by the straight-line method over
estimated useful lives, which range from 3 to 40 years.

Real Estate Held for Sale. Foreclosed real estate is initially recorded at new
cost, defined as the lower of original cost or fair value minus estimated costs
of sale. SFAS No. 121 also requires that properties held for sale be reported at
the lower of carrying amount or fair value less costs of sale. If a reduction in
a held for sale property's carrying amount to fair value less costs of sale is
required, a provision for loss shall be recognized by a charge against earnings.
Subsequent revisions, either upward or downward, to a held for sale property's
estimated fair value less costs of sale is recorded as an adjustment to the
property's carrying amount, but not in excess of the property's carrying amount
when originally classified as held for sale. A corresponding charge against or
credit to earnings is recognized. Properties held for sale are not to be
depreciated.

Present value discounts. The Company provides for present value discounts on
notes receivable that have interest rates that differ substantially from
prevailing market rates and amortizes such discounts by the interest method over
the lives of the related notes. The factors considered in determining a market
rate for notes receivable include the borrower's credit standing, nature of the
collateral and payment terms of the note.

Revenue recognition on the sale of real estate. Sales of real estate are
recognized when and to the extent permitted by Statement of Financial Accounting
Standards No. 66, "Accounting for Sales of Real Estate" ("SFAS No. 66"). Until
the requirements of SFAS No. 66 for full profit recognition have been met,
transactions are accounted for using either the deposit, the installment sale,
the cost recovery or the financing method, whichever is appropriate.

                                       33

<PAGE>   34



                    INCOME OPPORTUNITY REALTY INVESTORS, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)


NOTE 1.        SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Investment in noncontrolled partnerships. The Company uses the equity method to
account for investments in partnerships which it does not control. Under the
equity method, the Company's initial investment, recorded at cost, is increased
by the Company's proportionate share of the partnership's operating income and
additional advances and decreased by the Company's proportionate share of the
partnership's operating losses and distributions received.

Fair value of financial instruments. The Company used the following assumptions
in estimating the fair value of its note receivable and notes payable. For its
note receivable, which is performing, the fair value was estimated by
discounting future cash flows using current interest rates for similar loans.
The estimated fair value presented does not purport to represent the amount to
be ultimately realized by the Company. The amount ultimately realized may vary
significantly from the estimated fair value presented. For notes payable the
fair value was estimated using year end interest rates for mortgages with
similar terms and maturities.

Cash equivalents. For purposes of the Consolidated Statements of Cash Flows, the
Company considers all highly liquid debt instruments purchased with an original
maturity of three months or less to be cash equivalents.

Earnings per share. Income (loss) per share is computed based upon the weighted
average number of shares of Common Stock outstanding during each year, adjusted
for the two for one stock split effective June 14, 1996.

NOTE 2.         NOTES AND INTEREST RECEIVABLE

Notes and interest receivable consisted of the following:

<TABLE>
<CAPTION>

                                        1997                     1996
                              ----------------------    ---------------------     
                              Estimated                            Estimated
                                Fair         Book         Fair       Book
                               Value         Value        Value      Value
                              ---------     --------    --------   ----------
<S>                            <C>          <C>          <C>         <C>
Note Receivable
   Performing ............     $ 2,015      $ 2,000      $ 2,020     $ 2,000
                               =======                   =======            

Accrued interest .........                       17                       17
Unamortized discount......                       (7)                     (19)
                                            -------                  -------
                                            $ 2,010                  $ 1,998
                                            =======                  =======
</TABLE>

The Company does not recognize interest income on nonperforming notes
receivable. For the year 1995, unrecognized interest income on nonperforming
notes receivable totaled $121,000. The Company's single note receivable was
performing throughout 1997, bears interest at 10.0% per annum and matures in
1998.

                                       34

<PAGE>   35



                    INCOME OPPORTUNITY REALTY INVESTORS, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)



NOTE 3.          REAL ESTATE AND DEPRECIATION

In January 1997, the Company purchased the Chuck Yeager Building, a 60,060
square foot industrial/office building in Chantilly, Virginia, for $5.1 million.
The Company paid $2.0 million in cash and obtained new mortgage financing of
$3.1 million.

In March 1997, the Company completed the sale of the Plumtree Apartments, a 116
unit apartment complex in Martinez, California, that was under contract for sale
at December 31, 1996, for $7.8 million in cash. The Company received net cash of
$1.6 million after the payoff of $5.7 million in existing mortgage debt and the
payment of various closing costs associated with the sale. The Company
recognized a gain of $1.8 million on the sale.

In May 1997, the Company purchased the La Mesa Village Plaza, a 92,611 square
foot office building in La Mesa, California, for $8.1 million. The Company paid
$2.1 million in cash and obtained new mortgage financing of $6.0 million.

In June 1997, the Company sold the Porticos Apartments, a 256 unit apartment
complex in Milwaukee, Wisconsin, for $15.2 million in cash. The Company received
net cash of $5.2 million after the payoff of $9.6 in existing mortgage debt and
the payment of various closing costs associated with the sale. The Company
recognized a gain of $1.5 million on the sale.

Also in June 1997, the Company purchased Renaissance Parc Apartments, a 294 unit
apartment complex in Dallas, Texas, for $15.7 million. The Company paid $3.2
million in cash and obtained new mortgage financing of $12.5 million.

Further in June 1997, the Company purchased LaMonte Park Apartments, a 128 unit
apartment complex in Houston, Texas, for $3.7 million. The Company paid $200,000
cash and assumed the existing mortgage of $3.5 million.

In September 1997, the Company purchased Valley View Center, a partially
complete four story office building in Farmers Branch, Texas, for $565,000 in
cash.

In November 1997, the Company purchased Westlake Village, a 45,500 square foot
office building in Westlake Village, California, for $3.9 million. The Company
paid $1.0 million in cash and obtained new mortgage financing of $2.9 million.

In December 1997, the Company purchased Akard Plaza, a 42,895 square foot office
building in Dallas, Texas, for $3.5 million. The Company paid $1.0 million in
cash with the seller providing purchase money financing of the remaining $2.5
million of the purchase price.

                                       35

<PAGE>   36



                    INCOME OPPORTUNITY REALTY INVESTORS, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)


NOTE 3.    REAL ESTATE AND DEPRECIATION

Also in December 1997, the Company purchased Fireside Thrift, a 56,120 square
foot office building in Newark, California, for $6.0 million. The Company paid
$1.7 million in cash and assumed the existing mortgage of $4.3 million.

Further in December 1997, the Company sold the Spanish Trace Apartments, a 136
unit apartment complex in Irving, Texas, for $1.8 million in cash. The Company
had obtained the property through foreclosure in 1994. The Company received net
cash of $1.7 million after the payment of various closing costs associated with
the sale. The Company recognized a gain of $631,000 on the sale.

In 1996, the Company purchased two office buildings: Daley Plaza Corporate
Center, a three building, 122,795 square foot office facility in San Diego,
California, and the Olympic Building, a 57,000 square foot office building in
Los Angeles, California. The Company paid $5.1 million in cash and either
obtained new mortgage or seller financing of $8.0 million.

NOTE 4.    ALLOWANCE FOR ESTIMATED LOSSES

Activity in the allowance for estimated losses was as follows:

<TABLE>
<CAPTION>

                                          1997           1996         1995
                                        --------      ---------     --------
<S>                                     <C>           <C>           <C>
Balance  January 1,..........           $      -      $     121     $    121
   Amounts charged off........                 -           (121)           -
                                        --------      ---------     --------                                        
Balance  December 31,.........                 -              -          121
                                        ========      =========     ======== 
</TABLE>

NOTE 5.    INVESTMENT IN EQUITY METHOD PARTNERSHIPS

The Company's investments in equity method partnerships consist of the
following:

<TABLE>
<CAPTION>
                                                   1997            1996
                                                 --------       -------- 
<S>                                              <C>            <C>     
Tri-City Limited Partnership ("Tri-City")....    $  1,523       $  2,072
Nakash Income Associates ("NIA").............         239            259
                                                 --------       --------
                                                 $  1,762       $  2,331
                                                 ========       ========    
</TABLE>

The Company uses the equity method to account for its 36.3% general partner
interest in Tri-City, which owns five properties in Texas. Transcontinental
Realty Investors, Inc. ("TCI") owns a combined 63.7% general and limited partner
interest in Tri-City. In September 1997, Tri-City obtained first mortgage
financing of $1.9 million secured by the previously unencumbered Oaks of Inwood
and Inwood Green Apartments. The Company received $627,000 of the net financing
proceeds. As of March 6, 1998, TCI owned approximately 22.5% of the Company's
outstanding shares of Common Stock.

In July 1995, Tri-City obtained first mortgage financing of $1.4 million,
secured by a previously unencumbered office building in Dallas, Texas. The
Company received $486,000 of the net financing proceeds.

                                       36

<PAGE>   37



                    INCOME OPPORTUNITY REALTY INVESTORS, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)


NOTE 5.      INVESTMENT IN EQUITY METHOD PARTNERSHIPS (Continued)

The Company also uses the equity method to account for its 40% general partner
interest in NIA. TCI owns the remaining 60% general partner interest in NIA.

At December 31, 1995, NIA owned two wraparound mortgage notes receivable, one of
which was secured by a shopping center in Onandaga, New York. In July 1995, the
owner of the shopping center informed NIA that it had determined that further
investment in the shopping center was not justified and further that it had
offered to deed the property back to the first lien holder in lieu of
foreclosure making the wraparound note receivable held by NIA uncollectible. NIA
recorded a provision for loss of $1.5 million to write its wraparound note
receivable down to the balance of the first lien mortgage. The Company's equity
portion of the loss was $601,000. The property was returned to the lender in
March 1996. In September 1995, the Company received notice from NIA that the
other of its wraparound notes receivable secured by a shopping center in
Maulden, Missouri had been modified in conjunction with the modification of the
underlying note payable. NIA recorded a provision for loss of $212,000 on such
modification of which the Company's equity share was $85,000. In August 1997,
the owner of the shopping center refinanced the matured mortgage secured by the
shopping center in the amount of $850,000.

Set forth below are summarized financial data for the partnerships the Company
accounts for using the equity method:

<TABLE>
<CAPTION>

                                                       1997           1996
                                                    ---------       --------
<S>                                                 <C>             <C>     
Notes receivable...........................         $     902       $    902
Real estate, net of accumulated
   depreciation ($4,368 in 1997 and $3,896
   in 1996 ................................            10,024          9,906
Other assets...............................               410            148
Notes payable..............................            (4,102)        (2,422)  
Other liabilities..........................              (415)          (384)
                                                    ---------       --------                                                 
Partners' capital .........................         $   6,819       $  8,150
                                                    =========       ========
</TABLE>

<TABLE>
<CAPTION>
                                     1997           1996          1995
                                   --------       --------      --------
<S>                                <C>            <C>           <C>     
Rents..........................    $  2,648       $  2,643      $  2,478
Interest income................          30            121           319
Interest expense...............        (289)          (249)         (259)
Property operations expense....      (1,757)        (1,768)       (1,587)
Depreciation...................        (472)          (501)         (607)
Provision for losses...........           -              -        (1,714)
                                   --------       --------      --------
Net income (loss)..............    $    160       $    246      $ (1,370)
                                   ========       ========      ========
</TABLE>

The Company's equity share of the above net income (loss) for 1997, 1996 and
1995 was $56,000, $89,000 and $(552,000), respectively, before amortization of
property acquisition costs discussed below.

                                       37

<PAGE>   38



                    INCOME OPPORTUNITY REALTY INVESTORS, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)


NOTE 5.    INVESTMENT IN EQUITY METHOD PARTNERSHIPS (Continued)

The Company's share of the above partnerships' capital was $2.5 million in 1997
and $3.0 million in 1996.

The excess of the Company's investment over its respective share of the equity
in the underlying net assets of Tri-City relates principally to the remaining
unamortized property acquisition costs of $172,000 in 1997 and $176,000 in 1996.
These amounts are being amortized over the remaining estimated useful lives of
the properties.

NOTE 6.    NOTES AND INTEREST PAYABLE

Notes and interest payable consist of the following:

<TABLE>
<CAPTION>
                                        1997                      1996
                               ----------------------    ----------------------
                               Estimated                 Estimated
                                 Fair         Book          Fair       Book
                                 Value        Value         Value      Value
                               ---------    ---------     --------   ---------    
<S>                            <C>          <C>           <C>        <C>      
Notes payable...............   $  62,612    $  60,998     $ 38,612   $  38,652
                               =========                  ========    
Interest payable............                      325                      305
                                            ---------                ---------
                                            $  61,323                $  38,957
                                            =========                =========   
</TABLE>

Scheduled notes payable principal payments are due as follows:

<TABLE>

             <S>                                        <C>     
             1998....................................  $  3,525
             1999....................................     3,304
             2000....................................       823
             2001....................................     4,019
             2002....................................    10,136
             Thereafter..............................    39,191
                                                       --------
                                                       $ 60,998
                                                       ========
</TABLE>

Mortgage notes payable at December 31, 1997, bear interest at rates ranging from
7.75% to 11.0% and mature between 1998 and 2007. These notes are collateralized
by deeds of trust on real estate with a net carrying value of $81.2 million.

In 1997, the Company purchased two apartment complexes and six office buildings
for a total of $46.6 million. In conjunction with the purchases, the Company
either assumed existing mortgage debt or obtained new mortgage financing
totaling $34.8 million. The mortgages bear interest at rates ranging from 8.375%
to 11.0% per annum, require monthly payments of principal and interest,
currently totaling $310,939, and mature from June 1998 to July 2007.

In October 1997, the Company refinanced the matured mortgage debt secured by
Daley Plaza Corporate Center in San Diego, California in the amount of $7.0
million. The Company received net cash of $3.3 million after the payoff of $3.7
million in existing mortgage debt and the payment of various closing costs
associated with the refinancing. The

                                       38

<PAGE>   39



                    INCOME OPPORTUNITY REALTY INVESTORS, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)


NOTE 6.    NOTES AND INTEREST PAYABLE (Continued)

new mortgage bears interest at a variable rate, currently 9.75% per annum,
requires monthly payments of principal and interest of $62,380 and matures in
October 2002.

In 1996, the Company obtained mortgage financing totaling $8.5 million on the
previously unencumbered Saratoga and Town Center Plaza Office Buildings in
Saratoga, California and Boca Raton, Florida, respectively. The Company received
net cash of $7.6 million after funding required escrows and the payment of
various closing costs associated with the financings. The mortgages bear
interest at 9.0% and 9.16% per annum, respectively, mature in April and October
2006 and both require principal and interest payments totaling $71,557.

NOTE 7.    DIVIDENDS

The Company has paid quarterly dividends to its stockholders since the first
quarter of 1993. The Company paid dividends of $.40 per share in 1997 and 1996
and $.30 per share in 1995 totaling $567,000, $621,000 and $475,000,
respectively.

The Company reported to the Internal Revenue Service that 100% of the dividends
paid in 1997 represented capital gains and 100% of the dividends paid in 1996
and 1995 represented a return on capital.

NOTE 8.    RENTS UNDER OPERATING LEASES

The Company's operations include the leasing of office buildings. The leases
thereon expire at various dates through 2007. The following is a schedule of
minimum future rents on non-cancelable operating leases as of December 31, 1997:

<TABLE>
         <S>                                                   <C>      
         1998...............................................   $   8,224
         1999...............................................       6,795
         2000...............................................       3,948
         2001...............................................       2,064
         2002...............................................         701
         Thereafter.........................................         586
                                                               ---------
                                                               $  22,318
                                                               =========  
</TABLE>

NOTE 9.    ADVISORY AGREEMENT

Basic Capital Management, Inc. ("BCM" or the "Advisor") has served as
advisor to the Company since March 28, 1989.  BCM is a company owned by
a trust for the benefit of the children of Gene E. Phillips.  Mr.
Phillips served as a Director of the Company until December 31, 1992,
and as a director of BCM until December 22, 1989, and as Chief Executive
Officer of BCM until September 1, 1992.  Mr. Phillips serves as a
representative of his children's trust which owns BCM and, in such
capacity, has substantial contact with the management of BCM and input
with respect to its performance of advisory services to the Company.

                                       39

<PAGE>   40



                    INCOME OPPORTUNITY REALTY INVESTORS, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)


NOTE 9.    ADVISORY AGREEMENT (Continued)

At the Company's annual meeting of stockholders held on May 8, 1997, the renewal
of the Company's Advisory Agreement with BCM through the next annual meeting of
the Company's stockholders was approved. Subsequent renewals of the Company's
Advisory Agreement with BCM do not require the approval of the Company's
stockholders, but do require approval of the Company's Board of Directors.

Under the Advisory Agreement, the Advisor is required to formulate and submit
annually for approval by the Company's Board of Directors a budget and business
plan for the Company containing a twelve-month forecast of operations and cash
flow, a general plan for asset sales and acquisitions, lending foreclosure and
borrowing activity and other investments. The Advisor is required to report
quarterly to the Company's Board of Directors on the Company's performance
against the business plan. In addition, all transactions by the Company shall
require prior approval by the Company's Board of Directors, unless they are
explicitly provided for in the approved business plan or are made pursuant to
authority expressly delegated to the Advisor by the Company's Board of
Directors.

The Advisory Agreement also requires prior approval of the Company's Board of
Directors for the retention of all consultants and third party professionals,
other than legal counsel. The Advisory Agreement provides that the Advisor shall
be deemed to be in a fiduciary relationship to the Company's stockholders and
contains a broad standard governing the Advisor's liability for losses by the
Company.

The Advisory Agreement provides for BCM to be responsible for the day-to-day
operations of the Company and to receive an advisory fee comprised of a gross
asset fee of .0625% per month (.75% per annum) of the average of the gross asset
value of the Company (total assets less allowance for amortization, depreciation
or depletion and valuation reserves) and an annual net income fee equal to 7.5%
per annum of the Company's net income.

The Advisory Agreement also provides for BCM to receive an annual incentive
sales fee. BCM or an affiliate of BCM is to receive an acquisition commission
for supervising the acquisition, purchase or long-term lease of real estate for
the Company. BCM or an affiliate of BCM is to receive a mortgage or loan
acquisition fee with respect to the acquisition or purchase of any existing
mortgage loan by the Company. BCM or an affiliate of BCM is also to receive a
mortgage brokerage and equity refinancing fee for obtaining loans to the Company
or refinancing on the Company's properties and BCM is to receive reimbursement
of certain expenses incurred by it, in the performance of advisory services to
the Company.

The Advisory Agreement requires BCM or any affiliate of BCM to pay to the
Company one-half of any compensation received from third parties with respect to
the origination, placement or brokerage of any loan made by the Company.

                                       40

<PAGE>   41



                    INCOME OPPORTUNITY REALTY INVESTORS, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)



NOTE 9.    ADVISORY AGREEMENT (Continued)

Under the Advisory Agreement all or a portion of the annual advisory fee must be
refunded by the Advisor to the Company if the Operating Expenses of the Company
(as defined in the Advisory Agreement) exceed certain limits specified in the
Advisory Agreement. The effect of this limitation was to require that BCM refund
$201,000, $191,000 and $44,000, of the 1997, 1996 and 1995 annual advisory fee,
respectively.

Additionally, if the Company were to request that BCM render services to the
Company other than those required by the Advisory Agreement, BCM or an affiliate
of BCM will be separately compensated for such additional services on terms to
be agreed upon from time to time. As discussed in NOTE 10. "PROPERTY
MANAGEMENT," the Company has hired Carmel Realty Services, Ltd. ("Carmel,
Ltd."), an affiliate of BCM, to provide property management for the Company's
properties and, as discussed in NOTE 11. "REAL ESTATE BROKERAGE," the Company
has engaged Carmel Realty, Inc. ("Carmel Realty"), also an affiliate of BCM, on
a non-exclusive basis, to provide brokerage services for the Company.

BCM may only assign the Advisory Agreement with the prior consent of the
Company.


NOTE 10.   PROPERTY MANAGEMENT

Carmel, Ltd. provides property management services to the Company for a
fee of 5% or less of the monthly gross rents collected on the properties
under its management.  Carmel, Ltd. subcontracts with other entities for
the property-level management services to the Company at various rates.
The general partner of Carmel, Ltd. is BCM.  The limited partners of
Carmel, Ltd. are (i) First Equity Properties, Inc. ("First Equity"),
which is 50% owned by BCM, (ii) Gene E. Phillips and (iii) a trust for
the benefit of the children of Mr. Phillips.  Carmel, Ltd. subcontracts
the property-level management and leasing of nine of the Company's
office buildings and the commercial properties owned by Tri-City in
which the Company and TCI are partners to Carmel Realty which is a
company owned by First Equity.  Carmel Realty is entitled to receive
property and construction management fees and leasing commissions in
accordance with the terms of its property-level management agreement
with Carmel, Ltd.


NOTE 11.   REAL ESTATE BROKERAGE

Carmel Realty, also provides brokerage services to the Company on a
non-exclusive basis. Carmel Realty is entitled to receive a commission for
property purchases and sales in accordance with a sliding scale of total fees to
be paid by the Company.

                                       41

<PAGE>   42



                    INCOME OPPORTUNITY REALTY INVESTORS, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 12.   ADVISORY FEES, PROPERTY MANAGEMENT FEES, ETC.

Fees and cost reimbursements to BCM and its affiliates:

<TABLE>
<CAPTION>

Fees                                    1997         1996           1995
                                   -----------   -----------    ----------
<S>                                <C>           <C>            <C>       
Advisory.........................  $       343   $       227    $      316
Net income ......................          269             -             -
Incentive sales .................            6             -             -
Brokerage commissions............        2,472           532             -
Mortgage brokerage and equity
  refinancing....................           70            85            63
Property and construction
  management and leasing
  commissions*...................          503           209           156
                                   -----------   -----------    ----------
                                   $     3,663   $     1,053    $      535
                                   ===========   ===========    ==========
Cost reimbursements..............  $       248   $       175    $      140
                                   ===========   ===========    ==========
</TABLE>

----------------------

*  Net of property management fees paid to subcontractors, other than Carmel
   Realty.

NOTE 13.   INCOME TAXES

For the years 1997, 1996 and 1995, the Company has elected and qualified to be
treated as a Real Estate Investment Trust ("REIT"), as defined in Sections 856
through 860 of the Internal Revenue Code of 1986, as amended (the "Code"), and
as such, will not be taxed for federal income tax purposes on that portion of
its taxable income which is distributed to stockholders, provided that at least
95% of its REIT taxable income, plus 95% of its taxable income from foreclosure
property as defined in Section 857 of the Code, is distributed.

The Company had net income for federal income tax purposes before the
application of operating loss carryforwards in 1997 and net losses in 1996 and
1995 for federal income tax purposes; therefore, the Company recorded no
provision for income taxes. The Company's tax basis in its net assets differs
from the amount at which its net assets are reported for financial statement
purposes, principally due to the accounting for gains and losses on property
sales, the difference in the allowance for estimated losses, depreciation on
owned properties and investments in joint venture partnerships. At December 31,
1997, the Company's tax basis in its net assets exceeded its basis for financial
statement purposes by $3.0 million. As a result, aggregate future income for
income tax purposes will be less than such amount for financial statement
purposes and the Company would be able to maintain its REIT status without
distributing 95% of its financial statement income. Additionally, at December
31, 1997, the Company had tax net operating loss carryforwards of $15.2 million
expiring through the year 2011.

As a result of the Company's election to be treated as a REIT for income tax
purposes and of its intention to distribute its taxable income, if any, in
future years, no deferred tax asset, liability or valuation allowance was
recorded.

                                       42

<PAGE>   43



                    INCOME OPPORTUNITY REALTY INVESTORS, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)



NOTE 14.   COMMITMENTS AND CONTINGENCIES

Olive Litigation. In February 1990, the Company, together with Continental
Mortgage and Equity Trust ("CMET"), National Income Realty Trust and TCI, three
real estate entities with, at the time, the same officers, directors or trustees
and advisor as the Company, entered into a settlement of a class and derivative
action entitled Olive et al. v. National Income Realty Trust et al., relating to
the operation and management of each of the entities. On April 23, 1990, the
Court granted final approval of the terms of the settlement.

On May 4, 1994, the parties entered into a Modification of Stipulation of
Settlement dated April 27, 1994 (the "Olive Modification") which settled
subsequent claims of breaches of the settlement that were asserted by the
plaintiffs and that modified certain provisions of April 1990 settlement. The
Olive Modification was preliminarily approved by the Court July 1, 1994 and
final Court approval was entered on December 12, 1994. The effective date of the
Olive Modification was January 11, 1995.

The Court retained jurisdiction to enforce the Olive Modification, and during
August and September 1996, the Court held evidentiary hearings to assess
compliance with the terms of the Olive Modification by various parties. The
Court issued no ruling or order with respect to the matters addressed at the
hearings.

Separately, in 1996, legal counsel for the plaintiffs notified the Company's
Board of Directors that he intended to assert that certain actions taken by the
Board of Directors breached the terms of the Olive Modification. On January 27,
1997, the parties entered into an Amendment to the Olive Modification effective
January 9, 1997 (the "Olive Amendment"), which was submitted to the Court for
approval on January 29, 1997. The Olive Amendment provides for the settlement of
all matters raised at the evidentiary hearings and by plaintiffs' counsel in his
notices to the Company's Board of Directors. On May 2, 1997, a hearing was held
for the Court to consider approval of the Olive Amendment. As a result of the
hearing, the parties entered into a revised Olive Amendment. The Court issued an
order approving the Olive Amendment on July 3,1997.

The Olive Amendment provides for the addition of four new unaffiliated members
to the Company's Board of Directors and sets forth new requirements for the
approval of any transactions with certain affiliates until April 28, 1999. In
addition, the Company, CMET, TCI and their stockholders released the defendants
from any claims relating to the plaintiffs' allegations and matters which were
the subject of the evidentiary hearings. The plaintiffs' allegations of any
breaches of the Olive Modification shall be settled by mutual agreement of the
parties or, lacking such agreement, by an arbitration proceeding.

                                       43

<PAGE>   44



                    INCOME OPPORTUNITY REALTY INVESTORS, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)


NOTE 14.   COMMITMENTS AND CONTINGENCIES (Continued)

Under the Olive Amendment, all shares of the Company owned by Gene E. Phillips
or any of his affiliates shall be voted at all stockholder meetings of the
Company held until April 28, 1999 in favor of all new members of the Company's
Board of Directors added under the Olive Amendment. The Olive Amendment also
requires that, until April 28, 1999, all shares of the Company owned by Mr.
Phillips or his affiliates in excess of forty percent (40%) of the Company's
outstanding shares shall be voted in proportion to the votes cast by all
non-affiliated stockholders of the Company.

In accordance with the Olive Amendment, Richard W. Douglas, Larry E. Harley and
R. Douglas Leonhard were added to the Company's Board of Directors in January
1998 and Murray Shaw was added to the Company's Board of Directors in February
1998.

Other Litigation. The Company is also involved in various other lawsuits arising
in the ordinary course of business. The Company's management is of the opinion
that the outcome of these lawsuits will have no material impact on the Company's
financial condition, results of operations or liquidity.

NOTE 15.   QUARTERLY DATA

The following is a tabulation of the Company's quarterly results of operations
for the years 1997 and 1996 (unaudited).

<TABLE>
<CAPTION>

                                                Three Months Ended
                                  ------------------------------------------------
                                  March 31     June 30   September 30  December 31
                                  ---------    -------   ------------  ----------- 
1997
----
<S>                                <C>          <C>         <C>          <C>    
Revenues .....................     $ 2,761      $ 2,966     $ 3,235      $ 3,525
Expenses .....................       3,094        2,855       3,476        3,750
                                   -------      -------     -------      -------
Income (loss) from operations         (333)         111        (241)        (225)
Equity in income (loss) of
    partnerships .............          17           29         (25)          31
Gain on sale of real estate ..     $ 1,849        1,473          --          631
                                   -------      -------     -------      -------
Net income (loss) ............     $ 1,533      $ 1,613     $  (266)     $   437
                                   =======      =======     =======      =======
Earnings per share
Net income (loss) ............     $  1.01      $  1.06     $  (.18)     $   .29
                                   =======      =======     =======      =======
</TABLE>




                     [THIS SPACE INTENTIONALLY LEFT BLANK.]

                                       44

<PAGE>   45


                    INCOME OPPORTUNITY REALTY INVESTORS, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)


NOTE 15.   QUARTERLY DATA (Continued)

<TABLE>
<CAPTION>

                                                   Three Months Ended
                                 ----------------------------------------------------  
                                  March 31     June 30     September 30   December 31
                                 ----------   ---------    ------------   -----------
1996
----
<S>                               <C>          <C>           <C>           <C>      
Revenues......................    $  2,110     $  2,114      $   2,173     $   2,608
Expenses......................       2,255        2,374          2,384         2,645
                                  --------     --------      ---------     --------- 
(Loss  from operations........        (145)        (260)          (211)          (37)
Equity in income (loss)
     of partnerships                    (1)          31             (1)           56
                                  --------     --------      ---------     --------- 
Net income (loss).............        (146)    $   (229)     $    (212)    $      19
                                  ========     ========      =========     ========= 
 Earnings per share

Net income (loss).............    $   (.09)    $   (.15)     $    (.14)    $     .01
                                  ========     ========      =========     ========= 
</TABLE>



                                       45



<PAGE>   46
                                                                    SCHEDULE III
                   INCOME OPPORTUNITY REALTY INVESTORS, INC.
                    REAL ESTATE AND ACCUMULATED DEPRECIATION
                               DECEMBER 31, 1997

<TABLE>
<CAPTION>
                                                                                      Cost                                         
                                                                                   Capitalized                                    
                                                                                  Subsequent to    Gross Amounts of Which Carried 
                                              Initial Cost                         Acquisition              at End of Year       
                                         ------------------------   Construction   ------------  -----------------------------------
                                                     Building &        in                                   Building &        (1)  
  Property/Location        Encumbrances    Land      Improvements    Progress      Improvements     Land    Improvements     Total
----------------------     ------------  ----------  ------------   ------------   ------------  ---------- ------------   ---------
                                                                      (dollars in thousands)
<S>                        <C>           <C>          <C>           <C>            <C>           <C>        <C>           <C>    
Properties Held For Investment
------------------------------

APARTMENTS
----------

Eastpoint .............    $    3,341     $   1,181   $     2,749   $        --    $      441    $    1,333  $   3,038     $   4,371
   Mesquite, TX
LaMonte Park ..........         3,439           784         3,137            --            53           784      3,190         3,974
   Houston, TX
Renaissance Parc ......        12,489         3,274        13,095            --            50         3,279     13,140        16,419
   Dallas, TX
Treehouse .............         2,822           375         2,124            --           232           412      2,319         2,731
   San Antonio, TX

OFFICE BUILDINGS
----------------

Akard Plaza ...........         2,500           734         2,936            --            --           734      2,936         3,670
   Dallas, TX
Chuck Yeager ..........         2,890         1,080         4,321            --            46         1,080      4,367         5,447
   Chantilly, VA
Daley Plaza Corporate
 Center ...............         6,985         1,502         6,008            --           231         1,502      6,239         7,741
   San Diego, CA
Fireside Thrift .......         4,263         1,263         5,054            --            --         1,263      5,054         6,317
   Newark, CA
La Mesa Village Plaza .         5,968         1,709         6,836            --            17         1,709      6,853         8,562
   La Mesa, CA
Olympic ...............         4,456         1,264         5,055            --           122         1,264      5,177         6,441
   Los Angeles, CA
Saratoga ..............         7,160         2,577        10,306            --           792         2,596     11,079        13,675
   Saratoga, CA
Town Center Plaza .....         1,194           554         2,214            --           141           554      2,355         2,909
   Boca Raton, FL
Valley View Center ....            --           120           479           114            --           120        593           713
   Farmers Branch, TX
Westlake Village ......         2,923           831         3,324            --            --           831      3,324         4,155
   Westlake Village, CA
                           ----------     ---------   -----------   -----------    ----------    ----------  ---------     ---------
                           $   60,430     $  17,248   $    67,638   $       114    $    2,125    $   17,461  $  69,664     $  87,125
                           ==========     =========   ===========   ===========    ==========    ==========  =========     =========
</TABLE>
<TABLE>
<CAPTION>
                                                               Life on Which
                                             Date               Depreciation
                                             of                  In Latest    
                                             Con-                Statement   
                              Accumulated    struc-   Date     of Operation  
  Property/Location           Depreciation   tion    Acquired  is Computed
----------------------        ------------   ----    --------  -------------
                                           (dollars in thousands)
<S>                           <C>          <C>        <C>       <C> 
Properties Held For Investment
------------------------------

APARTMENTS
----------

Eastpoint .............   $    1,255       1985       01/86       5 - 40 years
   Mesquite, TX
LaMonte Park ..........           47       1981       06/97       5 - 40 years
   Houston, TX
Renaissance Parc ......          192       1972       06/97       5 - 40 years
   Dallas, TX
Treehouse .............          546       1975       09/89       5 - 40 years
   San Antonio, TX

OFFICE BUILDINGS
----------------

Akard Plaza ...........            6       1984       12/97           40 years
   Dallas, TX
Chuck Yeager ..........          111       1991       01/97       5 - 40 years
   Chantilly, VA
Daley Plaza Corporate
 Center ...............          226       1987       09/96       5 - 40 years
   San Diego, CA
Fireside Thrift .......           11       1987       12/97           40 years
   Newark, CA
La Mesa Village Plaza .          116       1991       05/97       5 - 40 years
   La Mesa, CA
Olympic ...............          149       1990       11/96       5 - 40 years
   Los Angeles, CA
Saratoga ..............        2,059       1986       12/91       3 - 40 years
   Saratoga, CA
Town Center Plaza .....          475       1985       03/91       5 - 40 years
   Boca Raton, FL
Valley View Center ....            4         (2)      09/97       5 - 40 years
   Farmers Branch, TX
Westlake Village ......           14       1982       11/97       40 years
   Westlake Village, CA
                          ----------
                          $    5,211
                          ==========
</TABLE>

(1)     The aggregate cost for Federal income tax purposes is $88.9 million.
(2)     Under construction at December 31, 1997.

                                       46
<PAGE>   47

                                                                    SCHEDULE III
                                                                     (Continued)


                    INCOME OPPORTUNITY REALTY INVESTORS, INC.
                    REAL ESTATE AND ACCUMULATED DEPRECIATION




<TABLE>
<CAPTION>
                                             1997          1996          1995  
                                           --------      --------      --------
                                                 (dollars in thousands)
<S>                                       <C>           <C>           <C>
Reconciliation of Real Estate

Balance at January 1, ................     $ 60,551      $ 46,553      $ 46,211

   Additions

     Acquisitions and Improvements ...       49,905        14,119           342

   Deductions

     Sale of real estate .............      (22,278)           --            --
     Sale of foreclosed property .....       (1,053)           --            --
     Writedown due to permanent
       impairment of property,
       previously reserved ...........           --          (121)           -- 
                                           --------      --------      --------


Balance at December 31, ..............     $ 87,125      $ 60,551      $ 46,553
                                           ========      ========      ========



Reconciliation of Accumulated
  Depreciation

Balance at January 1, ................     $  7,235      $  6,107      $  5,055

   Additions

     Depreciation ....................        1,615         1,128         1,052

   Deductions

     Sale of real estate .............       (3,619)           --            --
     Sale of foreclosed property .....          (20)           --            -- 
                                           --------      --------      --------


Balance at December 31, ..............     $  5,211      $  7,235      $  6,107
                                           ========      ========      ========
</TABLE>



                                       47
<PAGE>   48
                                                                     SCHEDULE IV




                    INCOME OPPORTUNITY REALTY INVESTORS, INC.
                          MORTGAGE LOANS ON REAL ESTATE
                                December 31, 1997

<TABLE>
<CAPTION>
                                                                                                                         Principal
                                                                                                                          amount
                                                                                                                         of loans
                                                                                                                        subject to
                                      Final                                                                Carrying     delinquent
                            Interest maturity                                      Prior    Face amount     amounts      principal
      Description             rate     date           Periodic payment terms       liens    of mortgage  of mortgage(1) or interest
------------------------    -------- -------- ----------------------------------  --------  ----------- --------------- -----------
                                                                                           (dollars in thousands)
<S>                          <C>      <C>     <C>                                 <C>        <C>          <C>              <C>

WRAPAROUND MORTGAGE NOTE

Twin Oaks..................  10.00%   08/98   Monthly interest - only payments    $    568   $   2,000    $    2,000       $     -
Secured by shopping                           due through maturity, at which      ========   =========                     =======
center in Joliet, IL.                         time the entire principal balance
                                              and all accrued and unpaid
                                              interest are due.


Accrued interest                                                                                                  17

Unamortized discount                                                                                              (7)
                                                                                                           ---------

                                                                                                           $   2,010
                                                                                                           =========

</TABLE>










--------------------
(1)  The aggregate cost for Federal income tax purposes is $2.0 million.

                                       48

<PAGE>   49

                                                                     SCHEDULE IV
                                                                     (Continued)






                    INCOME OPPORTUNITY REALTY INVESTORS, INC.
                          MORTGAGE LOANS ON REAL ESTATE






<TABLE>
<CAPTION>
                                             1997         1996          1995
                                           ---------    --------     ----------
                                                  (dollars in thousands)
<S>                                        <C>          <C>          <C>       


Balance at January 1 and
   December 31,....................        $   2,000    $  2,000     $    2,000


</TABLE>


                                       49

<PAGE>   50

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

Not applicable.

                           __________________________


                                    PART III


ITEM 10.    DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT


Directors

The affairs of Income Opportunity Realty Investors, Inc. (the "Company" or the
"Registrant") are managed by a Board of Directors.  The Directors are elected
at the annual meeting of stockholders or appointed by the incumbent Board of
Directors and serve until the next annual meeting of stockholders or until a
successor has been elected or approved.

The Directors of the Company are listed below, together with their ages, terms
of service, all positions and offices with the Company or its advisor, Basic
Capital Management, Inc. ("BCM" or the "Advisor"), their principal occupations,
business experience and directorships with other companies during the last five
years or more.  The designation "Affiliated", when used below with respect to a
Director, means that the Director is an officer, director or employee of the
Advisor or an officer of the Company.  The designation "Independent" when used
below with respect to a Director, means that the Director is neither an officer
of the Company nor a director, officer or employee of the Advisor, although the
Company may have certain business or professional relationships with such
Director as discussed in ITEM 13.  "CERTAIN RELATIONSHIPS AND RELATED
TRANSACTIONS -Certain Business Relationships."


TED P. STOKELY:  Age 64, Director (Independent) (since April 1990)
and Chairman of the Board (since January 1995).

         General Manager (since January 1995) of ECF Senior Housing Corporation,
         a nonprofit corporation; General Manager (since January 1993) of
         Housing Assistance Foundation, Inc., a nonprofit corporation; Part-time
         unpaid Consultant (since January 1993) and paid Consultant (April 1992
         to December 1992) of Eldercare Housing Foundation ("Eldercare"), a
         nonprofit corporation; President (April 1992 to April 1994) of PSA
         Group; Executive Vice President (1987 to 1991) of Key Companies Inc.;
         Trustee (since April 1990) and Chairman of the Board (since January
         1995) of Continental Mortgage and Equity Trust ("CMET"); Director
         (since April 1990) and Chairman of the Board (since January 1995) of
         Transcontinental Realty Investors, Inc. ("TCI"); and Trustee (April
         1990 to August 1994) of National Income Realty Trust ("NIRT").





                                       50
<PAGE>   51
ITEM 10.    DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT
            (Continued)


Directors (Continued)

RICHARD W. DOUGLAS:  Age 50, Trustee (Independent) (since January 1998).

         President (since 1991) of Dallas Chamber of Commerce; President (1988
         to 1991) of North Texas Commission; President (1978 to 1981) of Las
         Colinas Corporation and Southland Investment Properties, both
         affiliates of Southland Financial Corporation; Trustee (since January
         1998) of CMET; and Director (since January 1998) of TCI.

LARRY E. HARLEY:  Age 57, Trustee (Independent) (since January 1998).

         President (1993 to 1997) and Executive Vice President (1992 to 1993)
         of U.S. Operations, Executive Vice President (1989 to 1992) and Senior
         Vice President (1986 to 1989) of Distribution Operations, Director of
         Marketing (1984 to 1986), and Manager of North Central Distribution
         Center (1974 to 1984) of Mary Kay Cosmetics; Trustee (since January
         1998) of CMET; and Director (since January 1998) of TCI.

R. DOUGLAS LEONHARD:  Age 61, Trustee (Independent) (since January 1998).

         Senior Vice President (1986 to 1997) of LaCantera Development Company,
         a wholly-owned subsidiary of USAA; Senior Vice President (1980 to
         1985) of The Woodlands Development Corporation; Vice President and
         Houston Projects Manager (1973 to 1979) of Friendswood Development
         Company; Manager in various capacities (1960 to 1973) of Exxon Corp.;
         Trustee (since January 1998) of CMET; and Director (since January 1998)
         of TCI.

MURRAY SHAW:  Age 66, Trustee (Independent) (since February 1998).

         Chairman of the Board of Regents (since 1997) of Stephen F. Austin
         University; Vice President (1967 to 1996) of Tracor, Inc.; Trustee
         (since February 1998) of CMET; and Director (since February 1998) of
         TCI.

MARTIN L. WHITE:  Age 58, Director (Independent) (since January 1995).

         Chief Executive Officer (since 1995) of Builders Emporium, Inc.;
         Chairman and Chief Executive Officer (since 1993) of North American
         Trading Company Ltd.; President and Chief Operating Officer (since
         1992) of Community Based Developers, Inc.;  Development Officer and
         Loan Manager (1986 to 1992) of the City of San Jose, California; Vice
         President and Director of Programs (1967 to 1986) of Arpact, Inc., a
         government contractor for small business development and trade;
         Trustee (since January 1995) of CMET; and Director (since January
         1995) of TCI.





                                       51
<PAGE>   52
ITEM 10.    DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT
            (Continued)

Directors (Continued)

EDWARD G. ZAMPA:  Age 63, Director (Independent) (since January 1995).

         General Partner (since 1976) of Edward G. Zampa and Company;  Trustee
         (since January 1995) of CMET; and Director (since January 1995) of
         TCI.


Board Committees

The Company's Board of Directors held seven meetings during 1997.  For such
year, no incumbent Director attended fewer than 75% of the aggregate of (i) the
total number of meetings held by the Company's Board of Directors during the
period for which he had been a Director and (ii) the total number of meetings
held by all committees of the Board of Directors on which he served during the
period that he served, except Mr. White, who attended only one of the two audit
committee meetings held in 1997.

The Company's Board of Directors has an Audit Committee, the function of which
is to review the Company's operating and accounting procedures.  The current
members of the Audit Committee, all of whom are Independent Directors, are
Messrs.  Stokely, Leonhard and White.  The Audit Committee met twice during
1997.

The Company's Board of Directors has a Relationship with Advisor Committee and
a Board Development Committee.  The current members of the Relationship with
Advisor Committee are Messrs. Stokely and Zampa.  The Relationship with Advisor
Committee reviews and reports to the Company's Board of Directors on the
services provided to the Company by the Advisor and its affiliates and the
terms of any engagement or compensation of the Advisor or its affiliates.  The
Relationship with Advisor Committee did not meet in 1997.  The Board
Development Committee reviews and reports to the Company's Board of Directors
on the membership, compensation and functions of the Board of Directors.  The
current member of the Board Development Committee is Mr. White.  The Board
Development Committee did not meet in 1997.

The Company's Board of Directors does not have Nominating or Compensation
Committees.


Executive Officers

The following persons currently serve as executive officers of the Company:
Randall M. Paulson, President; Karl L.  Blaha, Executive Vice President -
Commercial Asset Management; Bruce A. Endendyk, Executive Vice President; and
Thomas A. Holland, Executive Vice President and Chief Financial Officer.  Their
positions with the Company are not subject to a vote of stockholders.  Their
ages, terms of service, all





                                       52
<PAGE>   53
ITEM 10.    DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT
            (Continued)


Executive Officers (Continued)

positions and offices  with the Company or BCM, other principal occupations,
business experience and directorships with other companies during the last five
years or more are set forth below.

RANDALL M. PAULSON:  Age 51, President (since August 1995) and Executive Vice
President (January 1995 to August 1995).

         President (since August 1995) and Executive Vice President (January
         1995 to August 1995) of CMET, TCI and Syntek Asset Management, Inc.
         ("SAMI"), the managing general partner of Syntek Asset Management,
         L.P. ("SAMLP"), which is the general partner of National Realty, L.P.
         ("NRLP") and National Operating, L.P. ("NOLP"), and (October 1994 to
         August 1995) of BCM; Director (since August 1995) of SAMI; Executive
         Vice President (since January 1995) of American Realty Trust, Inc.
         ("ART"); Vice President (1993 to 1994) of GSSW, LP, a joint venture of
         Great Southern Life and Southwestern Life; Vice President (1990 to
         1993) of Property Company of America Realty, Inc.; President (1990) of
         Paulson Realty Group; President (1983 to 1989) of Johnstown Management
         Company; and Vice President (1979 to 1982) of Lexton-Ancira.


KARL L. BLAHA:  Age 50, Executive Vice President - Commercial Asset Management
(since July 1997).

         Executive Vice President- Commercial Asset Management (since July
         1997) and Executive Vice President and Director of Commercial
         Management (April 1992 to August 1995) of BCM, CMET, TCI, and SAMI;
         Director (since June 1996), President (since October 1993) and
         Executive Vice President and Director of Commercial Management (April
         1992 to October 1993) of ART; Executive Vice President (October 1992
         to July 1997) of Carmel Realty, Inc. ("Carmel Realty"), a company
         owned by First Equity Properties, Inc. ("First Equity"), which is 50%
         owned by BCM; President and Director (since 1996) of First Equity;
         Executive Vice President and Director of Commercial Management (April
         1992 to February 1994) of NIRT and Vinland Property Trust ("VPT");
         Partner - Director of National Real Estate Operations (August 1988 to
         March 1992) of First Winthrop Corporation; Corporate Vice President
         (April 1984 to August 1988) of Southmark Corporation ("Southmark");
         and President (March 1986 to August 1988) of Southmark Commercial
         Management.



                     [THIS SPACE INTENTIONALLY LEFT BLANK.]





                                       53
<PAGE>   54
ITEM 10.    DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT
            (Continued)


Executive Officers (Continued)

BRUCE A. ENDENDYK:  Age 49, Executive Vice President (since January 1995).

         President (since January 1995) of Carmel Realty; Executive Vice
         President (since January 1995) of BCM, SAMI, ART, CMET and TCI;
         Management Consultant (November 1990 to December 1994); Executive Vice
         President (January 1989 to November 1990) of Southmark; President and
         Chief Executive Officer (March 1988 to January 1989) of Southmark
         Equities Corporation; and Vice President/Resident Manager (December
         1975 to March 1988) of Coldwell Banker Commercial/Real Estate Services
         in Houston, Texas.


THOMAS A. HOLLAND:  Age 55, Executive Vice President and Chief Financial
Officer (since August 1995); Secretary (since February 1997) and Senior Vice
President and Chief Accounting Officer (July 1990 to August 1995).

         Executive Vice President and Chief Financial Officer (since August
         1995) and Senior Vice President and Chief Accounting Officer (July
         1990 to August 1995) of BCM, SAMI, ART, CMET and TCI; Secretary (since
         February 1997) of CMET and TCI; Senior Vice President and Chief
         Accounting Officer (July 1990 to February 1994) of NIRT and VPT; Vice
         President and Controller (December 1986 to June 1990) of Southmark;
         Vice President-Finance (January 1986 to December 1986) of Diamond
         Shamrock Chemical Company; Assistant Controller (May 1976 to January
         1986) of Maxus Energy Corporation (formerly Diamond Shamrock
         Corporation); Trustee (August 1989 to June 1990) of Arlington Realty
         Investors; and Certified Public Accountant (since 1970).


Officers

Although not executive officers of the Company, the following persons currently
serve as officers of the Company: Robert A. Waldman, Senior Vice President and
General Counsel; and Drew D. Potera, Vice President and Treasurer.  Their
positions with the Company are not subject to a vote of  stockholders.  Their
ages, terms of service, all





                     [THIS SPACE INTENTIONALLY LEFT BLANK.]





                                       54
<PAGE>   55
ITEM 10.    DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT
            (Continued)

Officers (Continued)

positions and offices with the Company or BCM, other principal occupations,
business experience and directorships with other companies during the last five
years or more are set forth below.

ROBERT A. WALDMAN:  Age 45, Senior Vice President and General Counsel (since
January 1995); Vice President (December 1990 to January 1995) and Secretary
(December 1993 to February 1997).

         Senior Vice President and General Counsel (since January 1995), Vice
         President (December 1990 to January 1995) and Secretary (December 1993
         to February 1997) of CMET and TCI; Senior Vice President and General
         Counsel (since January 1995), Vice President (January 1993 to January
         1995) and Secretary (since December 1989) of ART; Senior Vice
         President and General Counsel (since November 1994), Vice President
         and Corporate Counsel (November 1989 to November 1994), and Secretary
         (since November 1989) of BCM; Senior Vice President and General
         Counsel (since January 1995), Vice President (April 1990 to January
         1995) and Secretary (since December 1990) of SAMI; Vice President
         (December 1990 to February 1994) and Secretary (December 1993 to
         February 1994) of NIRT and VPT; and Director (February 1987 to October
         1989) and General Counsel and Secretary (1985 to October 1989) of Red
         Eagle Resources Corporation.

DREW D. POTERA:  Age 38, Vice President (since December 1996) and Treasurer
(since December 1990).

         Vice President (since December 1996) and Treasurer (since December
         1990) of CMET and TCI; Vice President (since December 1996) and
         Treasurer (since August 1991) and Assistant Treasurer (December 1990
         to August 1991) of ART; Vice President, Treasurer and Securities
         Manager (since July 1990) of BCM; Vice President and Treasurer (since
         February 1992) of SAMI; Treasurer (December 1990 to February 1994) of
         NIRT and VPT; and Financial Consultant with Merrill Lynch, Pierce,
         Fenner & Smith Incorporated (June 1985 to June 1990).

In addition to the foregoing officers, the Company has several vice presidents
and assistant secretaries who are not listed herein.

Compliance with Section 16(a) of the Securities Exchange Act of 1934

Under the securities laws of the United States, the Company's Directors,
executive officers, and any persons holding more than ten percent of the
Company's shares of Common Stock are required to report their ownership of the
Company's shares and any changes in that ownership to the Securities and
Exchange Commission (the "Commission").  Specific due dates for these reports
have been established and the Company is required to report any failure to file
by these dates during 1997.  All





                                       55
<PAGE>   56
ITEM 10.    DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT
            (Continued)


Compliance with Section 16(a) of the Securities Exchange Act of 1934
(Continued)

of these filing requirements were satisfied by its Directors and executive
officers and ten percent holders.  In making these statements, the Company has
relied on the written representations of its incumbent Directors and executive
officers and its ten percent holders and copies of the reports that they have
filed with the Commission.

The Advisor

Although the Company's Board of Directors is directly responsible for managing
the affairs of the Company and for setting the policies which guide it, the
day-to-day operations of the Company are performed by a contractual advisor
under the supervision of the Company's Board of Directors.  The duties of the
advisor include, among other things, locating, investigating, evaluating and
recommending real estate and mortgage note investment and sales opportunities
as well as financing and refinancing sources for the Company.  The advisor also
serves as a consultant to the Company's Board of Directors in connection with
the business plan and investment policy decisions.

BCM has served as the Company's advisor since March 1989.  BCM is a company of
which Messrs. Paulson, Blaha, Endendyk and Holland serve as executive officers.
BCM is owned by a trust for the benefit of the children of Gene E. Phillips.
Mr. Phillips served as a director of BCM until December 22, 1989, and as Chief
Executive Officer of BCM until September 1, 1992.  Mr. Phillips serves as a
representative of his children's trust which owns BCM and, in such capacity,
has substantial contact with the management of BCM and input with respect to
BCM's performance of advisory services to the Company.

At the Company's annual meeting of stockholders held on May 8, 1997, the
Company's stockholders approved the renewal of the Company's Advisory Agreement
with BCM through the next annual meeting of the Company's stockholders.
Subsequent renewals of the Company's Advisory Agreement with BCM do not require
the approval of the Company's stockholders, but do require approval of the
Company's Board of Directors.

Under the Advisory Agreement, the Advisor is required to formulate and submit
annually for approval by the Company's Board of Directors a budget and business
plan for the Company containing a twelve month forecast of operations and cash
flow, a general plan for asset sales and acquisitions, lending foreclosure and
borrowing activity, and other investments.  The Advisor is required to report
quarterly to the Company's Board of Directors on the Company's performance
against the business plan.  In addition, all transactions by the Company shall
require prior approval by the Company's Board of Directors, unless they are
explicitly provided for in the approved business plan or are made pursuant to
authority expressly delegated to the Advisor by the Company's Board of
Directors.





                                       56
<PAGE>   57
ITEM 10.    DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT
            (Continued)

The Advisor (Continued)

The Advisory Agreement also requires prior approval of the Company's Board of
Directors for the retention of all consultants and third party professionals,
other than legal counsel.  The Advisory Agreement provides that the Advisor
shall be deemed to be in a fiduciary relationship to the Company's
stockholders; contains a broad standard governing the Advisor's liability for
losses by the Company; and contains guidelines for the Advisor's allocation of
investment opportunities as among itself, the Company and other entities it
advises.

The Advisory Agreement provides for BCM to be responsible for the day-to-day
operations of the Company and to receive an advisory fee comprised of a gross
asset fee of .0625% per  month (.75% per annum) of the average of the gross
asset value of the Company (total assets less allowance for amortization,
depreciation or depletion and valuation reserves) and an annual net income fee
equal to 7.5% per annum of the Company's net income.

The Advisory Agreement also provides for BCM to receive an annual incentive
sales fee equal to 10% of the amount, if any, by which the aggregate sales
consideration for all real estate sold by the Company during such fiscal year
exceeds the sum of:  (i) the cost of each such property as originally recorded
in the Company's books for tax purposes (without deduction for depreciation,
amortization or reserve for losses), (ii) capital improvements made to such
assets during the period owned by the Company, and (iii) all closing costs,
(including real estate commissions) incurred in the sale of such real estate;
provided, however, no incentive fee shall be paid unless (a) such real estate
sold in such fiscal year, in the aggregate, has produced an 8% simple annual
return on the Company's net investment including capital improvements,
calculated over the Company's holding period before depreciation and inclusive
of operating income and sales consideration and (b) the aggregate net operating
income from all real estate owned by the Company for each of the prior and
current fiscal years shall be at least 5% higher in the current fiscal year
than in the prior fiscal year.

Additionally, pursuant to the Advisory Agreement BCM or an affiliate of BCM is
to receive an acquisition commission for supervising the acquisition, purchase
or long-term lease of real estate for the Company equal to the lesser of (i) up
to 1% of the cost of acquisition, inclusive of commissions, if any, paid to
nonaffiliated brokers or (ii) the compensation customarily charged in
arm's-length transactions by others rendering similar property acquisition
services as an ongoing public activity in the same geographical location and
for comparable property, provided that the aggregate purchase price of each
property (including acquisition fees and real estate brokerage commissions) may
not exceed such property's appraised value at acquisition.

The Advisory Agreement requires BCM or any affiliate of BCM to pay to the
Company, one-half of any compensation received from third parties with respect
to the origination, placement or brokerage of any loan made





                                       57
<PAGE>   58
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT
         (Continued)

The Advisor (Continued)

by the Company; provided, however, that the compensation retained by BCM or any
affiliate of BCM shall not exceed the lesser of (i) 2% of the amount of the
loan committed by the Company or (ii) a loan brokerage and commitment fee which
is reasonable and fair under the circumstances.

The Advisory Agreement also provides that BCM or an affiliate of BCM is to
receive a mortgage or loan acquisition fee with respect to the acquisition or
purchase of any existing mortgage loan by the Company equal to the lesser of
(i) 1% of the amount of the loan purchased or (ii) a brokerage or commitment
fee which is reasonable and fair under  the circumstances.  Such fee will not
be paid in connection with the origination or funding by the Company of any
mortgage loan.

Under the Advisory Agreement, BCM or an affiliate of BCM is also to receive a
mortgage brokerage and equity refinancing fee for obtaining loans to the
Company or refinancing on Company properties equal to the lesser of (i) 1% of
the amount of the loan or the amount refinanced or (ii) a brokerage or
refinancing fee which is reasonable and fair under the circumstances; provided,
however, that no such fee shall be paid on loans from BCM or an affiliate of
BCM without the approval of the Company's Board of Directors.  No fee shall be
paid on loan extensions.

Under the Advisory Agreement, BCM is to receive reimbursement of certain
expenses incurred by it, in the performance of advisory services to the
Company.

Under the Advisory Agreement all or a portion of the annual advisory fee must
be refunded by the Advisor to the Company if the Operating Expenses  of the
Company (as defined in the Advisory Agreement) exceed certain limits specified
in the Advisory Agreement based on the book value, net asset value and net
income of the Company during such fiscal year.  The effect of this limitation
was to require that BCM refund $201,000, of the 1997 annual advisory fee.

Additionally, if the Company were to request that BCM render services to the
Company other than those required by the Advisory Agreement, BCM or an
affiliate of BCM will be separately compensated for such additional services on
terms to be agreed upon from time to time.  As discussed below, under "Property
Management", the Company has hired Carmel Realty Services, Ltd. ("Carmel,
Ltd."), an affiliate of BCM, to provide management for the Company's properties
and, as discussed below, under "Real Estate Brokerage" the Company has engaged
Carmel Realty, also an affiliate of BCM, on a non-exclusive basis to provide
brokerage services for the Company.

BCM may only assign the Advisory Agreement with the prior consent of the
Company.

The directors and principal officers of BCM are set forth below.

MICKEY N. PHILLIPS:   Director





                                       58
<PAGE>   59
ITEM 10.   DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT
           (Continued)

<TABLE>
<S>                                   <C>
The Advisor (Continued)
-----------            

RYAN T. PHILLIPS:                     Director

RANDALL M. PAULSON:                   President

KARL L. BLAHA:                        Executive Vice President - Commercial Asset
                                      Management

BRUCE A. ENDENDYK:                    Executive Vice President

THOMAS A. HOLLAND:                    Executive Vice President and Chief Financial
                                      Officer

A. CAL ROSSI, JR.:                    Executive Vice President

COOPER B. STUART:                     Executive Vice President

CLIFFORD C. TOWNS, JR:                Executive Vice President - Finance

DAN S. ALLRED                         Senior Vice President - Land Development

ROBERT A. WALDMAN:                    Senior Vice President, Secretary and General
                                      Counsel

DREW D. POTERA:                       Vice President, Treasurer and Securities
                                      Manager
</TABLE>

Mickey N. Phillips is Gene E. Phillips' brother and Ryan T. Phillips is Gene E.
Phillips' son.  Gene E. Phillips serves as a representative of the trust
established for the benefit of his children which owns BCM and, in such
capacity, has substantial contact with the management of BCM and input with
respect to its performance of advisory services to the Company.

Property Management

Since February 1, 1990, affiliates of BCM have provided property management
services to the Company.  Currently, Carmel, Ltd. provides such property
management services for a fee of 5% or less of the monthly gross rents
collected on the properties under its management.  Carmel, Ltd. subcontracts
with other entities for the provision of the property-level management services
to the Company at various rates.  The general partner of Carmel, Ltd. is BCM.
The limited partners of Carmel, Ltd. are (i) First Equity, which is 50% owned
by BCM, (ii) Gene E. Phillips and (iii) a trust for the benefit of the children
of Mr. Phillips.  Carmel, Ltd. subcontracts the property-level management and
leasing of nine of the Company's office buildings and the commercial properties
owned by a real estate partnership in which the Company and TCI are partners to
Carmel Realty which is a company owned by First Equity.  Carmel Realty is
entitled to receive property and construction management fees and leasing
commissions in accordance with its property-level management agreement with
Carmel, Ltd.





                                       59
<PAGE>   60
ITEM 10.   DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT
           (Continued)

Real Estate Brokerage

Since December 1, 1992, Carmel Realty has been engaged, on a non-exclusive
basis, to provide brokerage services for the Company.  Carmel Realty is
entitled to receive a real estate brokerage commission for property
acquisitions and sales by the Company in accordance with the following sliding
scale of total fees to be paid by the Company:  (i) maximum fee of 5% on the
first $2.0 million of any purchase or sale transaction of which no more than 4%
would be paid to Carmel Realty or affiliates; (ii) maximum fee of 4% on
transaction amounts between $2.0 million - $5.0 million of which no more than
3% would be paid to Carmel Realty or affiliates; (iii) maximum fee of 3% on
transaction amounts between $5.0 million - $10.0 million of which no more than
2% would be paid to Carmel Realty or affiliates; and, (iv) maximum fee of 2% on
transaction amounts in excess of $10.0 million of which no more than 1 1/2%
would be paid to Carmel Realty or affiliates.

ITEM 11.   EXECUTIVE COMPENSATION

The Company has no employees, payroll or benefit plans and pays no compensation
to the executive officers of the Company.  The executive officers of the
Company who are also officers or employees of BCM, the Company's Advisor, are
compensated by the Advisor.  Such executive officers of the Company perform a
variety of services for the Advisor and the amount of their compensation is
determined solely by the Advisor.  BCM does not allocate the cash compensation
of its officers among the various entities for which it serves as advisor.
See ITEM 10. "DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT  -
The Advisor" for a more detailed discussion of the compensation payable to BCM
by the Company.

The only remuneration paid by the Company is to the Directors who are not
officers or directors of BCM or its affiliated companies.  The Independent
Directors (i) review the business plan of the Company to determine that it is
in the best interest of the Company's stockholders, (ii) review the Company's
contract with the advisor, (iii) supervise the performance of the Company's
advisor and review the reasonableness of the compensation which the Company
pays to its advisor in terms of the nature and quality of services performed,
(iv) review the reasonableness of the total fees and expenses of the Company
and (v) select, when necessary, a qualified independent real estate appraiser
to appraise properties acquired by the Company.  Each Independent Director
receives compensation in the amount of $15,000 per year, plus reimbursement for
expenses, and the Chairman of the Board receives an additional fee of $1,500
per year for serving in such position.  In addition, each Independent Director
receives an additional fee of $1,000 per day for any special services rendered
by him to the Company outside of his ordinary duties as Director, plus
reimbursement of expenses.

During 1997, $65,500 was paid to the Independent Directors in total Directors'
fees for all services including the annual fee for service during the period
January 1, 1997 through December 31, 1997, and 1997 special service fees, as
follows:  Ted P. Stokely, $16,500 ; Edward L. Tixier, $15,000; Martin L. White,
$15,000; and Edward G. Zampa, $19,000.





                                       60
<PAGE>   61
ITEM 11.  EXECUTIVE COMPENSATION (Continued)



Performance Graph

The following performance graph compares the cumulative total stockholder
return on the Company's shares of Common Stock with the Standard & Poor's 500
Stock Index ("S&P 500 Index") and the National Association of Real Estate
Investment Trusts, Inc.  Hybrid REIT Total Return Index ("REIT Index").  The
comparison assumes that $100 was invested on December 31, 1992 in the Company's
shares of Common Stock and in each of the indices and further assumes the
reinvestment of all distributions.  Past performance is not necessarily an
indicator of future performance.




                            COMPARISON OF FIVE YEAR


                             CUMULATIVE TOTAL RETURN

<TABLE>
<CAPTION>

                         1992       1993      1994      1995      1996       1997
                         ----       ----      ----      ----      ----       ---- 
<S>                      <C>       <C>       <C>       <C>       <C>        <C>
THE COMPANY              100       244.11    327.82    338.65    394.69     425.95 

S&P 500 INDEX            100       109.99    111.43    153.13    188.29     251.13     

REIT INDEX               100       121.18    126.03    155.01    200.51     222.07

</TABLE>



                                       61
<PAGE>   62
ITEM 12.   SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

Security Ownership of Certain Beneficial Owners.  The following table sets
forth the ownership of the Company's shares of Common Stock, both beneficially
and of record, both individually and in the aggregate for those persons or
entities known by the Company to be beneficial owners of more than 5% of its
shares of Common Stock as of the close of business on March 6, 1998.

<TABLE>
<CAPTION>
                                                         Amount and Nature
    Name and Address of                                   of Beneficial                           Percent of
     Beneficial Owner                                       Ownership                              Class (1)
---------------------------                           ----------------------                      ----------
<S>                                                    <C>                                         <C>
American Realty Trust, Inc.                               452,102                                       29.7%
10670 N. Central Expressway
Suite 300
Dallas, Texas  75231

Transcontinental Realty
 Investors, Inc.                                          341,500                                       22.5%
10670 N. Central Expressway
Suite 300
Dallas, Texas  75231
                           
---------------------------
</TABLE>

(1)   Percentages are based upon 1,519,888 shares of Common Stock outstanding
      at March 6, 1998.

Security Ownership of Management.  The following table sets forth the ownership
of the Company's shares of Common Stock, both beneficially and of record, both
individually and in the aggregate for the Directors and executive officers of
the Company as of the close of business on March 6, 1998.

<TABLE>
<CAPTION>
                                                       Amount and Nature
                                                         of Beneficial                            Percent of
 Name of Beneficial Owner                                 Ownership                                Class (1)
--------------------------                            -----------------                           ----------
<S>                                                   <C>                                         <C>
All Directors and Executive                           896,052(2)                                  59.0%
Officers as a group
(11 individuals)
</TABLE>

___________________________

(1)   Percentage is based upon 1,519,888 shares of Common Stock outstanding at
      March 6, 1998.

(2)   Includes 341,500 shares owned by TCI of which the Directors may be deemed
      to be beneficial owners by virtue of their positions as directors of TCI
      and 452,102 shares owned by ART and 102,450 owned by BCM, of which the
      executive officers of the Company may be deemed to be beneficial owners
      by virtue of their positions as executive officers of ART and BCM.  The
      Company's Directors and executive officers disclaim beneficial ownership
      of such shares.  Each of the directors of ART may be deemed to be
      beneficial owners





                                       62
<PAGE>   63
ITEM 12.   SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
              (Continued)

           of the shares owned by ART by virtue of their positions as directors
           of ART.  Each of the directors of BCM may be deemed to be beneficial
           owners of the shares owned by BCM by virtue of their positions as
           directors of BCM.  The directors of ART and BCM disclaim such
           beneficial ownership.

ITEM 13.   CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Certain Business Relationships

In February 1989, the Company's Board of Directors voted to retain BCM as the
Company's advisor.  See ITEM 10.  "DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF
THE REGISTRANT - The Advisor."  BCM is a company of which Messrs. Paulson,
Blaha, Endendyk and Holland serve as executive officers.  Gene E. Phillips
served as a director of BCM until December 22, 1989, and as Chief Executive
Officer of BCM until September 1, 1992.  BCM is owned by a trust for the
benefit of the children of Mr. Phillips.  Mr. Phillips serves as a
representative of his children's trust which owns BCM and, in such capacity,
has substantial contact with the management of BCM and input with respect to
BCM's performance of advisory services to the Company.

Since February 1, 1991, affiliates of BCM have provided property management
services to the Company.  Currently, Carmel, Ltd. provides such property
management services.  The general partner of Carmel, Ltd. is BCM.  The limited
partners of Carmel, Ltd. are (i) First Equity, (ii) Mr. Phillips and (iii) a
trust for the benefit of the children of Mr. Phillips.  Carmel, Ltd.
subcontracts the property-level management and leasing of nine of the Company's
office buildings and the commercial properties owned by a real estate
partnership in which the Company and TCI are partners to Carmel Realty, which
is a company owned by First Equity.

Prior to December 1, 1992, affiliates of BCM provided brokerage services to the
Company and received brokerage commissions in accordance with the advisory
agreement.  Since December 1, 1992, the Company has engaged, on a non-
exclusive basis, Carmel Realty to perform brokerage services for the Company.
Carmel Realty is a company owned by First Equity.

The Directors and officers of the Company also serve as trustees or directors
and officers of CMET and TCI.  The Directors owe fiduciary duties to such
entities as well as to the Company under applicable law.  CMET and TCI have the
same relationship with BCM as the Company.  Mr. Phillips is a general partner
of SAMLP, the general partner of NRLP and NOLP.  BCM performs certain
administrative functions for NRLP and NOLP on a cost-reimbursement basis.  BCM
also serves as advisor to ART.  Mr. Phillips served as Chairman of the Board
and as a director of ART until November 16, 1992.  Messrs. Blaha, Paulson,
Endendyk and Holland serve as executive officers of ART.

From April 1992 to December 31, 1992, Mr. Stokely was employed as a paid Real
Estate Consultant and since January 1993 as a part-time unpaid Consultant for
Eldercare, a nonprofit corporation engaged in the





                                       63
<PAGE>   64
ITEM 13.   CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS (Continued)

Certain Business Relationships (Continued)

acquisition of low income and elderly housing. Eldercare has revolving loan
committment from Syntek West, Inc. of which Mr. Phillips is the sole
shareholder.  Eldercare filed for bankruptcy protection in July 1993  and was
dismissed from bankruptcy in October 1994. Eldercare again filed for bankruptcy
protection in May 1995 and was reorganized in bankruptcy in February 1996, and
has since paid all debts as directed by the Court.

Related Party Transactions

Historically, the Company has engaged in and may continue to engage in business
transactions, including real estate partnerships, with related parties.  The
Company's management believes that all of the related party transactions
represented the best investments available at the time and were at least as
advantageous to the Company as could have been obtained from unrelated third
parties.

As more fully described in ITEM 2. "PROPERTIES - Real Estate," the Company is a
partner with TCI in the Tri-City Limited Partnership and Nakash Income
Associates.

In 1997, the Company paid BCM and its affiliates $612,000 in advisory and net
income fees, $6,000 in incentive sales fees, $2.5 million in real estate
brokerage commissions, $70,000 in mortgage brokerage and equity refinancing
fees, and $503,000 in property management and construction supervision fees
(net of property management fees paid to subcontractors, other than Carmel
Realty).  In addition, as provided in the Advisory Agreement, BCM received cost
reimbursements from the Company of $248,000 in 1997.

Restrictions on Related Party Transactions

Article FOURTEENTH of the Company's Articles of Incorporation provides that the
Company shall not, directly or indirectly, contract or engage in any
transaction with (i) any director, officer or employee of the Company, (ii) any
director, officer or employee of the advisor, (iii) the advisor or (iv) any
affiliate or associate (as such terms are defined in Rule 12b-2 under the
Securities Exchange Act of 1934, as amended) of any of the aforementioned
persons, unless (a) the material facts as to the relationship among or
financial interest of the relevant individuals or persons and as to the
contract or transaction are disclosed to or are known by the Company's Board of
Directors or the appropriate  committee thereof and (b) the Company's Board of
Directors or committee thereof determines that such contract or transaction is
fair to the Company and simultaneously authorizes or ratifies such contract or
transaction by the affirmative vote of a majority of independent directors of
the Company entitled to vote thereon.

Article FOURTEENTH defines an "Independent Director" as one who is neither an
officer or employee of the Company nor a director, officer or employee of the
Company's advisor.

Pursuant to the terms of the Modification of Stipulation of Settlement (the
"Olive Modification") in the Olive Litigation, as more fully





                                       64
<PAGE>   65
ITEM 13.   CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS (Continued)


Restrictions on Related Party Transactions (Continued)

discussed in ITEM 3. "LEGAL PROCEEDINGS -  Olive Litigation," which became
effective on January 11, 1995, certain related party transactions which the
Company may enter into  prior to April 28, 1999, require the unanimous approval
of the Company's Board of Directors.  In addition, such related party
transactions are to be discouraged and may only be entered into in exceptional
circumstances and after a determination by the Company's Board of Directors
that the transaction is in the best interests of the Company and that no other
opportunity exists that is as good as the opportunity presented by such
transaction.

The Olive Modification requirements for related party transactions do not apply
to direct contractual agreements for services between the Company and the
Advisor or one of its affiliates, (including the Advisory Agreement, the
Brokerage Agreement and the property management contracts).  These agreements,
pursuant to the specific terms of the Olive Modification, require the prior
approval by two-thirds of the Directors of the Company, and if required,
approval by a majority of the Company's stockholders.  The Olive Modification
requirements for related party transactions also do not apply to joint ventures
between or among the Company and CMET, NIRT or TCI or any of their affiliates
or subsidiaries and a third party having no prior or intended future business
or financial relationship with Gene E. Phillips, William S. Friedman, the
Advisor, or any affiliate of such parties.  Such joint ventures may be entered
into on the affirmative vote of a majority of the Directors of the Company.

An Amendment to the Olive Modification (the "Olive Amendment") was approved by
the Court on July 3, 1997.  The Olive Amendment requires that additional
requirements be met for certain transactions with affiliates ("Affiliated
Transaction").  Independent counsel to the Board must review, advise and report
to the Company's Board of Directors on any Affiliated Transaction prior to its
consideration and approval by the Company's Board of Directors and the
Company's Board of Directors must unanimously approve the transaction after
receiving independent counsel's advice and report.  In addition, a notice must
be given to the plaintiffs' counsel at least 10 days prior to the closing of
the transaction and during such 10 day period plaintiffs' counsel is entitled
to seek a Court order prohibiting consummation of the transaction.  Neither BCM
nor any of its affiliates may receive any fees or commissions in connection
with an Affiliated Transaction.





                     [THIS SPACE INTENTIONALLY LEFT BLANK.]





                                       65
<PAGE>   66
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES, AND REPORTS ON
         FORM 8-K

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

1.  Consolidated Financial Statements

    Report of Independent Certified Public Accountants

    Consolidated Balance Sheets - December 31, 1997 and 1996

    Consolidated Statements of Operations -
         Years Ended December 31, 1997, 1996 and 1995

    Consolidated Statements of Stockholders' Equity -
         Years Ended December 31, 1997, 1996 and 1995

    Consolidated Statements of Cash Flows -
         Years Ended December 31, 1997, 1996 and 1995

    Notes to Consolidated Financial Statements

2.  Financial Statement Schedules

    Schedule III - Real Estate and Accumulated Depreciation

    Schedule IV  - Mortgage Loans on Real Estate

All other schedules are omitted because they are not applicable or because the
required information is shown in the Financial Statements or the Notes thereto.

3.  Exhibits

The following documents are filed as Exhibits to this Report:

<TABLE>
<CAPTION>
Exhibit
Number                              Description                         
-------    -------------------------------------------------------------
 <S>       <C>
  3.0      Articles of Incorporation of Income Opportunity Realty Investors, Inc. (incorporated by reference to Appendix
           C to the Registrant's Registration Statement on Form S-4 dated February 12, 1996).

  3.1      Bylaws of Income Opportunity Realty Investors, Inc. (incorporated by reference to Appendix D to the
           Registrant's Registration Statement on Form S-4 dated February 12, 1996).

 10.0      Advisory Agreement dated as of March 15, 1996, between Income Opportunity Realty Investors, Inc. and Basic
           Capital Management, Inc. (incorporated by reference to Exhibit No. 10.1 to the Registrant's Annual Report on
           Form 10-K for the year ended December 31, 1995).
</TABLE>





                                       66
<PAGE>   67
ITEM 14.   EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES, AND REPORTS ON
           FORM 8-K (Continued)


<TABLE>
<CAPTION>
Exhibit
Number                              Description                         
-------    -------------------------------------------------------------
<S>        <C>
 27.0      Financial Data Schedule, filed herewith.

</TABLE>

(b)        Reports on Form 8-K:

           A Current Report on Form 8-K, dated November 19, 1997, was filed with
           respect to Item 2. "Acquisition or Disposition of Assets," and Item
           7. "Financial Statements and Exhibits," which reports the acquisition
           of the Westlake Village Office Building, filed December 3, 1997 and
           was amended on Form 8-K/A, filed January 14, 1998.

           A Current Report on Form 8-K, dated December 30, 1997, was filed with
           respect to Item 2. "Acquisition or Disposition of Assets," and Item
           7. "Financial Statements and Exhibits," which reports the acquisition
           of the Akard Plaza and the Fireside Thrift Building, filed January 9,
           1998.




                                       67
<PAGE>   68
                                   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.

                                       INCOME OPPORTUNITY REALTY INVESTORS, INC.


Dated:    March 20, 1998               By:    /s/ Randall M. Paulson           
      ---------------------               -----------------------------------
                                          Randall M. Paulson
                                          President

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



<TABLE>
<S>                                                         <C>
                                                            By:     /s/ Ted P. Stokely              
                                                                -------------------------------------
                                                                Ted P. Stokely
                                                                Chairman of the Board
                                                                and Director




By:     /s/ Richard W. Douglas                              By:    /s/ Murray Shaw                  
   --------------------------------------                      -------------------------------------
 Richard W. Douglas                                             Murray Shaw
 Director                                                       Director




By:     /s/ Larry E. Harley                                 By:    /s/ Martin L. White              
   --------------------------------------                      -------------------------------------
 Larry E. Harley                                                Martin L. White
 Director                                                       Director




By:     /s/ R. Douglas Leonhard                             By:    /s/ Edward G. Zampa              
   --------------------------------------                      -------------------------------------
 R. Douglas Leonhard                                            Edward G. Zampa
 Director                                                       Director





Dated:        March 20, 1998                                By:    /s/ Thomas A. Holland            
      -----------------------------------                      -------------------------------------
                                                                Thomas A. Holland
                                                                Executive Vice President and
                                                                Chief Financial Officer
                                                                (Principal Financial and
                                                                Accounting Officer)
</TABLE>





                                       68
<PAGE>   69
                   INCOME OPPORTUNITY REALTY INVESTORS, INC.

                                  EXHIBITS TO
                           ANNUAL REPORT ON FORM 10-K

                      For the Year Ended December 31, 1997





<TABLE>
<CAPTION>
Exhibit
Number                        Description                                                         Page 
-------                    -----------------                                                     ------
 <S>              <C>                                                                            <C>
 27.0             Financial Data Schedule.                                                        70
</TABLE>





                                       69