UNITED
STATES

SECURITIES
AND EXCHANGE COMMISSION

Washington, D.C. 20549



FORM 10-Q

[Mark One]



|x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE | 
|- | ------------------------------------------------------- | 
|  | SECURITIES EXCHANGE ACT OF 1934                         | 



For the quarterly period ended June 30,
2012



OR



|o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE | 
|- | -------------------------------------------------------- | 
|  | SECURITIES EXCHANGE ACT OF 1934                          | 



For the transition period from ____________
to ____________



Commission File Number: 000-53159



United Development Funding III, L.P.

(Exact Name of Registrant as Specified in
Its Charter)



|Delaware                                                       |  | 20-3269195                          
|-------------------------------------------------------------- |  | ------------------------------------
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification No.)



1301 Municipal Way, Suite 100, Grapevine,
Texas 76051

(Address of principal executive offices)

(Zip Code)



Registrant’s telephone number,
including area code: (214) 370-8960



N/A

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



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



Indicate by check mark whether the registrant
has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted
and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter
period that the registrant was required to submit and post such files). Yesx
No o



Indicate by check mark whether the Registrant
is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions
of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2
of the Exchange Act.



|Large accelerated filer o                                             | Accelerated filer o        
|--------------------------------------------------------------------- | ---------------------------
|Non-accelerated filer x (Do not check if a smaller reporting company) | Smaller reporting company o



Indicate by check mark whether the
Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o
No x



As of August
7, 2012, the Registrant had18,612,722units of limited partnership interest outstanding.


















UNITED DEVELOPMENT FUNDING III, L.P.

FORM 10-Q

Quarter Ended
June 30, 2012



|            | PART I                                                                                         |   
|----------- | ---------------------------------------------------------------------------------------------- | --
|            | FINANCIAL INFORMATION                                                                          |   
|            |                                                                                                |   
|Item 1.     | Financial Statements.                                                                          |   
|            |                                                                                                |   
|            | Balance Sheets as of June 30, 2012 and December 31, 2011 (Unaudited)                           | 3 
|            |                                                                                                |   
|            | Statements of Operations for the three and six months ended June 30, 2012 and 2011 (Unaudited) | 4 
|            |                                                                                                |   
|            | Statements of Cash Flows for the six months ended June 30, 2012 and 2011 (Unaudited)           | 5 
|            |                                                                                                |   
|            | Notes to Financial Statements (Unaudited)                                                      | 6 
|            |                                                                                                |   
|Item 2.     | Management’s Discussion and Analysis of Financial Condition and Results of Operations.         | 37
|            |                                                                                                |   
|Item 3.     | Quantitative and Qualitative Disclosures About Market Risk.                                    | 58
|            |                                                                                                |   
|Item 4.     | Controls and Procedures.                                                                       | 59
|            |                                                                                                |   
|            | PART II                                                                                        |   
|            | OTHER INFORMATION                                                                              |   
|            |                                                                                                |   
|Item 1.     | Legal Proceedings.                                                                             | 60
|            |                                                                                                |   
|Item 1A.    | Risk Factors.                                                                                  | 60
|            |                                                                                                |   
|Item 2.     | Unregistered Sales of Equity Securities and Use of Proceeds.                                   | 62
|            |                                                                                                |   
|Item 3.     | Defaults Upon Senior Securities.                                                               | 64
|            |                                                                                                |   
|Item 4.     | Mine Safety Disclosures.                                                                       | 64
|            |                                                                                                |   
|Item 5.     | Other Information.                                                                             | 64
|            |                                                                                                |   
|Item 6.     | Exhibits.                                                                                      | 64
|            |                                                                                                |   
|Signatures. |                                                                                                | 65











PART I
FINANCIAL INFORMATION



Item 1. Financial Statements.

UNITED DEVELOPMENT FUNDING III, L.P.

BALANCE SHEETS

(Unaudited)



|                                                                                                                                                                                   |  | June 30, 2012 |             |  | December 31, 2011 |  
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------- | ----------- |  | ----------------- | -
|Assets:                                                                                                                                                                            |  |               |             |  |                   |  
|Cash and cash equivalents                                                                                                                                                          |  | $             | 1,478,252   |  |                   | $
|Restricted cash                                                                                                                                                                    |  |               | 1,526,630   |  |                   |  
|Accrued interest receivable                                                                                                                                                        |  |               | 5,508,281   |  |                   |  
|Accrued interest receivable – related parties                                                                                                                                      |  |               | 8,868,650   |  |                   |  
|Accounts receivable – related parties                                                                                                                                              |  |               | 323,986     |  |                   |  
|Mortgage notes receivable, net                                                                                                                                                     |  |               | 228,443,591 |  |                   |  
|Mortgage notes receivable – related parties, net                                                                                                                                   |  |               | 49,833,999  |  |                   |  
|Participation interest – related party, net                                                                                                                                        |  |               | 66,071,672  |  |                   |  
|Other assets                                                                                                                                                                       |  |               | 114,297     |  |                   |  
|                                                                                                                                                                                   |  |               |             |  |                   |  
|Total assets                                                                                                                                                                       |  | $             | 362,169,358 |  |                   | $
|                                                                                                                                                                                   |  |               |             |  |                   |  
|Liabilities and Partners’ Capital                                                                                                                                                  |  |               |             |  |                   |  
|Liabilities:                                                                                                                                                                       |  |               |             |  |                   |  
|Accounts payable                                                                                                                                                                   |  | $             | 133,078     |  |                   | $
|Accrued liabilities                                                                                                                                                                |  |               | 122,078     |  |                   |  
|Accrued liabilities – related parties                                                                                                                                              |  |               | 3,182,393   |  |                   |  
|Distributions payable                                                                                                                                                              |  |               | -           |  |                   |  
|Line-of-credit                                                                                                                                                                     |  |               | 15,000,000  |  |                   |  
|                                                                                                                                                                                   |  |               |             |  |                   |  
|Total liabilities                                                                                                                                                                  |  |               | 18,437,549  |  |                   |  
|                                                                                                                                                                                   |  |               |             |  |                   |  
|Commitments and contingencies                                                                                                                                                      |  |               |             |  |                   |  
|                                                                                                                                                                                   |  |               |             |  |                   |  
|Partners’ Capital:                                                                                                                                                                 |  |               |             |  |                   |  
|Limited partners’ capital:  22,500,000 units authorized; 18,575,098 units issued and outstanding at June 30, 2012 and 18,326,511 units issued and outstanding at December 31, 2011 |  |               | 343,336,625 |  |                   |  
|General partner’s capital                                                                                                                                                          |  |               | 395,184     |  |                   |  
|                                                                                                                                                                                   |  |               |             |  |                   |  
|Total partners’ capital                                                                                                                                                            |  |               | 343,731,809 |  |                   |  
|                                                                                                                                                                                   |  |               |             |  |                   |  
|Total liabilities and partners’ capital                                                                                                                                            |  | $             | 362,169,358 |  |                   | $



See accompanying notes to financial statements
(unaudited).



3







UNITED DEVELOPMENT FUNDING III, L.P.

STATEMENTS OF OPERATIONS

(Unaudited)



|                                                                         |  | Three Months Ended |            |  | Six Months Ended |  
|------------------------------------------------------------------------ |  | ------------------ | ---------- |  | ---------------- | -
|                                                                         |  | June 30,           |            |  | June 30,         |  
|                                                                         |  | 2012               |            |  | 2011             |  
|Revenues:                                                                |  |                    |            |  |                  |  
|Interest income                                                          |  | $                  | 8,782,887  |  |                  | $
|Interest income – related parties                                        |  |                    | 4,019,670  |  |                  |  
|Mortgage and transaction service revenues                                |  |                    | 166,251    |  |                  |  
|Mortgage and transaction service revenues – related parties              |  |                    | 165,667    |  |                  |  
|Total revenues                                                           |  |                    | 13,134,475 |  |                  |  
|                                                                         |  |                    |            |  |                  |  
|Expenses:                                                                |  |                    |            |  |                  |  
|Interest expense                                                         |  |                    | 373,972    |  |                  |  
|Loan loss reserve expense                                                |  |                    | 139,838    |  |                  |  
|General and administrative                                               |  |                    | 377,123    |  |                  |  
|General and administrative – related parties                             |  |                    | 688,853    |  |                  |  
|Total expenses                                                           |  |                    | 1,579,786  |  |                  |  
|                                                                         |  |                    |            |  |                  |  
|Net income                                                               |  | $                  | 11,554,689 |  |                  | $
|                                                                         |  |                    |            |  |                  |  
|Earnings allocated to limited partners                                   |  | $                  | 10,355,272 |  |                  | $
|                                                                         |  |                    |            |  |                  |  
|Earnings per limited partnership unit, basic and diluted                 |  | $                  | 0.56       |  |                  | $
|                                                                         |  |                    |            |  |                  |  
|Weighted average limited partnership units outstanding                   |  |                    | 18,501,746 |  |                  |  
|                                                                         |  |                    |            |  |                  |  
|Distributions per weighted average limited partnership units outstanding |  | $                  | 0.49       |  |                  | $



See accompanying notes to financial statements
(unaudited).



4







UNITED DEVELOPMENT FUNDING III, L.P.

STATEMENTS OF CASH FLOWS

(Unaudited)



|                                                                                  |  | Six Months Ended |            
|--------------------------------------------------------------------------------- |  | ---------------- | -----------
|                                                                                  |  | June 30,         |            
|                                                                                  |  | 2012             |            
|Operating Activities                                                              |  |                  |            
|Net income                                                                        |  | $                | 23,280,024 
|Adjustments to reconcile net income to net cash provided by operating activities: |  |                  |            
|Provision for loan losses                                                         |  |                  | 279,775    
|Amortization                                                                      |  |                  | 90,015     
|Changes in operating assets and liabilities:                                      |  |                  |            
|Accrued interest receivable                                                       |  |                  | 704,427    
|Accrued interest receivable – related parties                                     |  |                  | (6,245,784 
|Accounts receivable – related parties                                             |  |                  | (163,434   
|Other assets                                                                      |  |                  | (120,608   
|Accounts payable                                                                  |  |                  | (60,215    
|Accrued liabilities                                                               |  |                  | (83,388    
|Accrued liabilities – related parties                                             |  |                  | (324,819   
|Net cash provided by operating activities                                         |  |                  | 17,355,993 
|                                                                                  |  |                  |            
|Investing Activities                                                              |  |                  |            
|Investments in mortgage notes receivable                                          |  |                  | (14,574,863
|Investments in mortgage notes receivable – related parties                        |  |                  | (2,361,426 
|Investments in participation interest – related party                             |  |                  | -          
|Receipts from mortgage notes receivable                                           |  |                  | 10,322,859 
|Receipts from mortgage notes receivable – related parties                         |  |                  | 4,554,834  
|Receipts from participation interest – related party                              |  |                  | 78,852     
|Restricted cash                                                                   |  |                  | (7,968     
|Net cash used in investing activities                                             |  |                  | (1,987,712 
|                                                                                  |  |                  |            
|Financing Activities                                                              |  |                  |            
|Limited partner distributions                                                     |  |                  | (17,987,981
|Limited partner distribution reinvestment                                         |  |                  | 5,220,751  
|Limited partner redemptions                                                       |  |                  | (249,000   
|General partner distributions                                                     |  |                  | (3,608,177 
|Net cash used in financing activities                                             |  |                  | (16,624,407
|                                                                                  |  |                  |            
|Net decrease in cash and cash equivalents                                         |  |                  | (1,256,126 
|Cash and cash equivalents at beginning of period                                  |  |                  | 2,734,378  
|Cash and cash equivalents at end of period                                        |  | $                | 1,478,252  
|                                                                                  |  |                  |            
|Supplemental Cash Flow Information:                                               |  |                  |            
|Cash paid for interest                                                            |  | $                | 752,055    



See accompanying notes to financial statements
(unaudited).



5







UNITED DEVELOPMENT FUNDING III, L.P.

NOTES TO FINANCIAL STATEMENTS

(Unaudited)



A. Nature of Business



United Development
Funding III, L.P. (which may be referred to as the “Partnership,” “we,” “us,” “our”
or “UDF III”) was organized on June 13, 2005 as a Delaware limited partnership. Our principal business purpose is to
originate, acquire, service, and otherwise manage, either alone or in association with others, a portfolio of mortgage loans that
are secured by real property or equity interests that hold real property already subject to other mortgages (including mortgage
loans that are not first in priority and participation interests in mortgage loans) and to issue or acquire an interest in credit
enhancements for the benefit of borrowers, such as guarantees or letters of credit. Our offices are located in Grapevine, Texas.



Our general partner
is UMTH Land Development, L.P. (“Land Development”), a Delaware limited partnership that is responsible for our overall
management, conduct, and operation. Our general partner has authority to act on our behalf in all matters respecting us, our business
and our property. Our limited partners take no part in the management of our business or transact any business for us and have
no power to sign for or bind us; provided, however, that our limited partners, by a majority vote and without the concurrence of
our general partner, have the right to: (a) amend the Second Amended and Restated Agreement of Limited Partnership governing the
Partnership, as amended (the “Partnership Agreement”), (b) dissolve the Partnership, (c) remove our general partner
or any successor general partner, (d) elect a new general partner, and (e) approve or disapprove a transaction entailing the sale
of all or substantially all of the real properties acquired by the Partnership.



UMT Holdings, L.P.
(“UMT Holdings”), a Delaware limited partnership, holds 99.9% of the limited partnership interests in our general partner.
UMT Services, Inc. (“UMT Services”), a Delaware corporation, owns the remaining 0.1% of the limited partnership interests
in our general partner and serves as its general partner. Land Development has been engaged to provide asset management services
for four investment partnerships (United Development Funding, L.P. (“UDF I”), United Development Funding II, L.P.,
United Development Funding Land Opportunity Fund, L.P. (“UDF LOF”), all Delaware limited partnerships, and UDF Texas
Two, L.P., a Texas limited partnership), and a Maryland real estate investment trust (United Development Funding IV (“UDF
IV”)). Land Development also holds a 99.9% partnership interest in UMTHLD FLF I, L.P. and UMTHLD FLF II, L.P., both Texas
limited partnerships, and United Development Funding X, L.P., a Delaware limited partnership, with the remaining 0.1% interest
owned by UMT Services. In addition, Land Development owns 100% of the interests in UDF Land GP, LLC, which serves as the general
partner of the general partner of UDF LOF. See Note K for discussion of related party transactions.



B. Basis of Presentation



The accompanying unaudited
financial statements were prepared in accordance with generally accepted accounting principles in the United States of America
(“GAAP”) for interim financial information, with the instructions to Form 10-Q and with Regulation S-X. They do not
include all information and footnotes required by GAAP for complete financial statements. However, except as disclosed herein,
there has been no material change to the information disclosed in our Annual Report on Form 10-K for the year ended December 31,
2011, which was filed with the Securities and Exchange Commission (the “Annual Report”). The accompanying interim unaudited
financial statements should be read in conjunction with the financial statements filed in our Annual Report. In the opinion of
management, the accompanying unaudited financial statements include all adjustments, consisting solely of normal recurring adjustments,
considered necessary to present fairly our financial position as of June 30, 2012, operating results for the three and six months
ended June 30, 2012 and 2011 and cash flows for the six months ended June 30, 2012 and 2011. Operating results and cash flows for
the six months ended June 30, 2012 are not necessarily indicative of the results that may be expected for the year ending December
31, 2012.



6







Mortgage Notes Receivable
and Mortgage Notes Receivable – Related Parties



Mortgage notes receivable
and mortgage notes receivable – related parties are recorded at the lower of cost or estimated net realizable value. The
mortgage investments are collateralized by land and related improvements to residential property owned by the borrowers and/or
the ownership interests of the borrower. Currently, the mortgage investments have terms ranging from five to 36 months. None of
such mortgages are insured or guaranteed by a federally owned or guaranteed mortgage agency. We originate and/or acquire all mortgage
notes receivable and intend to hold the mortgage notes receivable for the life of the notes.



Participation Interest
– Related Party



Participation interest
– related party is recorded at the lower of cost or net realizable value. Participation interest – related party represents
an Economic Interest Participation Agreement with United Mortgage Trust, a real estate investment trust organized under the laws
of the state of Maryland (“UMT”), pursuant to which we purchased (i) an economic interest in a $75 million revolving
credit facility (the “UMT Loan”) from UMT to UDF I, and (ii) a purchase option to acquire a full ownership participation
interest in the UMT Loan. See Note K, “Related Party Transactions” for further details. Our general partner serves
as the asset manager for UDF I. An affiliate of our general partner serves as the advisor to UMT.



Allowance for Loan Losses



The allowance for loan
losses is our estimate of incurred losses in our portfolio of mortgage notes receivable, mortgage notes receivable – related
parties and participation interest – related party. We periodically perform a detailed review of our portfolio of mortgage
notes and other loans to determine if impairment has occurred and to assess the adequacy of the allowance for loan losses. Our
review consists of evaluating economic conditions, the estimated value of the underlying collateral, the guarantor, adverse situations
that may affect the borrower’s ability to pay or the value of the collateral, and other relevant factors. This review is
inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.



In reviewing our portfolio,
we use cash flow estimates from the disposition of finished lots, paper lots (residential lots shown on a plat that has been accepted
by the city or county, but which is currently undeveloped or under development) and undeveloped land as well as cash flow received
from the issuance of bonds from municipal reimbursement districts. These estimates are based on current market metrics, including,
without limitation, the supply of finished lots, paper lots and undeveloped land, the supply of homes and the rate and price at
which land and homes are sold, historic levels and trends, executed purchase contracts, appraisals and discussions with third party
market analysts and participants, including homebuilders. We base our valuations on current and historic market trends on our analysis
of market events and conditions, including activity within our portfolio, as well as the analysis of third-party services such
as Metrostudy and Residential Strategies, Inc. Cash flow forecasts also are based on executed purchase contracts which provide
base prices, escalation rates, and absorption rates on an individual project basis. For projects deemed to have an extended time
horizon for disposition, we consider third-party appraisals to provide a valuation in accordance with guidelines set forth in the
Uniform Standards of Professional Appraisal Practice. In addition to cash flows from the disposition of property, cost analysis
is performed based on estimates of development and senior financing expenditures provided by developers and independent professionals
on a project-by-project basis. These amounts are reconciled with our best estimates to establish the net realizable value of the
portfolio.



We charge additions
to the allowance for loan losses to current period earnings through a provision for loan losses. Amounts determined to be uncollectible
are charged directly against, or “charged off,” and decrease the allowance for loan losses, while amounts recovered
on previously charged off accounts increase the allowance.



Revenue Recognition



Interest income on
mortgage notes receivable, mortgage notes receivable – related parties and participation interest – related party is
recognized over the life of the loan and recorded on the accrual basis. Income recognition is suspended for loans at the date at
which, in the opinion of management, a full recovery of income and principal becomes more likely than not, but is no longer probable,
based upon our review of economic conditions, the estimated value of the underlying collateral, the guarantor, adverse situations
that may affect the borrower’s ability to pay or the value of the collateral and other relevant factors. Income recognition
is resumed when the loan becomes contractually current and performance is demonstrated to be resumed. Any payments received on
loans classified as non-accrual status are typically applied first to outstanding loan amounts and then to the recovery of lost
interest. As of both June 30, 2012 and December 31, 2011, we were suspending income recognition on two mortgage notes receivable
with an aggregate unpaid principal balance of approximately $2.2 million.



7







We generate mortgage
and transaction service revenues and mortgage and transaction service revenues – related parties by originating and acquiring
mortgage notes receivable and other loans. In accordance with Financial Accounting Standards Board (“FASB”) Accounting
Standards Codification (“ASC”) 310-20, Receivables – Nonrefundable Fees and Other Costs (“ASC 310-20”),
we defer recognition of income from nonrefundable commitment fees paid by the borrowers and recognize such amount on a straight-line
basis over the expected life of such notes. In addition, credit enhancement fee income is generated by fees charged to parties
for credit enhancements provided to lenders by the Partnership on behalf of the parties. Income related to credit enhancements
is earned as fees are paid, based on the terms of the credit enhancement agreement. As of June 30, 2012, the Partnership was providing
9 credit enhancements to related parties (see Note K for further discussion).



The Partnership also
expenses acquisition and origination fees (“Placement Fees”) paid to the general partner to provide for processing
and origination costs (including, but not limited to, legal fees and expenses, travel and communications expenses, costs of appraisals,
accounting fees and expenses, and title insurance funded by us) associated with mortgage notes receivable or participation interest
held by the Partnership on a straight-line basis. As of June 30, 2012 and December 31, 2011, approximately $3.0 million and $3.3
million, respectively, of such net deferred fees are included in mortgage notes receivable. Approximately $749,000 and $779,000
of net deferred fees are included in mortgage notes receivable – related parties as of June 30, 2012 and December 31, 2011,
respectively. As of June 30, 2012 and December 31, 2011, approximately $568,000 and $647,000, respectively, of deferred fees are
included in participation interest – related party. See Note K, “Related Party Transactions” for further details.



Cash Flow Distributions



Cash available for
distributions represents the cash funds received by us from operations (other than net proceeds from a capital transaction) that
produces proceeds from (i) the repayment of principal or prepayment of a mortgage to the extent classified as a return of capital
for federal income tax purposes, (ii) the foreclosure, sale, exchange, condemnation, eminent domain taking or other disposition
of a mortgage loan or of a property subject to a mortgage, or (iii) insurance or a guarantee with respect to a mortgage, including,
without limitation, interest, points, revenue participations in property appreciation and interest or dividends from interim investments
or proceeds from borrowings, if appropriate, less all cash used to pay Partnership expenses and debt payments and amounts
set aside to create a retained earnings reserve (currently at 9.5% of our net income; the retained earnings reserve is intended
to recover some of the organization and offering expenses incurred in connection with our public offering of our units of limited
partnership interest). Our general partner receives a monthly distribution for promotional and carried interest from the cash available
for distributions, in addition to the payments made to our general partner and related parties. See Note K for further discussion
of related party transactions.



A “carried interest”
is an equity interest in us to participate in all distributions, other than distributions attributable to our general partner’s
promotional interest, of cash available for distribution and net proceeds from a capital transaction that are distributable under
the distribution priority for net proceeds from a capital transaction described below. If our general partner enters into commitments
to investments in mortgages in excess of 82% of the gross proceeds of our public offering of our units of limited partnership interest,
our general partner will be entitled to a carried interest equal to (a) 1% for the first 2.5% of commitments to investments
in mortgages above 82% of the gross proceeds of our initial public offering, as declared effective on May 15, 2006 pursuant to
a Registration Statement on Form S-11 (File No. 333-127891) under the Securities Act of 1933, as amended (the “Offering”)
(or if commitments to investments in mortgages are above 82% but no more than 84.5%, 1% multiplied by the fractional amount of
commitments to investments in mortgages above 82%), (b) 1% for the next 2% of additional commitments to investments in mortgages
above 84.5% of the gross proceeds of the Offering (or if commitments to investments in mortgages are above 84.5% but no more than
86.5%, 1% multiplied by the fractional amount of commitments to investments in mortgages above 84.5%) and (c) 1% for each
additional 1% of additional commitments to investments in mortgages above 86.5% of the gross proceeds of the Offering (or a fractional
percentage equal to the fractional amount of any 1% of additional commitments to investments in mortgages). By way of illustration,
if 85.5% of the gross proceeds of the Offering are committed to investments in mortgages, then our general partner would be entitled
to a carried interest of 1.5% (1% for the first 2.5% of commitments to investments in mortgages above 82% of the gross proceeds
of the Offering and 0.5% for the next 1% of additional commitments to investments in mortgages above 84.5% of the gross proceeds
of the Offering) of any amount otherwise distributable to the limited partners after deduction of any promotional interest payable
to our general partner.



8







In order for proceeds
to be considered “committed” for purposes of calculation and payment of a carried interest, we must be obligated by
contract or other binding agreement to invest such proceeds in mortgages, to the exclusion of any other use for such proceeds or
no use at all.



“Investments
in mortgages” are the aggregate amount of capital contributions from investors used by us to make or invest in mortgage loans
or the amount actually paid or allocated to the purchase of mortgages, working capital reserves (but excluding working capital
reserves in excess of 3% of the aggregate capital contributions) and other cash payments such as interest and taxes but excluding
our organization and offering expenses, selling commissions, wholesaling fees, marketing support fees, due diligence fees, acquisition
and origination fees, and any other front-end fees.



Our general partner’s
“promotional interest” is our general partner’s right to receive:



| | · | prior to the return to the limited partners of all of their capital contributions plus an 8% per
annum, non-compounding, cumulative return on their unreturned capital contributions, 10% of all cash available for distribution;
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | · | following the return to the limited partners of all of their capital contributions plus an 8% per
annum, non-compounding, cumulative return on their unreturned capital contributions, 15% of all cash available for distribution; and
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | · | following the return to the limited partners of all of their capital contributions plus an 8% per
annum, non-compounding, cumulative return on their unreturned capital contributions, 15% of all net proceeds from a capital transaction.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Monthly distributions
are currently paid to our limited partners at a 9.75% annualized return, assuming a purchase price of $20.00 per unit, on a pro
rata basis based on the number of days in the Partnership. Retained earnings would contain a surplus if the cash available for
distributions less the 9.5% reserve exceeded the monthly distribution to the general and limited partners. Retained earnings would
contain a deficit if cash available for distributions less the 9.5% reserve is less than the monthly distribution to general and
limited partners. It is the intent of management to monitor and distribute such surplus, if any, on an annual basis.



The chart below summarizes
the approximate aggregate amount of distributions to our general partner and limited partners and the retained earnings deficit
as of June 30, 2012 and December 31, 2011:



|                          |  | As of June 30, |             |     |  | As of December 31, |  
|------------------------- |  | -------------- | ----------- | --- |  | ------------------ | -
|                          |  | 2012           |             |     |  | 2011               |  
|General Partner           |  | $              | 17,398,000  | (1) |  |                    | $
|Limited Partners          |  |                | 142,445,000 | (3) |  |                    |  
|Retained Earnings Reserve |  |                | 8,204,000   |     |  |                    |  
|Retained Earnings Deficit |  |                | (8,080,000  | )   |  |                    |  



| | (1) | approximately $17.4 million paid in cash.
| | --- | -----------------------------------------



| | (2) | approximately $13.7 million paid in cash and $1.6 million has been declared, but not paid.
| | --- | ------------------------------------------------------------------------------------------



| | (3) | approximately $94.3 million paid in cash and approximately $48.1 million reinvested in 2,405,792
units of limited partnership pursuant to our DRIP and Secondary DRIP, each as defined in Note C below.
| | --- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (4) | approximately $81.6 million paid in cash and approximately $42.9 million reinvested in 2,144,754
units of limited partnership pursuant to our DRIP and Secondary DRIP, each as defined in Note C below.
| | --- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



The chart below summarizes
the payment of related party fees and reimbursements associated with the Offering and origination and management of assets, including
the distributions to our general partner described above, and general and administrative – related parties expenses for the
six months ended June 30, 2012 and 2011. We believe that these fees and reimbursements are reasonable and customary for comparable
mortgage programs.



9







|                                                                                     |  | For the Six Months Ended June 30, |          
|------------------------------------------------------------------------------------ |  | --------------------------------- | ---------
|                                                                                     |  | 2012                              |          
|Payments to General Partner and Related Parties                                      |  | $                                 | 4,680,000
|Total General and Administrative Expenses
    to General Partner and Related Parties |  |                                   | 1,377,000



Fair Value of Financial Instruments



In accordance with
the reporting requirements of FASB ASC 825-10, Financial Instruments-Fair Value, we calculate the fair value of our assets
and liabilities that qualify as financial instruments under this statement and include this additional information in the notes
to the financial statements when the fair value is different than the carrying value of those financial instruments. The estimated
fair value of restricted cash, accrued interest receivable, accounts payable, accrued liabilities, and distributions payable approximates
the carrying amounts due to the relatively short maturity of these instruments. The estimated fair value of mortgage notes receivable,
participation interest, and line-of-credit approximates the carrying amount since they bear interest at the market rate.



Impact of Recently Issued Accounting
Standards



In July 2010,
the FASB issued Accounting Standards Update (“ASU”) No. 2010-20, Disclosures about the Credit Quality of Financing
Receivables and the Allowance for Credit Losses. ASU 2010-20 requires enhanced disclosures regarding the nature of credit risk
inherent in an entity’s portfolio of financing receivables, how that risk is analyzed, and the changes and reasons for those
changes in the allowance for credit losses. It requires an entity to provide a greater level of disaggregated information about
the credit quality of its financing receivables and its allowance for credit losses. ASU 2010-20 will only impact disclosures.
Disclosures related to information as of the end of a reporting period are effective for interim and annual reporting periods beginning
on or after December 15, 2010.  The Partnership’s adoption of this guidance did not have a material impact
on its financial statements or accompanying notes to the financial statements.



Guarantees



The Partnership from
time to time enters into guarantees of debtor’s borrowings and provides credit enhancements for the benefit of senior lenders
in connection with the Partnership’s debtors and investments in partnerships (collectively referred to as “guarantees”),
and accounts for such guarantees in accordance with FASB ASC 460-10, Guarantees.



Reclassification



Certain prior year
amounts have been reclassified to conform to current presentation.



C. Registration Statement



On May 15, 2006, the
Offering pursuant to a Registration Statement on Form S-11 (File No. 333-127891) was declared effective under the Securities Act
of 1933, as amended. The Offering, at the time of such effectiveness, covered up to 12,500,000 units of limited partnership interest
at a price of $20.00 per unit (the “Primary Offering”) and up to 5,000,000 units of limited partnership interest to
be issued pursuant to our distribution reinvestment plan (the “DRIP”) at a price of $20.00 per unit. We had the right
to reallocate the units of limited partnership interest we were offering between the Primary Offering and our DRIP, and pursuant
to Supplement No. 8 to our prospectus regarding the Offering, which was filed with the Securities and Exchange Commission on September
4, 2008, we reallocated the units being offered such that 16,250,000 units were offered pursuant to the Primary Offering and 1,250,000
units were offered pursuant to the DRIP. Pursuant to Supplement No. 11 to our prospectus regarding the Offering, which was filed
with the Securities and Exchange Commission on March 6, 2009, we further reallocated the units being offered such that 16,500,000
units were offered pursuant to the Primary Offering and 1,000,000 units were offered pursuant to the DRIP. The Primary Offering
was terminated on April 23, 2009. We extended the offering of our units of limited partnership interest
pursuant to our DRIP until the earlier of the sale of all units of limited partnership interest being offered pursuant to our DRIP
or May 15, 2010; provided, however, that our general partner was permitted to terminate the offering of units pursuant to
our DRIP at any earlier time.



10







On June 9, 2009, we
held a special meeting of our limited partners as of April 13, 2009, at which our limited partners approved three proposals to
amend certain provisions of our Partnership Agreement for the purpose of making available additional units of limited
partnership interest for sale pursuant to an Amended and Restated Distribution Reinvestment Plan. On June 12, 2009, we registered
5,000,000 additional units to be offered pursuant to an Amended and Restated Distribution Reinvestment Plan in a Registration Statement
on Form S-3 (File No. 333-159939) (“Secondary DRIP”). As such, we ceased offering units under the DRIP as of July 21,
2009and concurrently commenced our offering of units pursuant to the Secondary DRIP, which is currently ongoing.



D. Loans and Allowance for Loan Losses



Our loan portfolio is comprised of mortgage
notes receivables, net, mortgage notes receivables – related parties, net and participation interest – related party,
net and is recorded at the lower of cost or estimated net realizable value.



|                                                 |  | June 30, |             |  | December 31, |  
|------------------------------------------------ |  | -------- | ----------- |  | ------------ | -
|                                                 |  | 2012     |             |  | 2011         |  
|Mortgage notes receivable, net                   |  | $        | 228,443,000 |  |              | $
|Mortgage notes receivable - related parties, net |  |          | 49,834,000  |  |              |  
|Participation interest - related party, net      |  |          | 66,072,000  |  |              |  
|Total                                            |  | $        | 344,349,000 |  |              | $



Our loans are classified as follows:



|                                               |  | June 30, |             |   | December 31, |  
|---------------------------------------------- |  | -------- | ----------- | - | ------------ | -
|                                               |  | 2012     |             |   | 2011         |  
|Real Estate:                                   |  |          |             |   |              |  
|Acquisition and land development               |  | $        | 351,432,000 |   |              | $
|Allowance for loan losses                      |  |          | (11,354,000 | ) |              |  
|Unamortized commitment fees and placement fees |  |          | 4,271,000   |   |              |  
|Total                                          |  | $        | 344,349,000 |   |              | $



As of June 30, 2012,
we had originated or purchased 60 loans, including 32 loans that had been repaid in full by the respective borrower. For the six
months ended June 30, 2012, we did not originate or purchase any loans, sold 1 loan participation, and did not acquire any additional
participation interests. Of the 28 loans outstanding as of June 30, 2012, the scheduled maturity dates are as follows as of June
30, 2012:





|              |  | Related |             |  | Non-Related |  |   | Total      | 
|------------- |  | ------- | ----------- |  | ----------- |  | - | ---------- | 
|Maturity Date |  | Amount  |             |  | Loans       |  |   | % of
Total | 
|Matured       |  | $       | -           |  |             |  | - |            | 
|2012 Q3-Q4    |  |         | 66,768,000  |  |             |  | 4 |            | 
|2013          |  |         | 35,818,000  |  |             |  | 3 |            | 
|2014          |  |         | -           |  |             |  | - |            | 
|2015          |  |         | 12,003,000  |  |             |  | 1 |            | 
|Total         |  | $       | 114,589,000 |  |             |  | 8 |            | 



As of December 31,
2011, we had originated or purchased 60 loans, including 31 loans that have been repaid in full by the respective borrower. For
the year ended December 31, 2011, we originated 2 loans, sold 3 loan participations, and did not purchase any loans or acquire
any additional participation interests. Of the 29 loans outstanding as of December 31, 2011, the scheduled maturity dates were
as follows as of December 31, 2011:



11









|              |  | Related |             |  | Non-Related |  |   | Total      | 
|------------- |  | ------- | ----------- |  | ----------- |  | - | ---------- | 
|Maturity Date |  | Amount  |             |  | Loans       |  |   | % of Total | 
|Matured       |  | $       | -           |  |             |  | - |            | 
|2012          |  |         | 105,120,000 |  |             |  | 6 |            | 
|2013          |  |         | 11,633,000  |  |             |  | 2 |            | 
|Total         |  | $       | 116,753,000 |  |             |  | 8 |            | 



The following table
represents the maturity dates of loans that were matured as of June 30, 2012 and had not been repaid or extended as of June 30,
2012:



|              |  | Related |   |  | Non-Related |  |   | Total      | 
|------------- |  | ------- | - |  | ----------- |  | - | ---------- | 
|Maturity
Date |  | Amount  |   |  | Loans       |  |   | % of
Total | 
|2009          |  | $       | - |  |             |  | - |            | 
|2010          |  |         | - |  |             |  | - |            | 
|Total         |  | $       | - |  |             |  | - |            | 



Of these 9 loans, as
of June 30, 2012, full collectability is considered probable for 7 loans with an aggregate unpaid principal balance of approximately
$35.6 million and full collectability is considered more likely than not, but not probable, for 2 loans with an aggregate unpaid
principal balance of approximately $2.2 million.



The following table
represents the maturity dates of loans that were matured as of December 31, 2011 and had not been repaid or extended as of December
31, 2011:



|              |       |  | Related |   |   | Non-Related |  |  | Total      | 
|------------- | ----- |  | ------- | - | - | ----------- |  |  | ---------- | 
|Maturity
Date |       |  | Amount  |   |   | Loans       |  |  | % of
Total | 
|              | 2009  |  |         | $ | - |             |  |  | -          | 
|              | 2010  |  |         |   | - |             |  |  | -          | 
|              | 2011  |  |         |   | - |             |  |  | -          | 
|              |       |  |         |   |   |             |  |  |            | 
|              | Total |  |         | $ | - |             |  |  | -          | 



Of these 12 loans,
as of December 31, 2011, full collectability was considered probable for 10 loans with an aggregate unpaid principal balance of
approximately $54.5 million and full collectability was considered more likely than not, but not probable, for 2 loans with an
aggregate unpaid principal balance of approximately $2.2 million.



The following table
describes the loans that were matured as of December 31, 2011, the activity with respect to such loans during the six months ended
June 30, 2012 and the loans that matured during the six months ended June 30, 2012 and remained matured as of June 30, 2012:



12







|         |  |                                     |            |  |                       |  |    |                                 |  |  | Matured Loan      |   |  | Net Activity   |             |   |                   |   |            |        |  |   |       |  |  |       |           
|-------- |  | ----------------------------------- | ---------- |  | --------------------- |  | -- | ------------------------------- |  |  | ----------------- | - |  | -------------- | ----------- | - | ----------------- | - | ---------- | ------ |  | - | ----- |  |  | ----- | ----------
|         |  |                                     |            |  |                       |  |    |                                 |  |  | Extensions During |   |  | During the Six |             |   |                   |   |            |        |  |   |       |  |  |       |           
|         |  |                                     |            |  |                       |  |    |                                 |  |  | the Six Months    |   |  | Months Ended   |             |   | Loans             |   |            |        |  |   |       |  |  |       |           
|         |  |                                     |            |  |                       |  |    |                                 |  |  | Ended June 30,    |   |  | June 30, 2012  |             |   | Matured           |   |            |        |  |   |       |  |  |       |           
|         |  |                                     |            |  |                       |  |    |                                 |  |  | 2012 on Loans     |   |  | on Loans       |             |   | During the        |   |            |        |  |   |       |  |  |       |           
|         |  |                                     |            |  |                       |  |    |                                 |  |  | Matured as of     |   |  | Matured as of  |             |   | Six Months        |   |            |        |  |   |       |  |  |       |           
|Maturity |  |                                     |            |  |                       |  |    | % of                            |  |  | December 31,      |   |  | December 31,   |             |   | Ended June        |   |            |        |  |   |       |  |  | % of  |           
|Date     |  | Amount                              |            |  | Loans                 |  |    | Total                           |  |  | 2011 (1)          |   |  | 2011 (2)       |             |   | 30, 2012
     (3) |   |            | Amount |  |   | Loans |  |  | Total |           
|         |  |                                     |            |  |                       |  |    |                                 |  |  |                   |   |  |                |             |   |                   |   |            |        |  |   |       |  |  |       |           
|         |  | Non-Related                         |           
|         |  | Matured as
    of December 31, 2011 |            |  | 2012 Activity
    (4) |  |    | Matured as
    of June 30, 2012 | 
|2009     |  | $                                   | 21,926,000 |  |                       |  | 7  |                                 |  |  | 39                | % |  | $              | -           |   |                   | $ | (2,148,000 | )      |  | $ | -     |  |  | $     | 19,778,000
|2010     |  |                                     | 28,990,000 |  |                       |  | 3  |                                 |  |  | 51                | % |  |                | (12,296,000 | ) |                   |   | 1,376,000  |        |  |   | -     |  |  |       | 18,070,000
|2011     |  |                                     | 5,832,000  |  |                       |  | 2  |                                 |  |  | 10                | % |  |                | (5,832,000  | ) |                   |   | -          |        |  |   | -     |  |  |       | -         
|Total    |  | $                                   | 56,748,000 |  |                       |  | 12 |                                 |  |  | 100               | % |  | $              | (18,128,000 | ) |                   | $ | (772,000   | )      |  | $ | -     |  |  | $     | 37,848,000





|      |  |                                     | Related |  |                  
|----- |  | ----------------------------------- | ------- |  | -----------------
|      |  | Matured as of December
    31, 2011 |         |  | 2012 Activity (4)
|2009  |  | $                                   | -       |  |                  
|2010  |  |                                     | -       |  |                  
|2011  |  |                                     | -       |  |                  
|Total |  | $                                   | -       |  |                  



|
|




| | (1) | Amounts represent aggregate unpaid principal balance as of December 31, 2011 of matured loans as
of December 31, 2011 that were extended during the six months ended June 30, 2012.
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (2) | For loans matured as of December 31, 2011, net loan activity represents all activity on the loans
during the six months ended June 30, 2012, including accrued interest, payment of fees and expenses, charge-offs and/or repayments.
| | --- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (3) | Amounts represent aggregate unpaid principal balance as of June 30, 2012 of loans that matured
during the six months ended June 30, 2012 and remained matured as of June 30, 2012.
| | --- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (4) | The table does not reflect activity for loans that matured or were due to mature during the six
months ended June 30, 2012, but were extended prior to June 30, 2012.
| | --- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------



A loan is placed on
non-accrual status and income recognition is suspended at the date at which, in the opinion of management, a full recovery of income
and principal becomes more likely than not, but is no longer probable, based upon our review of economic conditions, the estimated
value of the underlying collateral, the guarantor, adverse situations that may affect the borrower’s ability to pay or the
value of the collateral and other relevant factors. Income recognition is resumed when the loan becomes contractually current and
performance is demonstrated to be resumed. Any payments received on loans classified as non-accrual status are typically applied
first to outstanding loan amounts and then to the recovery of lost interest. As of both June 30, 2012 and December 31, 2011, we
were suspending income recognition on two mortgage notes receivable with an aggregate unpaid principal balance of approximately
$2.2 million.



Loans are considered
impaired when, based on current information and events, it is probable that we will be unable to collect all amounts due in accordance
with the contractual terms of the loan agreement, including scheduled principal and interest payments. Impairment is generally
evaluated on an individual loan basis for each loan in the portfolio. If an individual loan is considered impaired, a specific
valuation allowance may be allocated, if necessary, so that the individual loan is reported net, at the present value of estimated
future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from
collateral. Loans that are not individually considered impaired are collectively and qualitatively measured as a portfolio for
general valuation allowance. In reviewing our portfolio for this valuation analysis, we use cash flow estimates from the disposition
of finished lots, paper lots (residential lots shown on a plat that has been accepted by the city or county, but which is currently
undeveloped or under development) and undeveloped land as well as cash flow received from the issuance of bonds from municipal
reimbursement districts. These estimates are based on current market metrics, including, without limitation, the supply of finished
lots, paper lots and undeveloped land, the supply of homes and the rate and price at which land and homes are sold, historic levels
and trends, executed purchase contracts, appraisals and discussions with third party market analysts and participants, including
homebuilders. We base our valuations on current and historic market trends on our analysis of market events and conditions, including
activity within our portfolio, as well as the analysis of third-party services such as Metrostudy and Residential Strategies, Inc.
Cash flow forecasts also are based on executed purchase contracts which provide base prices, escalation rates, and absorption rates
on an individual project basis. For projects deemed to have an extended time horizon for disposition, we consider third-party appraisals
to provide a valuation in accordance with guidelines set forth in the Uniform Standards of Professional Appraisal Practice. In
addition to cash flows from the disposition of property, cost analysis is performed based on estimates of development and senior
financing expenditures provided by developers and independent professionals on a project-by-project basis. These amounts are reconciled
with our best estimates to establish the net realizable value of the portfolio.



13







Interest is recognized
on an accrual basis for impaired loans in which the collectability of the unpaid principal amount is deemed probable. Any payments
received on such loans are first applied to outstanding accrued interest receivable and then to outstanding unpaid principal balance.
Unpaid principal balance is materially the same as recorded investments. Any payments received on impaired loans in which the collectability
of the unpaid principal amount is less than probable are typically applied to outstanding unpaid principal and then to the recovery
of lost interest on a cash basis. Impaired loans, or portions thereof, are charged off when deemed uncollectible.



As of June 30, 2012,
we have 9 mortgage notes receivable with an aggregate unpaid principal balance of approximately $37.8 million that are considered
impaired due to the loans remaining outstanding beyond the contractual term of the loan agreement. Of these 9 loans, full collectability
is considered probable for 7 loans with an aggregate unpaid principal balance of approximately $35.6 million and full collectability
is considered more likely than not, but not probable, for 2 loans with an aggregate unpaid principal balance of approximately $2.2
million. As of December 31, 2011, we had 12 mortgage notes receivable with an aggregate unpaid principal balance of approximately
$56.7 million that were considered impaired due to the loans remaining outstanding beyond the contractual term of the loan agreement.
Of these 12 loans, full collectability was considered probable for 10 loans with an aggregate unpaid principal balance of approximately
$54.5 million and full collectability was considered more likely than not, but not probable, for 2 loans with an aggregate unpaid
principal balance of approximately $2.2 million. For the six months ended June 30, 2012 and the year ended December 31, 2011, the
average outstanding aggregate unpaid principal balance for impaired loans was approximately $38.2 million and $54.1 million, respectively.
For the three months ended June 30, 2012 and 2011, we recognized approximately $1.4 million and $1.7 million of interest income,
respectively, related to impaired loans. For the six months ended June 30, 2012 and 2011, we recognized approximately $2.9 million
and $3.5 million of interest income, respectively, related to impaired loans. For the three and six months ended June 30, 2012
and the year ended December 31, 2011, we did not recognize any cash basis interest income related to impaired loans. Although no
specific allowance was allocated on impaired loans as of June 30, 2012 and December 31, 2011, we did charge-off approximately $276,000
against the allowance for loan losses associated with repayment of one impaired loan during 2011.



As part of the ongoing
monitoring of the credit quality of the loan portfolio, we periodically, no less than quarterly, perform a detailed review of our
portfolio of mortgage notes and other loans. The following is a general description of the credit levels used:



Level 1 – Full collectability
of loans in this category is considered probable.



Level 2 – Full collectability
of loans in this category is deemed more likely than not, but not probable, based upon our review of economic conditions, the estimated
value of the underlying collateral, the guarantor, adverse situations that may affect the borrower’s ability to pay or the
value of the collateral and other relevant factors. Interest income is suspended on Level 2 loans.



Level 3 – For loans in
this category, it is probable that we will be unable to collect all amounts due.



As of June 30, 2012
and December 31, 2011, our loans were classified as follows:



|        |  | June 30, |             |  | December 31, |  
|------- |  | -------- | ----------- |  | ------------ | -
|        |  | 2012     |             |  | 2011         |  
|Level 1 |  | $        | 349,261,000 |  |              | $
|Level 2 |  |          | 2,171,000   |  |              |  
|Level 3 |  |          | -           |  |              |  
|Total   |  | $        | 351,432,000 |  |              | $



14







The allowance for loan
losses is our estimate of incurred losses in our portfolio of mortgage notes receivable, mortgage notes receivable – related
parties and participation interest – related party. We periodically perform a detailed review of our portfolio of mortgage
notes and other loans to determine if impairment has occurred and to assess the adequacy of the allowance for loan losses. We charge
additions to the allowance for loan losses to current period earnings through a provision for loan losses. Amounts determined to
be uncollectible are charged directly against (and decrease) the allowance for loan losses (“charged off”), while amounts
recovered on previously charged off amounts increase the allowance for loan losses. The following table summarizes the change in
the reserve for loan losses during the six months ended June 30, 2012 and the year ended December 31, 2011, which is offset against
mortgage notes receivable:



|                           |  | For the Six Months |            |  | For the Year Ended |  
|-------------------------- |  | ------------------ | ---------- |  | ------------------ | -
|                           |  | Ended June 30,     |            |  | December 31,       |  
|                           |  | 2012               |            |  | 2011               |  
|                           |  |                    |            |  |                    |  
|Balance, beginning of year |  | $                  | 11,075,000 |  |                    | $
|Provision for loan losses  |  |                    | 279,000    |  |                    |  
|Charge-offs                |  |                    | -          |  |                    |  
|Balance, end of period     |  | $                  | 11,354,000 |  |                    | $



We follow the provisions
of ASU No. 2011-02, A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring. In
accordance with ASU 2011-02, the restructuring of a loan is considered a “troubled debt restructuring” if both (i) the
borrower is experiencing financial difficulties and (ii) the creditor has granted a concession. Concessions may include interest
rate reductions or below market interest rates, principal forgiveness, restructuring amortization schedules and other actions intended
to minimize potential losses. As of June 30, 2012 and December 31, 2011, we have no loan modifications that are classified as troubled
debt restructurings.



E. Line-of-Credit



On September 21,
2009, during the credit crisis in which financial institutions severely reduced the number of loans made to entities involved
in real estate, the Partnership entered into a Loan and Security Agreement (the “Loan Agreement”) with Wesley J.
Brockhoeft, an unaffiliated individual (the “Lender”), pursuant to which the Lender provided the Partnership with
a revolving credit facility in the maximum principal amount of $15 million (the “Brockhoeft Credit Facility”).
The interest rate on the Brockhoeft Credit Facility is equal to 10% per annum. Accrued interest on the outstanding principal
amount of the Brockhoeft Credit Facility is payable monthly. The Brockhoeft Credit Facility is secured by a first priority
lien on all of the Partnership’s existing and future assets. In consideration of the Lender originating the Brockhoeft
Credit Facility, the Partnership paid the Lender an origination fee in the amount of $300,000. On June 21, 2010, the
Partnership entered into the First Amendment to Loan and Security Agreement (the “Amended Loan Agreement”),
pursuant to which the maturity date on the Brockhoeft Credit Facility was extended from September 20, 2010 to June 21, 2012.
In consideration for amending the Brockhoeft Credit Facility, the Partnership paid the Lender an amendment fee in the amount
of $150,000, which was amortized over the life of the Amended Loan Agreement. The Amended Loan Agreement also permittedthe
Partnership’s existing and future assets to secure our guaranty of a $15 million loan (the “UDF I –
Brockhoeft Loan”) from the Lender, as agent for a group of lenders, to UDF I. In connection with the guaranty, we
receive from UDF I a monthly fee equal to 3% per annum of the outstanding balance of the UDF I – Brockhoeft Loan. The
Amended Loan Agreement also provides for cross-default of the Brockhoeft Credit Facility with the UDF I – Brockhoeft
Loan. On June 21, 2012, the Partnership entered into the Second Amendment to Loan and Security Agreement (the “Second
Amended Loan Agreement”), pursuant to which the maturity date on the Brockhoeft Credit Facility was extended from June
21, 2012 to June 21, 2014. Our guaranty of the UDF I – Brockhoeft Loan was also modified effective June 21,
2012, pursuant to which UDF I agreed to pay us a monthly fee equal to one-twelfth of 1% of the outstanding principal balance
of the UDF I – Brockhoeft Loan. In consideration for further amending the Brockhoeft Credit Facility, the Partnership
paid the Lender an additional amendment fee in the amount of $150,000, which is being amortized over the life of the Second
Amended Loan Agreement. We believe that the interest rate and terms of the Brockhoeft Credit Facility, the Amended Loan
Agreement and the Second Amended Loan Agreement are consistent with those offered by financial institutions.



15







The Partnership’s
eligibility to borrow up to $15 million under the Brockhoeft Credit Facility is determined pursuant to a borrowing base. The borrowing
base is equal to (a) the lesser of (i) up to 50% of the aggregate principal amount outstanding under the Partnership’s eligible
notes, (ii) up to 50% of the face amount of the Partnership’s eligible notes, or (iii) 40% of the appraised value
of the real property subject to the liens securing the Partnership’s eligible notes; minus (b) any reserves required
by the Lender. Eligible notes are those promissory notes which are secured by first liens, meet certain other criteria established
by the Lender, and are otherwise approved by the Lender for inclusion in the borrowing base. The Second Amended Loan Agreement
requires the Partnership to make various representations to the Lender and to comply with various covenants and agreements, including,
without limitation, maintaining at least $30 million in eligible notes, maintaining an adjusted tangible net worth of no less than
$250 million, maintaining its current line of business, operating its business in accordance with applicable laws, providing the
Lender with information, financial statements and reports, and not permitting a change of control to occur.



After June 21, 2012,
the Partnership may not borrow any additional advances under the Second Amended Loan Agreement. The Partnership shall repay the
principal amount of the loan in equal installments of $1,250,000 on the 21st day of each March, June, September and
December beginning on September 21, 2012. On June 21, 2014, the Partnership shall pay the aggregate unpaid principal amount of
all advances outstanding, all accrued but unpaid interest thereon, all fees and expenses owing to the lender and all other non-contingent
obligations.



If a default occurs
under the Brockhoeft Credit Facility, the Lender may declare the Brockhoeft Credit Facility to be due and payable immediately.
A default may occur under the Brockhoeft Credit Facility in various circumstances including, without limitation, if (i) the Partnership
fails to pay amounts due to the Lender when due under the Second Amended Loan Agreement, (ii) the Partnership fails to comply with
its covenants and agreements with the Lender, (iii) the Partnership defaults under obligations for money borrowed in excess of
$500,000, (iv) the Lender deems itself insecure or determines that a material adverse effect with respect to the Brockhoeft Credit
Facility, the Partnership, or the Brockhoeft Credit Facility collateral has occurred, (v) a criminal action is filed against the
Partnership under a federal or state racketeering statute, (vi) a bankruptcy action is filed with respect to the Partnership, (vii)
the Partnership conceals, removes, or permits to be concealed or removed, any of its assets with the intent to hinder, delay or
defraud the Lender or its other creditors, or (viii) the Second Amended Loan Agreement or other loan documents are terminated,
become void or unenforceable, or any security interest issued in connection with the Brockhoeft Credit Facility ceases to be a
valid and perfected first priority security interest in any portion of the Brockhoeft Credit Facility collateral. In such event,
the Lender may exercise any rights or remedies it may have, including, without limitation, increasing the interest rate to 12%
per annum, prohibiting distributions to be made to the Partnership’s partners, and foreclosure of the Partnership’s
assets. Any such event may materially impair the Partnership’s ability to conduct its business.



The Partnership intends
to utilize the Brockhoeft Credit Facility as transitory indebtedness to provide liquidity and to reduce and avoid the need for
large idle cash reserves, including usage to fund identified investments pending receipt of proceeds from the partial or full repayment
of loans. This allows the Partnership to keep funds invested in loans, instead of holding such loan repayment proceeds idle until
new investments are identified. The Partnership intends to use the Brockhoeft Credit Facility as a Partnership portfolio administration
tool and not to provide long-term or permanent leverage on Partnership investments. Proceeds from the operations of the Partnership
will be used to repay the Brockhoeft Credit Facility. As of June 30, 2012 and December 31, 2011, $15 million in principal was outstanding
under the Brockhoeft Credit Facility. Interest expense associated with the Brockhoeft Credit Facility was approximately $374,000
for each of the three months ended June 30, 2012 and 2011, and approximately $748,000 and $744,000, respectively, for the six months
ended June 30, 2012 and 2011.



F. Partners’ Capital



As of June 30, 2012,
we had issued an aggregate of 18,575,098 units of limited partnership interest in the Primary Offering, DRIP and Secondary DRIP,
consisting of 16,499,994 units issued to our limited partners pursuant to the Primary Offering in exchange for gross proceeds of
approximately $330.3 million (approximately $290.7 million, net of costs associated with the Primary Offering), 716,260 units of
limited partnership interest issued to our limited partners pursuant to our DRIP in exchange for gross proceeds of approximately
$14.3 million, and 1,689,531 units of limited partnership interest issued to our limited partners pursuant to our Secondary DRIP
in exchange for gross proceeds of approximately $33.8 million, less 330,687 units of limited partnership interest that we had repurchased
pursuant to our unit redemption program for approximately $6.6 million.



16







As of December 31,
2011, we had issued an aggregate of 18,326,511 units of limited partnership interest in the Primary Offering, DRIP and Secondary
DRIP, consisting of 16,499,994 units issued to our limited partners pursuant to the Primary Offering in exchange for gross proceeds
of approximately $330.3 million (approximately $290.7 million, net of costs associated with the Primary Offering), 716,260 units
of limited partnership interest issued to our limited partners pursuant to our DRIP in exchange for gross proceeds of approximately
$14.3 million, and 1,428,494 units of limited partnership interest issued to our limited partners pursuant to our Secondary DRIP
in exchange for gross proceeds of approximately $28.6 million, less 318,237 units of limited partnership interest that we had repurchased
pursuant to our unit redemption program for approximately $6.4 million.



For
the six months ended June 30, 2012, we have made the following distributions to our limited partners:



|Period Ended      |  | Date Paid         |  | Distribution Amount |           
|----------------- |  | ----------------- |  | ------------------- | ----------
|December 31, 2011 |  | January 24, 2012  |  | $                   | 3,030,091 
|January 31, 2012  |  | February 24, 2012 |  |                     | 3,036,865 
|February 29, 2012 |  | March 23, 2012    |  |                     | 2,847,457 
|March 31, 2012    |  | April 24, 2012    |  |                     | 3,051,709 
|April 30, 2012    |  | May 24, 2012      |  |                     | 2,958,253 
|May 31, 2012      |  | June 22, 2012     |  |                     | 3,063,606 
|                  |  |                   |  | $                   | 17,987,981



For the six months
ended June 30, 2012, we paid distributions to our limited partners of $17,987,981 ($12,767,230 in cash and $5,220,751 in limited
partnership units pursuant to our Secondary DRIP), as compared to cash flows from operations of $17,355,993. For the six months
ended June 30, 2011, we paid distributions to our limited partners of $17,369,053 ($11,876,195 in cash and $5,492,858 in limited
partnership units pursuant to our Secondary DRIP), as compared to cash flows from operations of $18,722,261. For the period from
our inception through June 30, 2012, we paid distributions to our limited partners of approximately $142.4 million (approximately
$94.3 million in cash and approximately $48.1 million in limited partnership units pursuant to our DRIP and Secondary DRIP), as
compared to cumulative cash flows from operations of approximately $168.5 million and cumulative net income of approximately $171.4
million.



The distributions to
our limited partners paid during the six months ended June 30, 2012 and 2011, along with the amount of distributions reinvested
pursuant to our Secondary DRIP and the sources of our distributions were as follows:



|                                  |  | Six Months Ended June 30, |           
|--------------------------------- |  | ------------------------- | ----------
|                                  |  | 2012                      |           
|Distributions paid in cash        |  | $                         | 12,767,230
|Distributions reinvested          |  |                           | 5,220,751 
|Total distributions               |  | $                         | 17,987,981
|Source of distributions:          |  |                           |           
|Cash flows from operations        |  | $                         | 17,355,993
|Cash flows from operating reserve |  |                           | 631,988   
|Total sources                     |  | $                         | 17,987,981



G. Operational Compensation



The general partner
receives Placement Fees of 3% of the net amount available for investment in mortgages for fees and expenses associated with the
selection and origination of mortgages, including, but not limited to, legal fees and expenses, travel and communications expenses,
costs of appraisals, accounting fees and expenses, and title insurance funded by the Partnership. The general partner also receives
mortgage servicing fees of 0.25% of the aggregate outstanding loan balance held by the Partnership (the “Mortgage Servicing
Fee”) for services rendered in connection with the servicing of Partnership loans.



17







The general partner
also receives a “carried interest,” which is an equity interest in us to participate in all distributions, other than
distributions attributable to our general partner’s promotional interest, of cash available for distribution (as described
below) and net proceeds from a capital transaction that are distributable under the distribution priority for net proceeds from
a capital transaction described below. If our general partner enters into commitments to investments in mortgages in excess of
82% of the gross proceeds of our public offering of our units of limited partnership interest, our general partner will be entitled
to a carried interest equal to (a) 1% for the first 2.5% of commitments to investments in mortgages above 82% of the gross
proceeds of the Offering (or if commitments to investments in mortgages are above 82% but no more than 84.5%, 1% multiplied by
the fractional amount of commitments to investments in mortgages above 82%), (b) 1% for the next 2% of additional commitments
to investments in mortgages above 84.5% of the gross proceeds of the Offering (or if commitments to investments in mortgages are
above 84.5% but no more than 86.5%, 1% multiplied by the fractional amount of commitments to investments in mortgages above 84.5%)
and (c) 1% for each additional 1% of additional commitments to investments in mortgages above 86.5% of the gross proceeds
of the Offering (or a fractional percentage equal to the fractional amount of any 1% of additional commitments to investments in
mortgages). By way of illustration, if 85.5% of the gross proceeds of the Offering are committed to investments in mortgages, then
our general partner would be entitled to a carried interest of 1.5% (1% for the first 2.5% of commitments to investments in mortgages
above 82% of the gross proceeds of the Offering and 0.5% for the next 1% of additional commitments to investments in mortgages
above 84.5% of the gross proceeds of the Offering) of any amount otherwise distributable to the limited partners after deduction
of any promotional interest payable to our general partner.



Cash available for
distribution represents the cash funds received by the Partnership from operations (other than net proceeds from a capital transaction)
that produces proceeds from (i) the repayment of principal or prepayment of a mortgage to the extent classified as a return of
capital for federal income tax purposes, (ii) the foreclosure, sale, exchange, condemnation, eminent domain taking or other disposition
of a mortgage loan or of a property subject to a mortgage, or (iii) insurance or a guarantee with respect to a mortgage, including,
without limitation, interest, points, revenue participations in property appreciation and interest or dividends from interim investments
or proceeds from borrowings, if appropriate, less all cash used to pay Partnership expenses and debt payments and amounts set aside
to create a retained earnings reserve (currently at 9.5% of our net income; the retained earnings reserve is intended to recover
some of the organization and offering expenses incurred in connection with our public offering of our units of limited partnership
interest).



In order for proceeds
to be considered “committed” for purposes of calculation and payment of a carried interest, we must be obligated by
contract or other binding agreement to invest such proceeds in mortgages, to the exclusion of any other use for such proceeds or
no use at all.



“Investments
in mortgages” are the aggregate amount of capital contributions from investors used by us to make or invest in mortgage loans
or the amount actually paid or allocated to the purchase of mortgages, working capital reserves (but excluding working capital
reserves in excess of 3% of the aggregate capital contributions) and other cash payments such as interest and taxes but excluding
our organization and offering expenses, selling commissions, wholesaling fees, marketing support fees, due diligence fees, acquisition
and origination fees, and any other front-end fees.



Our general partner’s
“promotional interest” is our general partner’s right to receive:



| | · | prior to the return to the limited partners
of all of their capital contributions plus an 8% per annum, non-compounding, cumulative return on their unreturned capital
contributions, 10% of all cash available for distribution;
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | · | following the return to the limited partners
of all of their capital contributions plus an 8% per annum, non-compounding, cumulative return on their unreturned capital
contributions, 15% of all cash available for distribution; and
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | · | following the return to the limited partners
of all of their capital contributions plus an 8% per annum, non-compounding, cumulative return on their unreturned capital
contributions, 15% of all net proceeds from a capital transaction.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



18







H. Unit Redemption Program



Limited partners who
have held their units for at least one year may request that the Partnership repurchase their units. A limited partner wishing
to have units repurchased must mail or deliver in writing a request to the Partnership indicating such desire. However, effective
June 30, 2009, in order to conserve cash and in response to increasing requests for redemptions, we limited our redemptions primarily
to those requested as a result of death, disability and exigent circumstances, to the extent our general partner determines there
are sufficient funds to redeem units. No units were redeemed from May 2010 through March 2012. In April 2012, our general partner
determined that the Partnership has sufficient excess cash from operations to repurchase some units as a result of the deaths of
limited partners. Therefore, our general partner approved and the Partnership redeemed approximately 12,450 units as a result of
the deaths of limited partners for $249,000 (an average repurchase price of approximately $20.00 per unit). However, as stated
below, our general partner will determine from time to time whether the Partnership has sufficient excess cash from operations
to repurchase units, and there is no guarantee that the Partnership will repurchase any additional units in the future



Prior to October 15,
2010, the purchase price of repurchased units, except as described below for redemptions upon the death of a limited partner, was
equal to (i) 92% of the purchase price actually paid for any units held less than two years, (ii) 94% of the purchase price
actually paid for any units held for at least two years but less than three years, (iii) 96% of the purchase price actually paid
for any units held for at least three years but less than four years, (iv) 98% of the purchase price actually paid for any units
held for at least four years but less than five years, and (v) the lesser of the purchase price actually paid for any units held
at least five years or the then-current fair market value of the units, as determined by the most recent annual valuation of units.
The purchase price for units redeemed upon the death of a limited partner was the lesser of (i) the price such limited partner
actually paid for the units or (ii) $20.00 per unit; provided, however, that the aggregate annual redemptions for all deceased
limited partners was not to exceed 1% of units outstanding in the preceding 12-month period.



As a result of the
requirement to determine an estimated value of our units, the method for determining the purchase price for current and future
redeemed units has been revised. Except as described below for redemptions upon the death of a limited partner, the purchase price
for the redeemed units, for the period beginning after a limited partner has held the units for a period of one year, will be (i)
92% of the Estimated Unit Value (as defined below) for any units held less than two years, (ii) 94% of the Estimated Unit Value
for any units held for at least two years but less than three years, (iii) 96% of the Estimated Unit Value for any units held at
least three years but less than four years, (iv) 98% of the Estimated Unit Value for any units held at least four years but less
than five years; and (v) 100% of the Estimated Unit Value for any units held at least five years. The price the Partnership will
pay for redeemed units will be offset by any net proceeds from capital transactions previously distributed to the redeeming limited
partner in respect of such units as a return of his or her capital contributions.  In addition, the purchase price for
units redeemed upon the death of a limited partner will be 100% of the Estimated Unit Value, with the aggregate annual number of
units redeemed upon death of a limited partner not to exceed 1% of units outstanding in the preceding twelve-month period. The
price the Partnership will pay for units redeemed upon the death of a limited partner will be offset by any net proceeds from capital
transactions previously distributed to the deceased limited partner, or his or her estate, in respect of such units as a return
of capital contributions. For purposes of establishing the redemption price per unit, “Estimated Unit Value” shall
mean the most recently disclosed reasonable estimated value of the Partnership’s units of limited partnership interest as
determined by our general partner. On March 6, 2012, our general partner determined the most recent Estimated Unit Value to be
$20.00 per unit, which will be used as the Estimated Unit Value until such time as our general partner provides a new estimated
value of the Partnership’s units of limited partnership interest.



The Partnership will
not redeem in excess of 5% of the weighted average number of units outstanding during the 12-month period immediately prior to
the date of redemption. Our general partner reserves the right in its sole discretion at any time and from time to time to (1)
waive the one-year holding period in the event of the death or bankruptcy of a limited partner or other exigent circumstances,
(2) reject any request for redemption, (3) change the purchase price for redemptions, or (4) terminate, suspend and/or reestablish
our unit redemption program. Our general partner will determine from time to time whether the Partnership has sufficient excess
cash from operations to repurchase units. Generally, the cash available for redemption will be limited to 1% of the operating cash
flow from the previous fiscal year, plus any net proceeds from the DRIP and Secondary DRIP. If the funds set aside for the unit
redemption program are not sufficient to accommodate all requests, at such time, if any, when sufficient funds become available,
pending requests will be honored among all requesting limited partners as follows: first, pro rata as to redemptions upon the death
or disability of a limited partner; next, pro rata as to limited partners who demonstrate, in the discretion of our general partner,
another involuntary exigent circumstance, such as bankruptcy; and, finally, pro rata as to all other redemption requests, if any,
until all other requests for redemption have been met.



19







The Partnership complies
with the Distinguishing Liabilities from Equity topic of the FASB ASC, which requires, among other things, that financial instruments
that represent a mandatory obligation of the Partnership to repurchase limited partnership units be classified as liabilities and
reported at settlement value. We believe that limited partnership units tendered for redemption by the unit holder under the Partnership’s
unit redemption program do not represent a mandatory obligation until such redemptions are approved at the discretion of our general
partner. At such time, we will reclassify such obligations from equity to an accrued liability based upon their respective settlement
values. As of June 30, 2012, we did not have any approved redemption requests included in our liabilities.



The following table
summarizes the redemption activity for the six months ended June 30, 2012 and the year ended December 31, 2011. The amounts presented
are in total units, rounded to the nearest thousand:



|                              |  | Six Months Ended |         |   | Year Ended        | 
|----------------------------- |  | ---------------- | ------- | - | ----------------- | 
|                              |  | June 30, 2012    |         |   | December 31, 2011 | 
|Balance, beginning of period  |  |                  | 719,000 |   |                   | 
|Redemption requests received  |  |                  | 61,000  |   |                   | 
|Redemption requests cancelled |  |                  | (8,000  | ) |                   | 
|Units redeemed                |  |                  | (12,000 | ) |                   | 
|Balance, end of period        |  |                  | 760,000 |   |                   | 



I. Commitments and Contingencies



From time to time,
the Partnership enters into guarantees of debtor’s borrowings and provides credit enhancements for the benefit of senior
lenders in connection with the Partnership’s debtors and investments in partnerships (collectively referred to as “guarantees”),
and accounts for such guarantees in accordance with FASB ASC 460-10, Guarantees. Guarantees generally have fixed expiration
dates or other termination clauses and may require payment of a fee by the debtor. A guarantee involves, to varying degrees, elements
of credit risk in excess of the amount recognized in the balance sheets. The Partnership’s exposure to credit loss in the
event of non-performance by the other party to the instrument is represented by the contractual notional amount of the guarantee.



In
February 2009, the Partnership deposited $1.5 million into a money market account (the “Deposit Account”) with LegacyTexas
Bank (“LegacyTexas”) for the purpose of providing collateral to LegacyTexas for the benefit of UMTH Lending
Company, L.P., a Delaware limited partnership (“UMTH Lending”). UMTH Lending and the Partnership’s general partner
are each owned 99.9% by UMT Holdings and 0.1% by UMT Services, which serves as the general partner for both UMTH Lending and the
Partnership’s general partner. The Partnership provided LegacyTexas a security interest in the Deposit Account as further
collateral for a loan (the “UMTH Lending Loan”) obtained by UMTH Lending from LegacyTexas. In connection therewith,
as required by the Partnership Agreement and the NASAA Mortgage Program Guidelines, the Partnership obtained an opinion from Jackson
Claborn, Inc., an independent advisor, stating that this credit enhancement is fair and at least as reasonable to the Partnership
as a loan or credit enhancement to an unaffiliated borrower in similar circumstances. In November 2010, UMTH Lending refinanced
the UMTH Lending Loan with United Texas Bank (“UTB”). In conjunction with this refinance, the Partnership deposited
$1.5 million into a deposit account (the “UTB Deposit Account”) with UTB for the purpose of providing collateral to
UTB for the benefit of UMTH Lending. The UTB Deposit Account replaced the Deposit Account previously established with LegacyTexas.  The
Partnership provided the UTB Deposit Account as further collateral for a loan obtained by UMTH Lending from UTB (the “UTB-UMTH
Lending Loan”). In consideration for providing the Deposit Account and UTB Deposit Account (collectively, the “UMTH
Lending Deposit Accounts”) as collateral for the UMTH Lending Loan and the UTB-UMTH Lending Loan (collectively, the “UMTH
Lending Loans”), UMTH Lending agreed to pay the Partnership a fee equal to 3% per annum of the amount outstanding in the
UMTH Lending Deposit Accounts, paid in 12 monthly installments for each year that the UMTH Lending Deposit Accounts secure the
UMTH Lending Loans. The UTB Deposit Account is included as restricted cash on the Partnership’s balance sheet. The fee is
included in mortgage and transaction service revenues – related parties income (see Note K for further discussion).



20







In August 2009, the
Partnership entered into a guaranty (the “TCB Guaranty”) with Texas Capital Bank, National Association (“Texas
Capital”), by which the Partnership guaranteed the repayment of up to $5 million owed to Texas Capital Bank with respect
to that certain promissory note between UMT Home Finance, L.P., a Delaware limited partnership (“UMT Home Finance”),
and Texas Capital. UMT Home Finance is a wholly-owned subsidiary of UMT. An affiliate of the Partnership’s general partner
serves as the advisor to UMT.  In connection therewith, as required by the Partnership Agreement and the NASAA Mortgage
Program Guidelines, the Partnership obtained an opinion from Jackson Claborn, Inc., an independent advisor, stating that this credit
enhancement is fair and at least as reasonable to the Partnership as a loan or credit enhancement to an unaffiliated borrower in
similar circumstances. In connection with the TCB Guaranty, the Partnership entered into a letter agreement with UMT Home Finance
which provides for UMT Home Finance to pay the Partnership annually, in advance, an amount equal to 1% of the Partnership’s
maximum exposure under the TCB Guaranty (i.e., $50,000 per annum).  These fees are included in mortgage and transaction
service revenues – related parties income (see Note K for further discussion).



In April 2010, the
Partnership entered into a guaranty (the “UDF IV HF Guaranty”) for the benefit of Community Trust Bank of Texas (“CTB”),
pursuant to which the Partnership guaranteed the repayment of up to $6 million owed to CTB with respect to a revolving line of
credit loan between UDF IV Home Finance, L.P., a Delaware limited partnership (“UDF IV Home Finance”), and CTB.   UDF
IV Home Finance is a wholly owned subsidiary of UDF IV.  The Partnership’s general partner serves as the asset
manager for UDF IV, and an affiliate of the Partnership’s general partner serves as the advisor for UDF IV.  In
connection therewith, as required by the Partnership Agreement and the NASAA Mortgage Program Guidelines, the Partnership obtained
an opinion from Jackson Claborn, Inc., an independent advisor, stating that this credit enhancement is fair and at least as reasonable
to the Partnership as a loan or credit enhancement to an unaffiliated borrower in similar circumstances.  In connection
with the UDF IV HF Guaranty, the Partnership entered into a letter agreement with UDF IV Home Finance which provides for UDF IV
Home Finance to pay the Partnership an annual credit enhancement fee equal to 1% of the maximum loan amount (i.e., $60,000
per annum).  The fee is to be paid in 12 equal monthly installments and is included in mortgage and transaction service
revenues – related parties income (see Note K for further discussion).



In April 2010, the
Partnership entered into a guaranty (the “UMT 15th Street Guaranty”) for the benefit of CTB, pursuant to which the
Partnership guaranteed the repayment of up to $1.6 million owed to CTB with respect to a loan between UMT 15th Street, L.P., a
Delaware limited partnership (“UMT 15th Street”), and CTB.  UMT 15th Street is a wholly owned subsidiary
of UMT.  An affiliate of the Partnership’s general partner serves as the advisor to UMT.  In connection
therewith, as required by the Partnership Agreement and the NASAA Mortgage Program Guidelines, the Partnership obtained an opinion
from Jackson Claborn, Inc., an independent advisor, stating that this credit enhancement is fair and at least as reasonable to
the Partnership as a loan or credit enhancement to an unaffiliated borrower in similar circumstances.  In connection
with the UMT 15th Street Guaranty, the Partnership entered into a letter agreement with UMT 15th Street which provides for UMT
15th Street to pay the Partnership a monthly credit enhancement fee equal to one-twelfth of 1% of the outstanding principal balance
on the loan at the end of the month.  The fee is included in mortgage and transaction service revenues – related
parties income (see Note K for further discussion).



In
June 2010, UDF I obtained the $15 million UDF I – Brockhoeft Loan from the Lender, as agent for a group of lenders. As security
for the UDF I – Brockhoeft Loan, the Partnership provided the Lender with a guaranty of repayment on the UDF I –
Brockhoeft Loan, which is secured by a lien on all of the Partnership’s existing and future assets. The Partnership’s
general partner serves as the asset manager for UDF I.  In connection therewith, as required by the Partnership Agreement
and the NASAA Mortgage Program Guidelines, the Partnership obtained an opinion from Jackson Claborn, Inc., an independent advisor,
stating that this credit enhancement is fair and at least as reasonable to the Partnership as a loan or credit enhancement to an
unaffiliated borrower in similar circumstances.  In consideration of the Partnership’s secured guaranty, commencing
July 31, 2010, UDF I agreed to pay the Partnership a monthly fee equal to 3% per annum of the outstanding balance of the UDF I
– Brockhoeft Loan.Effective June 21, 2012, the agreement was modified and UDF I agreed to pay the Partnership a monthly
fee equal to one-twelfth of 1% of the outstanding principal balance of the UDF I – Brockhoeft Loan. These
fees are included in mortgage and transaction service revenues – related parties income (see Note K for further discussion).



In August 2010, the
Partnership entered into a guaranty (the “UDF IV Acquisitions Guaranty”) for the benefit of CTB, pursuant to which
the Partnership guaranteed the repayment of up to $8 million owed to CTB with respect to a revolving line of credit loan between
UDF IV Acquisitions, L.P., a Delaware limited partnership (“UDF IV Acquisitions”), and CTB.  UDF IV Acquisitions
is a wholly owned subsidiary of UDF IV.  The Partnership’s general partner serves as the asset manager for UDF
IV, and an affiliate of the Partnership’s general partner serves as the advisor for UDF IV.  In connection therewith,
as required by the Partnership Agreement and the NASAA Mortgage Program Guidelines, the Partnership obtained an opinion
from Jackson Claborn, Inc., an independent advisor, stating that this credit enhancement is fair and at least as reasonable to
the Partnership as a loan or credit enhancement to an unaffiliated borrower in similar circumstances.  In connection
with the UDF IV Acquisitions Guaranty, the Partnership entered into a letter agreement with UDF IV Acquisitions which provides
for UDF IV Acquisitions to pay the Partnership a monthly credit enhancement fee equal to one-twelfth of 1% of the outstanding principal
balance on the revolving line of credit at the end of the month.  This fee is included in mortgage and transaction service
revenues – related parties income (see Note K for further discussion).



21







In December 2010, the
Partnership entered into a guaranty (the “UDF IV Finance II Guaranty”) for the benefit of The F&M Bank and Trust
Company (“F&M”), pursuant to which the Partnership guaranteed the repayment of up to $7.5 million owed to F&M
with respect to a loan between UDF IV Finance II, L.P., a Delaware limited partnership (“UDF IV Finance II”), and F&M.  UDF
IV Finance II is a wholly owned subsidiary of UDF IV.  The Partnership’s general partner serves as the asset manager
for UDF IV, and an affiliate of the Partnership’s general partner serves as the advisor for UDF IV.  In connection
therewith, as required by the Partnership Agreement and the NASAA Mortgage Program Guidelines, the Partnership obtained an
opinion from Jackson Claborn, Inc., an independent advisor, stating that this credit enhancement is fair and at least as reasonable
to the Partnership as a loan or credit enhancement to an unaffiliated borrower in similar circumstances.  In connection
with the UDF IV Finance II Guaranty, the Partnership entered into a letter agreement with UDF IV Finance II which provides for
UDF IV Finance II to pay the Partnership a monthly credit enhancement fee equal to one-twelfth of 1% of the outstanding principal
balance on the revolving line of credit at the end of the month.  This fee is included in mortgage and transaction service
revenues – related parties income (see Note K for further discussion).



In May 2011, the Partnership
entered into a guaranty (the “UMT HF III Guaranty”) for the benefit of Veritex Community Bank, National Association
(“Veritex”), pursuant to which the Partnership guaranteed the repayment of up to $4.3 million owed to Veritex with
respect to a loan between UMT Home Finance III, L.P., a Delaware limited partnership (“UMT HF III”), and Veritex. UMT
HF III is a wholly owned subsidiary of UMT.  An affiliate of the Partnership’s general partner serves as the advisor
to UMT.  In connection therewith, as required by the Partnership Agreement and the NASAA Mortgage Program Guidelines,
the Partnership obtained an opinion from Jackson Claborn, Inc., an independent advisor, stating that this credit enhancement
is fair and at least as reasonable to the Partnership as a loan or credit enhancement to an unaffiliated borrower in similar circumstances.
In connection with the UMT HF III Guaranty, the Partnership entered into a letter agreement with UMT HF III which provides for
UMT HF III to pay the Partnership a monthly credit enhancement fee equal to one-twelfth of 1% of the outstanding principal balance
on the loan at the end of the month.  The fee is included in mortgage and transaction service revenues – related
parties income (see Note K for further discussion).



In August 2011, the
Partnership entered into a guaranty (the “UMT HF II Guaranty”) for the benefit of First Financial Bank, N.A. (“FFB”),
pursuant to which the Partnership guaranteed the repayment of up to $250,000 owed to FFB with respect to a loan between UMT Home
Finance II, L.P., a Delaware limited partnership (“UMT HF II”), and FFB. UMT HF II is a wholly owned subsidiary of
UMT.  An affiliate of the Partnership’s general partner serves as the advisor to UMT.  In connection
therewith, as required by the Partnership Agreement and the NASAA Mortgage Program Guidelines, the Partnership obtained an opinion
from Jackson Claborn, Inc., an independent advisor, stating that this credit enhancement is fair and at least as reasonable to
the Partnership as a loan or credit enhancement to an unaffiliated borrower in similar circumstances. In connection with the UMT
HF II Guaranty, the Partnership entered into a letter agreement with UMT HF II which provides for UMT HF II to pay the Partnership
a monthly credit enhancement fee equal to one-twelfth of 1% of the outstanding principal balance on the loan at the end of the
month. The fee is included in mortgage and transaction service revenues – related parties income (see Note K for further
discussion).



In October 2011, the
Partnership entered into a guaranty (the “UMT HF II Green Bank Guaranty”) for the benefit of Green Bank, N.A. (“Green
Bank”), pursuant to which the Partnership guaranteed the repayment of up to $5 million owed to Green Bank with respect to
a loan between UMT HF II and Green Bank. UMT HF II is a wholly owned subsidiary of UMT.  An affiliate of the Partnership’s
general partner serves as the advisor to UMT. In connection therewith, as required by the Partnership Agreement and the NASAA Mortgage
Program Guidelines, the Partnership obtained an opinion from Jackson Claborn, Inc., an independent advisor, stating that this
credit enhancement is fair and at least as reasonable to the Partnership as a loan or credit enhancement to an unaffiliated borrower
in similar circumstances. In connection with the UMT HF II Green Bank Guaranty, the Partnership entered into a letter agreement
with UMT HF II which provides for UMT HF II to pay the Partnership a monthly credit enhancement fee equal to one-twelfth of 1%
of the outstanding principal balance on the loan at the end of the month. The fee is included in mortgage and transaction service
revenues – related parties income (see Note K for further discussion).



22







As of June 30, 2012,
we had 11 outstanding limited repayment guarantees with total credit risk to us of approximately $63.1 million, of which approximately
$42.2 million has been borrowed against by the debtor.



As of December 31,
2011, we had 14 outstanding guarantees, including: (1) 13 limited repayment guarantees with total credit risk to us of approximately
$65.4 million, of which approximately $47.8 million had been borrowed against by the debtor and (2) one letter of credit issued
on behalf of a borrower with total credit risk to us of approximately $400,000, of which no amount had been borrowed against by
the debtor.



As
of June 30, 2012, we had originated 60 loans, including 32 loans that have been repaid in full by the respective borrower, totaling
approximately $540.9 million. We had approximately $35.0 million of commitments to be funded, including approximately $13.4 million
of commitments for mortgage notes receivable – related parties and $9.5 million for participation interest – related
party.For the six months ended June 30, 2012, we did not originate or purchase any loans, sold 1 loan participation, and
did not acquire any additional participation interests.



As of December 31,
2011, we had originated 60 loans, including 31 loans that have been repaid in full by the respective borrower, totaling approximately
$537.3 million. We had approximately $35.1 million of commitments to be funded, including approximately $12.3 million of commitments
for mortgage notes receivable – related parties and $9.5 million for participation interest – related party. For the
year ended December 31, 2011, we originated 2 loans, sold 3 loan participations, and did not purchase any loans or acquire any
additional participation interests.



To date, the Partnership
has not incurred losses from guarantees entered into, and the debt that is guaranteed is also collateralized by real estate. The
value of such real estate may or may not be sufficient to settle such obligations if liquidated.



J. General and Administrative Expenses



General and administrative
expenses and general and administrative expenses – related parties of the Partnership are summarized in the following charts:



|                                          |  | For the Three Months Ended |         |  | For the Six Months Ended |  
|----------------------------------------- |  | -------------------------- | ------- |  | ------------------------ | -
|                                          |  | June 30,                   |         |  | June 30,                 |  
|General and administrative expenses       |  | 2012                       |         |  | 2011                     |  
|                                          |  |                            |         |  |                          |  
|Investor relations                        |  | $                          | 154,000 |  |                          | $
|Professional fees                         |  |                            | 65,000  |  |                          |  
|Other                                     |  |                            | 158,000 |  |                          |  
|Total general and administrative expenses |  | $                          | 377,000 |  |                          | $



|                                                            |  | For the Three Months Ended |         |  | For the Six Months Ended |  
|----------------------------------------------------------- |  | -------------------------- | ------- |  | ------------------------ | -
|                                                            |  | June 30,                   |         |  | June 30,                 |  
|General and administrative expenses –
related parties       |  | 2012                       |         |  | 2011                     |  
|                                                            |  |                            |         |  |                          |  
|Amortization of Placement Fees                              |  | $                          | 306,000 |  |                          | $
|Mortgage Servicing Fee                                      |  |                            | 239,000 |  |                          |  
|Amortization of debt financing fees                         |  |                            | 6,000   |  |                          |  
|Operating Expense Reimbursement (1)                         |  |                            | 138,000 |  |                          |  
|Total general and administrative expenses – related parties |  | $                          | 689,000 |  |                          | $



| | (1) | As defined in Note K.
| | --- | ---------------------



23







K. Related Party Transactions



As of June 30, 2012,
we have approximately $49.8 million of mortgage notes receivables – related parties, consisting of 7 related party loans,
and one participation interest – related party totaling approximately $66.1 million. Mortgage notes receivables – related
parties and participation interest – related party represent approximately 32% of our total assets. As of June 30, 2012,
we have approximately $8.9 million of accrued interest receivable – related parties, and we have paid our general partner
approximately $10.2 million since inception for acquisition and origination fee expenses associated with the mortgage notes receivable,
mortgage notes receivable – related parties and participation interest – related party. For the six months ended June
30, 2012, we recognized approximately $8.1 million and $379,000 for interest income – related parties and mortgage and transaction
service revenues – related parties, respectively. We also recognized approximately $1.4 million of general and administrative
expenses – related parties for the six months ended June 30, 2012. As of June 30, 2012, we had eight outstanding limited
repayment guarantees benefitting related parties with total credit risk to us of approximately $52.4 million, of which approximately
$32.2 million has been borrowed against by the debtor.



As of December 31,
2011, we had approximately $52.0 million of mortgage notes receivables – related parties, consisting of 7 related party loans,
and one participation interest – related party totaling approximately $66.2 million. Mortgage notes receivables – related
parties and participation interest – related party represented approximately 33% of our total assets. As of December 31,
2011, we had approximately $2.6 million of accrued interest receivable – related parties, and we had paid our general partner
approximately $10.0 million since inception for acquisition and origination fee expenses associated with the mortgage notes receivable,
mortgage notes receivable – related parties and participation interest – related party. For the year ended December
31, 2011, we recognized approximately $15.2 million and $1.0 million for interest income – related parties and mortgage and
transaction service revenues – related parties, respectively. We also recognized approximately $2.7 million of general and
administrative expenses – related parties for the year ended December 31, 2011. As of December 31, 2011, we had nine outstanding
limited repayment guarantees benefitting related parties with total credit risk to us of approximately $52.7 million, of which
approximately $37.1 million had been borrowed against by the debtor.



Land Development and
certain of its affiliates receive fees in connection with the acquisition and management of the assets and reimbursement of costs
of the Partnership.



We reimburse UMTH General
Services, L.P. (“General Services”), a Delaware limited partnership, for operating expenses incurred by General Services
in assisting Land Development in our management (the “Operating Expense Reimbursement”). General Services and Land
Development are each owned 99.9% by UMT Holdings and0.1% by UMT Services, which serves as the general partner for both
General Services and the Land Development.



We incurred Placement
Fees of 3% of the net amount available for investment in mortgages for fees and expenses associated with the selection and origination
of mortgages, including, but not limited to, legal fees and expenses, travel and communications expenses, costs of appraisals,
accounting fees and expenses, and title insurance funded by us. Such fees are amortized into expense on a straight line basis and
are currently being paid to Land Development. The unpaid portion of these fees is included in accrued liabilities – related
parties on our balance sheet.



Land Development currently
receives an unsubordinated promotional interest equal to 10% of cash available for distribution prior to the return to our limited
partners of all of their capital contributions and an 8% annual cumulative (non-compounded) return on their net capital contributions.
After our limited partners receive a return of their net capital contributions and an 8% annual cumulative (non-compounded) return
on their net capital contributions, Land Development will receive a subordinated promotional interest equal to 15% of remaining
cash available for distribution, including net proceeds from capital transactions or a pro rata portion thereof.



Land Development receives
a carried interest, which is an equity interest in us to participate in all distributions (the “Carried Interest”),
other than distributions attributable to its promotional interest of cash available for distribution and net proceeds from capital
transactions. If Land Development enters into commitments to investments in mortgages in excess of 82% of the gross offering proceeds,
it will be entitled to a carried interest equal to (a) 1% for the first 2.5% of commitments to investments in mortgages above
82% of the gross offering proceeds (or if commitments to investments in mortgages are above 82% but no more than 84.5%, 1% multiplied
by the fractional amount of commitments to investments in mortgages above 82%), (b) 1% for the next 2% of additional commitments
to investments in mortgages above 84.5% of the gross offering proceeds (or if commitments to investments in mortgages are above
84.5% but no more than 86.5%, 1% multiplied by the fractional amount of commitments to investments in mortgages above 84.5%) and
(c) 1% for each additional 1% of additional commitments to investments in mortgages above 86.5% of the gross offering proceeds
(or a fractional percentage equal to the fractional amount of any 1% of additional commitments to investments in mortgages).



For services rendered
in connection with the servicing of our loans, we incur a monthly Mortgage Servicing Fee payable to Land Development equal to one-twelfth
of 0.25% of our aggregate outstanding development mortgage notes receivable balance as of the last day of the month. Such fees
are included in general and administrative – related parties expenses. The unpaid portion of such fees is included in accrued
liabilities – related parties on our balance sheet.



24







On September 21, 2009,
the Partnership entered into the $15 million Brockhoeft Credit Facility with the Lender (as discussed in Note E).  In
conjunction with the Brockhoeft Credit Facility, the Partnership paid UMTH Funding Services, L.P. (“Funding Services”),
a Delaware limited partnership, a debt placement fee equal to 1% ($150,000) of the Brockhoeft Credit Facility, which was amortized
over the initial term of the Brockhoeft Credit Facility. Funding Services and the Partnership’s general partner are each
owned 99.9% by UMT Holdings and 0.1% by UMT Services, which serves as the general partner for both Funding Services and Land Development.



An affiliate of Land
Development serves as the advisor to UMT and UDF IV. The general partner of UDF LOF is a wholly-owned subsidiary of Land Development.  Land
Development serves as the asset manager of UDF I, UDF IV and UDF LOF.



The chart below summarizes
the payment of related party fees and reimbursements associated with the Offering and origination and management of assets for
the six months ended June 30, 2012 and 2011. We believe that these fees and reimbursements are reasonable and customary for comparable
mortgage programs.





|                 |  |                                 |  | For the Six Months Ended |          
|---------------- |  | ------------------------------- |  | ------------------------ | ---------
|                 |  |                                 |  | June 30,                 |          
|Payee            |  | Purpose                         |  | 2012                     |          
|Land Development |  |                                 |  |                          |          
|                 |  | Placement Fees                  |  | $                        | 272,000  
|                 |  | Promotional Interest            |  |                          | 3,146,000
|                 |  | Carried Interest                |  |                          | 462,000  
|                 |  | Mortgage Servicing Fee          |  |                          | 799,000  
|                 |  |                                 |  |                          |          
|General Services |  |                                 |  |                          |          
|                 |  | Operating Expense Reimbursement |  |                          | 1,000    
|                 |  |                                 |  |                          |          
|Total Payments   |  |                                 |  | $                        | 4,680,000



The chart below summarizes
general and administrative – related parties expense for the three months ended June 30, 2012 and 2011. We believe that these
expenses are reasonable and customary for comparable mortgage programs.





|                                                           |  | For the Three Months Ended |        
|---------------------------------------------------------- |  | -------------------------- | -------
|                                                           |  | June 30,                   |        
|General and administrative expense – related parties       |  | 2012                       |        
|                                                           |  |                            |        
|Amortization of Placement Fees                             |  | $                          | 306,000
|Mortgage Servicing Fee                                     |  |                            | 239,000
|Amortization of debt financing fees                        |  |                            | 6,000  
|Operating Expense Reimbursement                            |  |                            | 138,000
|Total general and administrative expense – related parties |  | $                          | 689,000



The chart below summarizes
general and administrative – related parties expense for the six months ended June 30, 2012 and 2011. We believe that these
expenses are reasonable and customary for comparable mortgage programs.





|                                                           |  | For the Six Months Ended |          
|---------------------------------------------------------- |  | ------------------------ | ---------
|                                                           |  | June 30,                 |          
|General and administrative expense – related parties       |  | 2012                     |          
|                                                           |  |                          |          
|Amortization of Placement Fees                             |  | $                        | 611,000  
|Mortgage Servicing Fee                                     |  |                          | 479,000  
|Amortization of debt financing fees                        |  |                          | 11,000   
|Operating Expense Reimbursement                            |  |                          | 276,000  
|Total general and administrative expense – related parties |  | $                        | 1,377,000



25







Mortgage Notes Receivable – Related Parties



UDF PM Note



In September 2007,
we originated a secured promissory note to UDF PM, LLC, a Texas limited liability company and wholly-owned subsidiary of UDF I
(“UDF PM”), in the principal amount of approximately $6.4 million (the “UDF PM Note”), and in connection
therewith, as required by our Partnership Agreement and the NASAA Mortgage Program Guidelines, we obtained an opinion from Jackson
Claborn, Inc., an independent advisor, stating that the UDF PM Note is fair and at least as reasonable to us as a transaction with
an unaffiliated party in similar circumstances. Our general partner serves as the asset manager for UDF I. The UDF PM Note, which
bears an interest rate of 15% per annum, is initially collateralized by a second lien deed of trust on approximately 335 finished
lots and 15 acres of land located in Texas and, per the First Amendment to Secured Promissory Note, matures on September 4, 2012.
In determining whether to modify the UDF PM Note, we evaluated the economic conditions, the estimated value and performance of
the underlying collateral, the guarantor, adverse situations that may affect the borrower’s ability to pay or the value of
the collateral and other relevant factors. In connection with the UDF PM Note, UDF PM agreed to pay us commitment fees equal to
3% of each advance on the note, or $187,500. We did not recognize any commitment fee income in connection with the UDF PM Note
for the three or six months ended June 30, 2012 or 2011. For the three months ended June 30, 2012 and 2011, we recognized approximately
$109,000 and $228,000, respectively, of interest income – related parties related to the UDF PM Note. For the six months
ended June 30, 2012 and 2011, we recognized approximately $263,000 and $519,000, respectively, of interest income – related
parties related to the UDF PM Note. Approximately $1.2 million and $4.2 million is included in mortgage notes receivable –
related parties as of June 30, 2012 and December 31, 2011, respectively. Approximately $11,000 and $17,000 is included in accrued
interest receivable – related parties as of June 30, 2012 and December 31, 2011, respectively.



UDF X Note



In November 2007, we
originated a secured promissory note to United Development Funding X, L.P., a Delaware limited partnership and wholly-owned subsidiary
of our general partner (“UDF X”), in the principal amount of approximately $70 million (the “UDF X Note”),
and in connection therewith, as required by our Partnership Agreement and the NASAA Mortgage Program Guidelines, we obtained an
opinion from Jackson Claborn, Inc., an independent advisor, stating that the UDF X Note is fair and at least as reasonable to us
as a transaction with an unaffiliated party in similar circumstances. Our general partner serves as the asset manager for UDF I.
In August 2008, we amended the UDF X Note to reduce the commitment amount to $25 million. In determining whether to modify this
loan, we evaluated the economic conditions, the estimated value and performance of the underlying collateral, the guarantor, adverse
situations that may affect the borrower’s ability to pay or the value of the collateral and other relevant factors. The UDF
X Note, which bears an interest rate of 15% per annum, is collateralized by a pledge of 100% of the ownership interests in UDF
X and is payable on November 11, 2013, as amended. In connection with the UDF X Note, UDF X agreed to pay us commitment fees equal
to 3% of each advance on the note, or approximately $751,000. For the three months ended June 30, 2012 and 2011, approximately
$41,000 in commitment fee income is included in mortgage and transaction service revenues – related parties. For the six
months ended June 30, 2012 and 2011, approximately $82,000 in commitment fee income is included in mortgage and transaction service
revenues – related parties. For the three months ended June 30, 2012 and 2011, we recognized approximately $862,000 and $794,000,
respectively, of interest income – related parties related to the UDF X Note. For the six months ended June 30, 2012 and
2011, we recognized approximately $1.7 million and $1.6 million, respectively, of interest income – related parties related
to the UDF X Note. Approximately $23.3 million and $22.7 million is included in mortgage notes receivable – related parties
as of June 30, 2012 and December 31, 2011, respectively. Approximately $2.0 million and $288,000 is included in accrued interest
receivable – related parties as of June 30, 2012 and December 31, 2011, respectively.



26







UDF NP Loan



In December 2007, we
originated a secured promissory note to UDF Northpointe, LLC, a Texas limited liability company and wholly-owned subsidiary of
UDF I (“Northpointe LLC”), in the principal amount of approximately $6 million (the “UDF NP Loan”), and
in connection therewith, as required by our Partnership Agreement and the NASAA Mortgage Program Guidelines, we obtained an opinion
from Jackson Claborn, Inc., an independent advisor, stating that the loan is fair and at least as reasonable to us as a loan or
credit enhancement to an unaffiliated borrower in similar circumstances.  Our general partner serves as the asset manager
for UDF I. In December 2008, Northpointe LLC was purchased by an unrelated third party, who thus assumed the UDF NP Loan. In May
2009, Northpointe LLC assigned its obligations associated with the UDF NP Loan and its interests in the collateral by special warranty
deed to UDF Northpointe II, L.P. (“Northpointe II”), a subsidiary of UDF I.  Concurrent with this assignment,
Northpointe LLC entered into a contract for deed with Northpointe II whereby Northpointe LLC agreed to make payments to Northpointe
II for all debt service payments in consideration for Northpointe II transferring ownership and possession of the collateral back
to Northpointe LLC. The secured promissory note, which bears an interest rate of 12% per annum, is initially collateralized by
a second lien deed of trust on 251 finished lots and 110 acres of land in Texas and was payable on December 28, 2010. The maturity
date was extended to December 28, 2013 pursuant to a modification agreement effective as of June 30, 2011 which also increased
the UDF NP Loan to a maximum of $15 million, pursuant to a second secured promissory note in the principal amount of $9 million.
In determining whether to modify this loan, we evaluated the economic conditions, the estimated value and performance of the underlying
collateral, the guarantor, adverse situations that may affect the borrower’s ability to pay or the value of the collateral
and other relevant factors. The second secured promissory note bears the same interest rate and is secured by the same collateral
as the original promissory note. For the three months ended June 30, 2012 and 2011, we recognized approximately $366,000 and $315,000,
respectively, of interest income – related parties related to this loan. For the six months ended June 30, 2012 and 2011,
we recognized approximately $719,000 and $615,000, respectively, of interest income – related parties related to this loan.
Approximately $12.5 million and $11.6 million is included in mortgage notes receivable – related parties associated with
the UDF NP Loan as of June 30, 2012 and December 31, 2011, respectively. There was no balance in accrued interest receivable –
related parties associated with this loan as of June 30, 2012 or December 31, 2011.



UDF LOF Note



In August 2008, we
originated a secured revolving line of credit to UDF LOF in the principal amount of up to $25 million, pursuant to a Secured Line
of Credit Promissory Note (the “UDF LOF Note”).  The general partner of UDF LOF is a wholly-owned subsidiary
of our general partner, and our general partner serves as the asset manager for UDF LOF. The UDF LOF Note, which bears interest
at a base rate equal to 15% per annum, is secured by a lien of all of UDF LOF’s existing and future acquired assets. In connection
therewith, as required by our Partnership Agreement and the NASAA Mortgage Program Guidelines, we obtained an opinion from Jackson
Claborn, Inc., an independent advisor, stating that the UDF LOF Note is fair and at least as reasonable to us as a transaction
with an unaffiliated party in similar circumstances. In August 2011, we amended the UDF LOF Note to reduce the commitment amount
to $10 million and extend the maturity date from August 20, 2011 to August 20, 2013. In determining whether to modify this loan,
we evaluated the economic conditions, the estimated value and performance of the underlying collateral, the guarantor, adverse
situations that may affect the borrower’s ability to pay or the value of the collateral and other relevant factors. In January
2010, the balance of the UDF LOF Note was paid in full, although UDF LOF still has the ability to draw on the UDF LOF Note until
it matures. In connection with this note, UDF LOF agreed to pay us commitment fees equal to 3% of each advance on the note, or
approximately $587,000. We did not recognize any commitment fee income related to the UDF LOF Note for the three or six months
ended June 30, 2012. For the three and six months ended June 30, 2011, approximately $54,000 and $108,000, respectively, in commitment
fee income is included in mortgage and transaction service revenues – related parties. We did not recognize any interest
income – related parties related to the UDF LOF Note for the three or six months ended June 30, 2012 or 2011. There was no
balance in mortgage notes receivable – related parties or accrued interest receivable – related parties associated
with the UDF LOF Note as of June 30, 2012 or December 31, 2011.



BCH Note



In August 2008, we
originated a secured promissory note with Buffington Capital Homes, Ltd., a Texas limited partnership (“Buffington Capital”),
in the principal amount of $2.5 million (the “BCH Note”). Our general partner had a minority partner interest in Buffington
Capital. In connection therewith, as required by our Partnership Agreement and the NASAA Mortgage Program Guidelines, we obtained
an opinion from Jackson Claborn, Inc., an independent advisor, stating that the BCH Note is fair and at least as reasonable to
us as a transaction with an unaffiliated party in similar circumstances. The secured note, which bears interest at 14% per annum,
is secured by a first lien on finished lot inventory that is owned and controlled by Buffington Capital. Pursuant to an Agreement
and Plan of Merger dated November 30, 2009, Buffington Capital merged into Buffington Signature Homes, LLC (“Buffington Signature”),
which is ultimately owned and controlled by Buffington Homebuilding Group, LTD, a Texas limited partnership (“BHG”).
Our general partner has a minority limited partnership interest in BHG. As a result of the merger and pursuant to the Agreement
and First Amendment to Loan Agreement dated December 8, 2009, Buffington Signature succeeded to all the rights, responsibilities
and obligations of Buffington Capital under the BCH Note. In determining whether to modify this loan, we evaluated the economic
conditions, the estimated value and performance of the underlying collateral, the guarantor, adverse situations that may affect
the borrower’s ability to pay or the value of the collateral and other relevant factors. Buffington Signature’s payment
and performance of the BCH Note is guaranteed by Buffington Land, Ltd., a Texas limited partnership, and, pursuant to the Extension
Agreement and Second Amendment to Loan Agreement dated August 12, 2010, matured on August 12, 2011 with no balance outstanding
on the note. The BCH Note was repaid in full in April 2010, although Buffington Signature still had the ability to draw on the
BCH Note until it matured. We did not recognize any interest income – related parties related to the BCH Note for the three
or six months ended June 30, 2012 or 2011. There was no balance in mortgage notes receivable – related parties or accrued
interest receivable – related parties associated with the BCH Note as of June 30, 2012 or December 31, 2011.



27







BTC Note



In August 2008, we
originated a secured promissory note with Buffington Texas Classic Homes, Ltd., a Texas limited partnership (“Buffington
Classic”), in the principal amount of $2 million (the “BTC Note”). Our general partner had a minority partner
interest in Buffington Classic. In connection therewith, as required by our Partnership Agreement and the NASAA Mortgage Program
Guidelines, we obtained an opinion from Jackson Claborn, Inc., an independent advisor, stating that the BTC Note is fair and at
least as reasonable to us as a transaction with an unaffiliated party in similar circumstances. The secured note, which bears interest
at 14% per annum, is secured by a first lien on finished lot inventory that is owned and controlled by Buffington Classic. Pursuant
to an Agreement and Plan of Merger dated November 30, 2009, Buffington Capital merged into Buffington Texas Classic Homes, LLC
(“BTC LLC”), which is ultimately owned and controlled by BHG. Our general partner has a minority limited partnership
interest in BHG. As a result of the merger and pursuant to the Agreement and First Amendment to Loan Agreement dated December 8,
2009, BTC LLC succeeded to all the rights, responsibilities and obligations of Buffington Classic under the BTC Note. In determining
whether to modify this loan, we evaluated the economic conditions, the estimated value and performance of the underlying collateral,
the guarantor, adverse situations that may affect the borrower’s ability to pay or the value of the collateral and other
relevant factors. BTC LLC’s payment and performance of the BTC Note is guaranteed by Buffington Land, Ltd., a Texas limited
partnership, and, pursuant to the Extension Agreement and Third Amendment to Loan Agreement dated August 21, 2011, is payable on
August 21, 2012. We did not recognize any interest income – related parties related to the BTC Note for the three or six
months ended June 30, 2012 or 2011. There was no balance in mortgage notes receivable – related parties or accrued interest
receivable – related parties associated with the BTC Note as of June 30, 2012 or December 31, 2011.



HTC Loan



Effective December
2008, we modified a secured promissory note evidencing a loan (the “HTC Loan”) in the principal amount of approximately
$8.1 million that it had originated with UDF I in December 2006 in the principal amount of approximately $6.9 million. Our general
partner serves as the asset manager for UDF I. In connection with the origination of such promissory note, and as required by our
Partnership Agreement and the NASAA Mortgage Program Guidelines, we obtained an opinion from Jackson Claborn, Inc., an independent
advisor, stating the HTC Loan is fair and at least as reasonable to us as a transaction with an unaffiliated party in similar circumstances.
UDF I’s obligations under the HTC Loan are initially secured by a first lien deed of trust filed on 190 entitled single-family
home lots located in Thornton, Colorado. The HTC Loan bears interest at a base rate equal to 12% per annum and interest payments
are due monthly.  Effective June 30, 2011, the HTC Loan was increased to a maximum of $12.8 million, pursuant to a second
secured promissory note in the principal amount of $4.7 million. The second secured promissory note bears the same interest rate
and is secured by the same collateral as the original promissory note. The HTC Loan had an initial maturity date of December 31,
2011, but was extended to June 30, 2012 pursuant to a fourth amendment to secured promissory note effective as of June 30, 2011,
and was further extended to June 30, 2015 pursuant to a fifth amendment to secured promissory note effective as of June 30, 2012.
In determining whether to modify this loan, we evaluated the economic conditions, the estimated value and performance of the underlying
collateral, the guarantor, adverse situations that may affect the borrower’s ability to pay or the value of the collateral
and other relevant factors. For the three months ended June 30, 2012 and 2011, we recognized approximately $394,000 and $347,000,
respectively, of interest income – related parties related to the HTC Loan. For the six months ended June 30, 2012 and 2011,
we recognized approximately $776,000 and $678,000, respectively, of interest income – related parties related to the HTC
Loan. Approximately $12.0 million and $12.6 million is included in mortgage notes receivable – related parties as of June
30, 2012 and December 31, 2011, respectively, related to the HTC Loan. There was no balance in accrued interest receivable –
related parties associated with the HTC Loan as of June 30, 2012 or December 31, 2011.



28







OU Land Note



In July 2009, we originated
a secured promissory note to OU Land Acquisitions, L.P., a Texas limited partnership and wholly-owned subsidiary of UDF I (“OU
Land”), in the principal amount of approximately $2.0 million (the “OU Land Note”), and in connection therewith,
as required by our Partnership Agreement and the NASAA Mortgage Program Guidelines, we obtained an opinion from Jackson Claborn,
Inc., an independent advisor, stating that the OU Land Note is fair and at least as reasonable to us as a loan or credit enhancement
to an unaffiliated borrower in similar circumstances. Our general partner serves as the asset manager for UDF I.  The
OU Land Note, which bore an interest rate of 15% per annum, was collateralized by a first lien on 56 acres of land located
in Houston, Texas and was payable on June 14, 2010, but remained outstanding as of December 31, 2010.  In January 2011, the
OU Land Note was paid off upon a sale of the underlying collateral. We did not recognize any interest income – related parties
related to the OU Land Note for the three or six months ended June 30, 2012. We did not recognize any interest income –
related parties related to the OU Land Note for the three months ended June 30, 2011. For the six months ended June 30, 2011,
we recognized approximately $22,000 of interest income – related parties related to the OU Land Note. There was no balance
in mortgage notes receivable – related parties or accrued interest receivable – related parties associated with the
OU Land Note as of June 30, 2012 or December 31, 2011.



UDF TX One Note



In November 2010,
we assumed a secured promissory note to UDF TX One, L.P., a Texas limited partnership and wholly owned subsidiary of UDF I (“UDF
TX One”), in the principal amount of $8.0 million (the “UDF TX One Note”). Our general partner serves as the
asset manager for UDF I.  In connection with the origination of the UDF TX One Note, and as required by our Partnership
Agreement and the NASAA Mortgage Program Guidelines, we obtained an opinion from Jackson Claborn, Inc., an independent advisor,
stating that the UDF TX One Note is fair and at least as reasonable to us as a loan or credit enhancement to an unaffiliated borrower
in similar circumstances.  The UDF TX One Note, which bore an interest rate of 9.55% per annum, was collateralized by finished
lots in Douglas County, Colorado and was payable on January 31, 2011. The UDF TX One Note was paid in full in January 2011. We
did not recognize any interest income – related parties related to the UDF TX One Note for the three or six months ended
June 30, 2012. We did not recognize any interest income – related parties related to the UDF TX One Note for the three months
ended June 30, 2011. For the six months ended June 30, 2011, we recognized approximately $200 of interest income – related
parties related to the UDF TX One Note. There was no balance in mortgage notes receivable – related parties or accrued interest
receivable – related parties associated with the UDF TX One Note as of June 30, 2012 or December 31, 2011.



Ash Creek Note



In April 2011, we
originated a promissory note to UDF Ash Creek, L.P. (the “Ash Creek Note”), a Delaware limited partnership and wholly-owned
subsidiary of UDF I, in the principal amount of $50,000, and in connection therewith as required by our Partnership Agreement
and the NASAA Mortgage Program Guidelines, we obtained an opinion from Jackson Claborn, Inc., an independent advisor, stating
that the Ash Creek Note is fair and at least as reasonable to us as a loan or credit enhancement to an unaffiliated borrower in
similar circumstances. Our general partner serves as the asset manager for UDF I. The Ash Creek Note, which bears interest at
a base rate equal to 15% per annum, was originally payable on December 5, 2011. Effective December 5, 2011, we entered into an
extension agreement with the borrower pursuant to which the maturity date of the Ash Creek Note was extended to December 21, 2012.
The Ash Creek Note is secured by a second lien deed of trust. In determining whether to modify this loan, we evaluated the economic
conditions, the estimated value and performance of the underlying collateral, the guarantor, adverse situations that may affect
the borrower’s ability to pay or the value of the collateral and other relevant factors. For the three months ended June
30, 2012 and 2011, we recognized approximately $2,000 and $1,800, respectively, of interest income – related parties related
to the Ash Creek Note. For the six months ended June 30, 2012 and 2011, we recognized approximately $4,000 and $1,800, respectively,
of interest income – related parties related to the Ash Creek Note. Approximately $58,000 and $50,000 is included in mortgage
notes receivable – related parties as of June 30, 2012 and December 31, 2011, respectively, related to the Ash Creek Note.
Approximately $1,500 and $5,600 is included in accrued interest receivable – related parties associated with the Ash
Creek Note as of June 30, 2012 and December 31, 2011, respectively.



29







Participation Interest – Related Party



In September 2008,
we entered into an Economic Interest Participation Agreement with UMT pursuant to which we purchased (i) an economic interest
in the UMT Loan and (ii) a purchase option to acquire a full ownership participation interest in the UMT Loan (the “Option”).  Our
general partner serves as the asset manager for UDF I. An affiliate of our general partner serves as the advisor to UMT. In connection
therewith, as required by our Partnership Agreement and the NASAA Mortgage Program Guidelines, we obtained an opinion from
Jackson Claborn, Inc., an independent advisor, stating that the Economic Interest Participation Agreement is fair and at least
as reasonable to us as a transaction with an unaffiliated party in similar circumstances. As of December 31, 2010, the UMT Loan
was a $60 million revolving line of credit facility evidenced by a Third Amended and Restated Secured Line of Credit Promissory
Note dated as of August 17, 2009, as extended to December 31, 2010 by an amendment effective December 31, 2009.  Effective
December 31, 2010, the UMT Loan was subsequently increased to $75 million and the maturity date was extended to December 31, 2011
as evidenced by a Second Amendment to Third Amended and Restated Secured Line of Credit Promissory Note dated as of December 31,
2010. Effective December 31, 2011, the UMT Loan was amended and the maturity date was extended to December 31, 2012 as evidenced
by a Third Amendment to Third Amended and Restated Secured Line of Credit Promissory Note dated as of December 31, 2011 (as amended,
the “UMT Note”). In determining whether to modify this loan, we evaluated the economic conditions, the estimated value
and performance of the underlying collateral, the guarantor, adverse situations that may affect the borrower’s ability to
pay or the value of the collateral and other relevant factors. The UMT Loan is secured by a security interest in the assets of
UDF I including UDF I’s land development loans and equity investments pursuant to the First Amended and Restated Security
Agreement dated as of September 30, 2004, executed by UDF I in favor of UMT (the “Security Agreement”).



Pursuant to the Economic
Interest Participation Agreement, each time UDF I requests an advance of principal under the UMT Note, we will fund the required
amount to UMT for application to its funding obligation to UDF I under the UMT Loan, and our economic interest in the UMT Loan
will increase proportionately.  Our economic interest in the UMT Loan gives us the right to receive payment from UMT
of principal and accrued interest relating to amounts funded by us to UMT which are applied towards UMT’s funding obligations
to UDF I under the UMT Loan. We may abate our funding obligations under the Economic Interest Participation Agreement at any time
for a period of up to twelve months by giving UMT notice of the abatement.



The Option gives us
the right to convert our economic interest into a full ownership participation interest in the UMT Loan at any time by giving
written notice to UMT and paying an exercise price of $100.  The participation interest includes all rights incidental
to ownership of the UMT Note and the Security Agreement, including participation in the management and control of the UMT Loan.  UMT
will continue to manage and control the UMT Loan while we own an economic interest in the UMT Loan.  If we exercise
our Option and acquire a participation interest in the UMT Loan, UMT will serve as the loan administrator but both UMT and we
will participate in the control and management of the UMT Loan. The purpose of the UMT Loan is to finance UDF I’s investments
in real estate development projects.  The UMT Loan interest rate is the lower of 14% per annum or the highest rate allowed
by law.  UDF I may use the UMT Loan proceeds to finance indebtedness associated with the acquisition of any assets
and to seek income that qualifies under the Real Estate Investment Trust provisions of the Internal Revenue Code of 1986, as amended,
to the extent such indebtedness, including indebtedness financed by funds advanced under the UMT Loan and indebtedness financed
by funds advanced from any other source, including senior debt, is no less than 68% of the appraised value of all subordinate
loans and equity interests for land development and/or land acquisition owned by UDF I and 75% for first lien secured loans for
land development and/or acquisitions owned by UDF I. For the three and six months ended June 30, 2012, we recognized approximately
$2.3 million and $4.6 million, respectively, of interest income – related parties related to this Economic Interest Participation
Agreement. For the three and six months ended June 30, 2011, we recognized approximately $2.0 million and $4.0 million, respectively,
of interest income – related parties related to this Economic Interest Participation Agreement. Approximately $6.9 million
and $2.3 million is included in accrued interest receivable – related parties as of June 30, 2012 and December 31, 2011,
respectively.



The UMT Loan is subordinate
to the UDF I – Brockhoeft Loan. As of both June 30, 2012 and December 31, 2011, approximately $65.5 million related to the
Economic Interest Participation Agreement is included in participation interest – related party.



Loan Participations Sold to Related Parties



From inception through
June 30, 2012, we have entered into 9 loan participation agreements with related parties whereby a related party has purchased
a participation interest in a mortgage investment that we have originated. As of June 30, 2012, 6 of these agreements remain outstanding.



30







Our related parties
participate in these mortgage investments by funding our lending obligations up to a maximum amount for each participation. Such
participations entitle our related parties to receive payments of principal up to the amounts they have funded and interest from
our borrower on the amounts they have funded and to share in the proceeds of the collateral for the loan, including the land and
related improvements to residential property owned by the borrowers and/or the ownership interests of the borrower that secure
the original mortgage investment. The income earned by our related parties and the amounts our borrowers owe to our related parties
for principal and interest earned with respect to these participation agreements are not reflected in our financial statements.



BCH Note and BTC Note



In August 2008, we
originated the $2.5 million BCH Note and the $2.0 million BTC Note with Buffington Capital and Buffington Classic, respectively
(collectively, “Buff Homes”).



Effective March 2010,
we entered into two Participation Agreements (collectively, the “BCH and BTC Participation Agreements”) with UDF IV
pursuant to which UDF IV purchased a participation interest in the BCH Note and the BTC Note (collectively, the “Lot Inventory
Loans”). Our general partner serves as the asset manager of UDF IV. We obtained an opinion from Jackson Claborn, Inc., an
independent advisor, stating that the loan participation agreement is fair and at least as reasonable to us as a loan participation
agreement with an unaffiliated borrower in similar circumstances.  Pursuant to the BCH and BTC Participation Agreements,
UDF IV will participate in the Lot Inventory Loans by funding our lending obligations under the Lot Inventory Loans. The BCH and
BTC Participation Agreements give UDF IV the right to receive repayment of all principal and accrued interest relating to amounts
funded by them under the BCH and BTC Participation Agreements. UDF IV’s participation interest is repaid as Buff Homes repays
the Lot Inventory Loans. For each loan originated, Buff Homes is required to pay interest monthly and to repay the principal advanced
no later than 12 months following the origination of the loan. The BCH Note matured in August 2011, was paid in full and was not
renewed, and the BTC Note, as amended, matures in August 2012. In determining whether to modify this loan, we evaluated the economic
conditions, the estimated value and performance of the underlying collateral, the guarantor, adverse situations that may affect
the borrower’s ability to pay or the value of the collateral and other relevant factors.



We are required to
purchase back from UDF IV the participation interest in the Lot Inventory Loans (i) upon a foreclosure of our assets by our lenders,
(ii) upon the maturity of the Lot Inventory Loans, or (iii) at any time upon 30 days prior written notice from UDF IV. In such
event, the purchase price paid to UDF IV will be equal to the outstanding principal amount of the Lot Inventory Loans on the date
of termination, together with all accrued interest due thereon, plus any other amounts due to UDF IV under the BCH and BTC Participation
Agreements.



On April 9, 2010,
we entered into the Agent Agreement. In accordance with the Agent Agreement, we will continue to manage and control the Lot Inventory
Loans and UDF IV has appointed us as its agent to act on its behalf with respect to all aspects of the Lot Inventory Loans, provided
that, pursuant to the Agent Agreement, UDF IV retains approval rights in connection with any material decisions pertaining to
the administration and services of the loans and, with respect to any material modification to the loans and in the event that
the loans become non-performing, UDF IV shall have effective control over the remedies relating to the enforcement of the loans,
including ultimate control of the foreclosure process.



As of June 30, 2012
and December 31, 2011, we did not have an outstanding balance in mortgage notes receivable – related parties or accrued
interest receivable – related parties associated with the BCH Note or the BTC Note. As of June 30, 2012 and December 31,
2011, UDF IV had a participation interest associated with the BCH and BTC Participation Agreements of approximately $235,000 and
$246,000, respectively. The UDF IV participation interest is not included on our balance sheet.



TR II Finished Lot Note



In August 2009, we
originated a $3.4 million secured promissory note (the “TR II Finished Lot Note”) with CTMGT Travis Ranch II, LLC,
an unaffiliated Texas limited liability company. The TR II Finished Lot Note is secured by a subordinate, second lien deed of
trust recorded against finished residential lots in the Travis Ranch residential subdivision located in Kaufman County, Texas.
The TR II Finished Lot Note is guaranteed by the limited liability company owners of the borrower and by the principal of the
borrower. The interest rate under the TR II Finished Lot Note is 15%. The borrower has obtained a senior loan secured by a first
lien deed of trust on the finished lots. For so long as the senior loan is outstanding, proceeds from the sale of the residential
lots securing the TR II Finished Lot Note will be paid to the senior lender and will be applied to reduce the outstanding balance
of the senior loan. After the senior lien is paid in full, the proceeds from the sale of the residential lots securing the TR
II Finished Lot Note are required to be used to repay the TR II Finished Lot Note. The TR II Finished Lot Note is due and payable
in full on August 28, 2012.



31







Effective June 2010,
we entered into a loan participation agreement with UDF IV pursuant to which UDF IV purchased a participation interest (the “TR
II Finished Lot Participation”) in the TR II Finished Lot Note. Our general partner serves as the asset manager of UDF IV.
We obtained an opinion from Jackson Claborn, Inc., an independent advisor, stating that the loan participation agreement is
fair and at least as reasonable to us as a loan participation agreement with an unaffiliated borrower in similar circumstances. 
Pursuant to the TR II Finished Lot Participation, UDF IV is entitled to receive repayment of its participation in the outstanding
principal amount of the TR II Finished Lot Note, plus accrued interest thereon, over time as the borrower repays the loan.



As of June 30, 2012
and December 31, 2011, we did not have an outstanding balance in mortgage notes receivable or accrued interest receivable associated
with the TR II Finished Lot Note. As of June 30, 2012 and December 31, 2011, UDF IV had a participation interest associated with
the TR II Finished Lot Participation of approximately $2.9 million and $2.7 million, respectively. The UDF IV participation interest
is not included on our balance sheet.



TR Paper Lot Note



In September 2009,
we originated an $8.1 million secured promissory note (the “TR Paper Lot Note”) with CTMGT Travis Ranch, LLC, an unaffiliated
Texas limited liability company. The borrower owns paper lots in the Travis Ranch residential subdivision of Kaufman County, Texas.
A “paper” lot is a residential lot shown on a plat that has been accepted by the city or county, but which is currently
undeveloped or under development. The TR Paper Lot Note was initially secured by a pledge of the equity interests in the borrower
instead of a real property lien, effectively subordinating the TR Paper Lot Note to all real property liens. The TR Paper Lot
Note is guaranteed by the limited liability company owners of the borrower and by the principal of the borrower. The interest
rate under the TR Paper Lot Note is 15%. The borrower has obtained a senior loan secured by a first lien deed of trust on the
paper lots. For so long as the senior loan is outstanding, proceeds from the sale of the paper lots will be paid to the senior
lender and will be applied to reduce the outstanding balance of the senior loan. After the senior lien is paid in full, the proceeds
from the sale of the paper lots are required to be used to repay the TR Paper Lot Note. The TR Paper Lot Note is due and payable
in full on September 24, 2012.



Effective June 2010,
we entered into a loan participation agreement with UDF IV pursuant to which UDF IV purchased a participation interest (the “TR
Paper Lot Participation”) in the TR Paper Lot Note. Our general partner serves as the asset manager of UDF IV. We obtained
an opinion from Jackson Claborn, Inc., an independent advisor, stating that the loan participation agreement is fair
and at least as reasonable to us as a loan participation agreement with an unaffiliated borrower in similar circumstances.
Pursuant to the TR Paper Lot Participation, UDF IV is entitled to receive repayment of its participation in the outstanding principal
amount of the TR Paper Lot Note, plus its proportionate share of accrued interest thereon, over time as the borrower repays the
TR Paper Lot Note.



As of June 30, 2012
and December 31, 2011, we did not have an outstanding balance in mortgage notes receivable or accrued interest receivable associated
with the TR Paper Lot Note. As of both June 30, 2012 and December 31, 2011, UDF IV had a participation interest associated with
the TR Paper Lot Participation of approximately $9.2 million. The UDF IV participation interest is not included on our balance
sheet.



Luckey Ranch Note



In November 2008,
we purchased a $1.7 million secured promissory note (the “Luckey Ranch Note”) from San Antonio Holding Company, Ltd.,
an unaffiliated Texas limited partnership (“SAHC”). SAHC originated the loan in October 2006 with Luckey Ranch Global
Associates, an unaffiliated Texas general partnership (“Luckey Ranch”). The Luckey Ranch Note was initially secured
by a second lien on approximately 610 acres of land located in Bexar County, Texas. The interest rate on the Luckey Ranch Note
is 12% and the Luckey Ranch Note matures on September 30, 2012, in accordance with the Tenth Modification Agreement entered into
in September 2011. In determining whether to modify this loan, we evaluated the economic conditions, the estimated value and performance
of the underlying collateral, the guarantor, adverse situations that may affect the borrower’s ability to pay or the value
of the collateral and other relevant factors.



Effective May 2011,
we entered into a loan participation agreement with UDF LOF pursuant to which UDF LOF purchased a participation interest (the
“Luckey Ranch Participation”) in the Luckey Ranch Note. The general partner of UDF LOF is a wholly-owned subsidiary
of our general partner, and our general partner serves as the asset manager for UDF LOF. We obtained an opinion from Jackson Claborn,
Inc., an independent advisor, stating that the loan participation agreement is fair and at least as reasonable to us
as a loan participation agreement with an unaffiliated borrower in similar circumstances.  Pursuant to the Luckey
Ranch Participation, UDF LOF is entitled to receive repayment of its participation in the outstanding principal amount of the
Luckey Ranch Note, plus its proportionate share of accrued interest thereon, over time as the borrower repays the Luckey Ranch
Note.



32







As of June 30, 2012,
we had an outstanding balance in mortgage notes receivable and accrued interest receivable of approximately $184,000 and $36,000,
respectively, associated with the Luckey Ranch Note. As of December 31, 2011, we had an outstanding balance in mortgage notes
receivable and accrued interest receivable of approximately $99,000 and $13,000, respectively, associated with the Luckey Ranch
Note. As of June 30, 2012 and December 31, 2011, UDF LOF had a participation interest associated with the Luckey Ranch Participation
of approximately $739,000 and $824,000, respectively. The UDF LOF participation interest is not included on our balance sheet.
For the three and six months ended June 30, 2012, we recognized approximately $17,000 and $31,000 of interest income associated
with the Luckey Ranch Note. For the three and six months ended June 30, 2011, we recognized approximately $31,000 and $72,000
of interest income associated with the Luckey Ranch Note.



Buffington Brushy Creek Note



In May 2008, we originated
a $4.7 million secured promissory note (the “Buffington Brushy Creek Note”) with Buffington Brushy Creek, Ltd., an
unaffiliated Texas limited liability company, and Buff Star Ventures, Ltd., an unaffiliated Texas limited liability company, as
co-borrowers (collectively, “Buff Star”). The Buffington Brushy Creek Note is secured by a pledge of ownership interests
in Buff Star. Buff Star owns partnership interests in a limited partnership that owns finished lots and entitled land in a residential
subdivision in Travis County, Texas. The interest rate under the Buffington Brushy Creek Note is 16%. Pursuant to the Second Amendment
to Secured Promissory Note entered into in May 2011, the maturity date of the Buffington Brushy Creek Note is May 19, 2013. In
determining whether to modify this loan, we evaluated the economic conditions, the estimated value and performance of the underlying
collateral, the guarantor, adverse situations that may affect the borrower’s ability to pay or the value of the collateral
and other relevant factors.



Effective May 2011,
we entered into a loan participation agreement with UDF LOF pursuant to which UDF LOF purchased a participation interest (the
“Brushy Creek Participation”) in the Buffington Brushy Creek Note. The general partner of UDF LOF is a wholly-owned
subsidiary of our general partner and our general partner serves as the asset manager for UDF LOF. We obtained an opinion from
Jackson Claborn, Inc., an independent advisor, stating that the loan participation agreement is fair and at least as
reasonable to us as a loan participation agreement with an unaffiliated borrower in similar circumstances.  Pursuant
to the Brushy Creek Participation, UDF LOF is entitled to receive repayment of its participation in the outstanding principal
amount of the Buffington Brushy Creek Note, plus its proportionate share of accrued interest thereon, over time as the borrower
repays the note. The Buffington Brushy Creek Note and Brushy Creek Participation were paid in full in May 2012.



As of June 30, 2012
and December 31, 2011, we did not have an outstanding balance in mortgage notes receivable or accrued interest receivable associated
with the Buffington Brushy Creek Note. As of December 31, 2011, UDF LOF had a participation interest associated with the Brushy
Creek Participation of approximately $619,000. The UDF LOF participation interest is not included on our balance sheet.



CTMGT Note



In December 2007,
we originated a $25 million secured promissory note (the “CTMGT Note”) with CTMGT, LLC, an unaffiliated Texas limited
liability company and its subsidiaries, who are co-borrowers of the CTMGT Note. The CTMGT Note was subsequently amended to $50
million pursuant to an amendment entered into in July 2008 and to $64.5 million pursuant to an amendment entered into in November
2011. The CTMGT Note is a co-investment loan secured by multiple investments. These investments are cross-collateralized and are
secured by collateral-sharing arrangements in second liens covering finished lots and entitled land, pledges of the ownership
interests in the borrowing entities, and guaranties. The collateral-sharing arrangements with our affiliates and our borrowers
allocate the proceeds of the co-investment collateral between us and our affiliates. Under these collateral-sharing arrangements
for the CTMGT Note, we are entitled to receive 75% of collateral proceeds. In the event of a borrower’s bankruptcy, we are
entitled to receive 100% of the collateral proceeds after payment of the senior lenders, ahead of payment to our affiliates. The
CTMGT collateral is located in multiple counties in the greater Dallas-Fort Worth area and surrounding counties. The interest
rate on the CTMGT Note is 16.25%. Pursuant to the amendment entered into in November 2011, the maturity date of the CTMGT Note
was July 1, 2012. Pursuant to a second amendment entered into in July 2012, the maturity date of the CTMGT Note was extended to
July 1, 2013. In determining whether to modify this loan, we evaluated the economic conditions, the estimated value and performance
of the underlying collateral, the guarantor, adverse situations that may affect the borrower’s ability to pay or the value
of the collateral and other relevant factors.



33







Effective July 2011,
we entered into a loan participation agreement with UDF LOF pursuant to which UDF LOF purchased a participation interest (the
“CTMGT Participation”) in the CTMGT Note. The general partner of UDF LOF is a wholly-owned subsidiary of our general
partner and our general partner serves as the asset manager for UDF LOF. We obtained an opinion from Jackson Claborn, Inc., an
independent advisor, stating that the loan participation agreement is fair and at least as reasonable to us as a loan participation
agreement with an unaffiliated borrower in similar circumstances.  Pursuant to the CTMGT Participation, UDF LOF is entitled
to receive repayment of its participation in the outstanding principal amount of the CTMGT Note, plus its proportionate share
of accrued interest thereon, over time as the borrower repays the note.



As of June 30, 2012,
we had an outstanding balance in mortgage notes receivable and accrued interest receivable of approximately $40.8 million and
$1.6 million, respectively, associated with the CTMGT Note. As of December 31, 2011, we had an outstanding balance in mortgage
notes receivable of approximately $40.7 million associated with the CTMGT Note. As of December 31, 2011, we did not have an outstanding
balance in accrued interest receivable associated with the CTMGT Note. For the three and six months ended June 30, 2012, we recognized
approximately $1.6 million and $3.3 million, respectively, of interest income associated with the CTMGT Note. For the three and
six months ended June 30, 2011, we recognized approximately $2.1 million and $4.1 million, respectively, of interest income associated
with the CTMGT Note. As of June 30, 2012 and December 31, 2011, UDF LOF had a participation interest associated with the CTMGT
Participation of approximately $16.4 million and $16.6 million, respectively. The UDF LOF participation interest is not included
on our balance sheet.



Northpointe LLC Note



In December 2008,
we originated a $4.2 million secured promissory note (the “Northpointe LLC Note”) with Northpointe LLC. The Northpointe
LLC Note is initially collateralized by a first lien deed of trust on 303 finished lots in Texas and assignments of distributions
from Northpointe LLC. The interest rate under the Northpointe LLC Note is 12%. Pursuant to the Second Loan Modification Agreement
entered into in April 2012, the Northpointe LLC Note matures on December 4, 2012. In determining whether to modify the Northpointe
LLC Note, we evaluated the economic conditions, the estimated value and performance of the underlying collateral, the guarantor,
adverse situations that may affect the borrower’s ability to pay or the value of the collateral and other relevant factors.



Effective June 2012,
we entered into a loan participation agreement with UDF IV pursuant to which UDF IV purchased a participation interest (the “Northpointe
LLC Participation”) in the Northpointe LLC Note. Our general partner serves as the asset manager of UDF IV. We obtained
an opinion from Jackson Claborn, Inc., an independent advisor, stating that the loan participation agreement is fair and at least
as reasonable to us as a loan participation agreement with an unaffiliated borrower in similar circumstances. Pursuant to the
Northpointe LLC Participation, UDF IV is entitled to receive repayment of its participation in the outstanding principal amount
of the Northpointe LLC Note, plus its proportionate share of accrued interest thereon, over time as the borrower repays the UDF
Northpointe Note.



As of June 30, 2012,
we had an outstanding balance in mortgage notes receivable and accrued interest receivable of approximately $1.2 million and $28,000,
respectively, associated with the Northpointe LLC Note. As of December 31, 2011, we had an outstanding balance in mortgage notes
receivable of approximately $3.3 million associated with the Northpointe LLC Note. As of December 31, 2011, we did not have an
outstanding balance in accrued interest receivable associated with the Northpointe LLC Note. For the three and six months ended
June 30, 2012, we recognized approximately $83,000 and $181,000, respectively, of interest income associated with the Northpointe
LLC Note. For the three and six months ended June 30, 2011, we recognized approximately $86,000 and $167,000, respectively, of
interest income associated with the Northpointe LLC Note. As of June 30, 2012, UDF IV had a participation interest associated
with the Northpointe LLC Participation of approximately $1.7 million. The UDF IV participation interest is not included on our
balance sheet.



34







Credit Enhancement Fees –
Related Parties



In February 2009,
we deposited $1.5 million into the Deposit Account with LegacyTexas for the purpose of providing collateral to LegacyTexas for
the benefit of UMTH Lending. UMTH Lending and our general partner are each owned 99.9% by UMT Holdings and 0.1% by UMT Services,
which serves as the general partner for both UMTH Lending and our general partner. We provided LegacyTexas a security interest
in the Deposit Account as further collateral for the UMTH Lending Loan obtained by UMTH Lending from LegacyTexas. In connection
therewith, as required by our Partnership Agreement and the NASAA Mortgage Program Guidelines, we obtained an opinion from Jackson
Claborn, Inc., an independent advisor, stating that this credit enhancement is fair and at least as reasonable to us as a loan
or credit enhancement to an unaffiliated borrower in similar circumstances. In November 2010, UMTH Lending refinanced the UMTH
Lending Loan with UTB. In conjunction with this refinance, we deposited $1.5 million into the UTB Deposit Account for the purpose
of providing collateral to UTB for the benefit of UMTH Lending. The UTB Deposit Account replaced the Deposit Account previously
established with LegacyTexas. We provided the UTB Deposit Account as further collateral for a loan obtained by UMTH Lending from
UTB. In consideration for providing the UMTH Lending Deposit Accounts as collateral for the UMTH Lending Loans, UMTH Lending agreed
to pay us a fee equal to 3% per annum of the amount outstanding in the UMTH Lending Deposit Accounts, paid in 12 monthly installments
for each year that the UMTH Lending Deposit Accounts secure the UMTH Lending Loans. This fee of approximately $11,000 for each
of the three months ended June 30, 2012 and 2011, and approximately $22,000 for each of the six months ended June 30, 2012 and
2011, is included in mortgage and transaction service revenues – related parties income. Approximately $30,000 and $23,000
related to these fees is included in accounts receivable – related parties as of June 30, 2012 and December 31, 2011, respectively.
The UTB Deposit Account is included as restricted cash on our balance sheet. For further discussion on the UMTH Lending Loans
and UMTH Lending Deposit Accounts, see Note I.



In August 2009, in
consideration for entering into the TCB Guaranty (as discussed in Note I), we entered into a letter agreement with UMT Home Finance
which provides for UMT Home Finance to pay us annually, in advance, an amount equal to 1% of our maximum exposure under the TCB
Guaranty (i.e., $50,000 per annum). UMT Home Finance is a wholly-owned subsidiary of UMT. An affiliate of our general partner
serves as the advisor to UMT. In connection therewith, as required by our Partnership Agreement and the NASAA Mortgage Program
Guidelines, we obtained an opinion from Jackson Claborn, Inc., an independent advisor, stating that this credit enhancement is
fair and at least as reasonable to us as a loan or credit enhancement to an unaffiliated borrower in similar circumstances. In
conjunction with this agreement, no amount is included in mortgage and transaction service revenues – related parties income
for the three and six months ended June 30, 2012 and 2011.



In April 2010, in
consideration of us entering into the UDF IV HF Guaranty (as discussed in Note I), we entered into a letter agreement with UDF
IV Home Finance which provides for UDF IV Home Finance to pay us an annual credit enhancement fee equal to 1% of the maximum loan
amount (i.e., $60,000 per annum). UDF IV Home Finance is a wholly-owned subsidiary of UDF IV. Our general partner serves
as the asset manager for UDF IV, and an affiliate of our general partner serves as the advisor for UDF IV. In connection therewith,
as required by our Partnership Agreement and the NASAA Mortgage Program Guidelines, we obtained an opinion from Jackson Claborn,
Inc., an independent advisor, stating that this credit enhancement is fair and at least as reasonable to us as a loan or credit
enhancement to an unaffiliated borrower in similar circumstances. This fee of approximately $15,000 for each of the three months
ended June 30, 2012 and 2011, and approximately $30,000 for each of the six months ended June 30, 2012 and 2011 is included in
mortgage and transaction service revenues – related parties income.



In April 2010, in
consideration of us entering into the UMT 15th Street Guaranty (as discussed in Note I), we entered into a letter agreement with
UMT 15th Street which provides for UMT 15th Street to pay us a monthly credit enhancement fee equal to one-twelfth of 1% of the
outstanding principal balance on the loan at the end of the month. UMT 15th Street is a wholly-owned subsidiary of UMT. An affiliate
of our general partner serves as the advisor to UMT. In connection therewith, as required by our Partnership Agreement and the
NASAA Mortgage Program Guidelines, we obtained an opinion from Jackson Claborn, Inc., an independent advisor, stating that this
credit enhancement is fair and at least as reasonable to us as a loan or credit enhancement to an unaffiliated borrower in similar
circumstances. This fee of approximately $3,000 and $6,000, respectively, is included in mortgage and transaction service revenues
– related parties income for the three and six months ended June 30, 2012. Approximately $3,000 and $5,000, respectively,
is included in mortgage and transaction service revenues – related parties income for the three and six months ended June
30, 2011. Approximately $1,000 and $8,000 related to these fees is included in accounts receivable – related parties as
of June 30, 2012 and December 31, 2011, respectively.



35







In June 2010, UDF
I obtained the $15 million UDF I – Brockhoeft Loan from the Lender, as agent for a group of lenders (as discussed in Note
I). As security for the UDF I – Brockhoeft Loan, we provided the Lender with a guaranty of repayment on the UDF I –
Brockhoeft Loan, which is secured by a lien on all of our existing and future assets. Our general partner serves as the asset
manager for UDF I. In connection therewith, as required by our Partnership Agreement and the NASAA Mortgage Program Guidelines,
we obtained an opinion from Jackson Claborn, Inc., an independent advisor, stating that this credit enhancement is fair and at
least as reasonable to us as a loan or credit enhancement to an unaffiliated borrower in similar circumstances. In consideration
of our secured guaranty, commencing July 31, 2010, UDF I agreed to pay us a monthly fee equal to 3% per annum of the outstanding
balance of the UDF I – Brockhoeft Loan. Effective June 21, 2012, the agreement was modified and UDF I agreed to pay us a
monthly fee equal to one-twelfth of 1% of the outstanding principal balance of the UDF I – Brockhoeft Loan. This fee of
approximately $60,000 and $168,000, respectively, is included in mortgage and transaction service revenues – related parties
income for the three and six months ended June 30, 2012. Approximately $113,000 and $225,000, respectively, is included in mortgage
and transaction service revenues – related parties income for the three and six months ended June 30, 2011. Approximately
$280,000 and $113,000 related to these fees is included in accounts receivable – related parties as of June 30, 2012 and
December 31, 2011, respectively.



In August 2010, in
consideration of us entering into the UDF IV Acquisitions Guaranty (as discussed in Note I), we entered into a letter agreement
with UDF IV Acquisitions which provides for UDF IV Acquisitions to pay us a monthly credit enhancement fee equal to one-twelfth
of 1% of the outstanding principal balance on the revolving line of credit at the end of the month. UDF IV Acquisitions is a wholly-owned
subsidiary of UDF IV. Our general partner serves as the asset manager for UDF IV, and an affiliate of our general partner serves
as the advisor for UDF IV. In connection therewith, as required by our Partnership Agreement and the NASAA Mortgage Program Guidelines,
we obtained an opinion from Jackson Claborn, Inc., an independent advisor, stating that this credit enhancement is fair and at
least as reasonable to us as a loan or credit enhancement to an unaffiliated borrower in similar circumstances. This fee of approximately
$14,000 and $28,000, respectively, is included in mortgage and transaction service revenues – related parties income for
the three and six months ended June 30, 2012. Approximately $10,000 and $19,000, respectively, is included in mortgage and transaction
service revenues – related parties income for the three and six months ended June 30, 2011. Approximately $5,000 related
to these fees is included in accounts receivable – related parties as of each of June 30, 2012 and December 31, 2011.



In December 2010,
in consideration of us entering into the UDF IV Finance II Guaranty (as discussed in Note I), we entered into a letter agreement
with UDF IV Finance II which provides for UDF IV Finance II to pay us a monthly credit enhancement fee equal to one-twelfth of
1% of the outstanding principal balance on a $7.5 million loan between UDF IV Finance II and F&M at the end of the month.
UDF IV Finance II is a wholly-owned subsidiary of UDF IV. Our general partner serves as the asset manager for UDF IV, and an affiliate
of our general partner serves as the advisor for UDF IV. In connection therewith, as required by our Partnership Agreement and
the NASAA Mortgage Program Guidelines, we obtained an opinion from an independent advisor stating that this credit enhancement
is fair and at least as reasonable to us as a loan or credit enhancement to an unaffiliated borrower in similar circumstances.
This fee of approximately $15,000 and $29,000, respectively, is included in mortgage and transaction service revenues –
related parties income for the three and six months ended June 30, 2012. Approximately $13,000 and $26,000, respectively, is included
in mortgage and transaction service revenues – related parties income for the three and six months ended June 30, 2011.
Approximately $5,000 related to these fees is included in accounts receivable – related parties as of each of June 30, 2012
and December 31, 2011.



In May 2011, in consideration
of us entering into the UMT HF III Guaranty (as discussed in Note I), we entered into a letter agreement with UMT HF III which
provides for UMT HF III to pay us a monthly credit enhancement fee equal to one-twelfth of 1% of the outstanding principal balance
on a $4.3 million loan between UMT HF III and Veritex at the end of the month. UMT HF III is a wholly-owned subsidiary of UMT.
An affiliate of our general partner serves as the advisor to UMT. In connection therewith, as required by our Partnership Agreement
and the NASAA Mortgage Program Guidelines, we obtained an opinion from Jackson Claborn, Inc., an independent advisor, stating
that this credit enhancement is fair and at least as reasonable to us as a loan or credit enhancement to an unaffiliated borrower
in similar circumstances. This fee of approximately $7,000 and $12,000, respectively, is included in mortgage and transaction
service revenues – related parties income for the three and six months ended June 30, 2012. Approximately $1,000 is included
in mortgage and transaction service revenues – related parties income for each of the three and six months ended June 30,
2011. Approximately $3,000 and $7,000 related to these fees is included in accounts receivable – related parties as of June
30, 2012 and December 31, 2011, respectively.



In August 2011, in
consideration of us entering into the UMT HF II Guaranty (as discussed in Note I), we entered into a letter agreement with UMT
HF II which provides for UMT HF II to pay us a monthly credit enhancement fee equal to one-twelfth of 1% of the outstanding principal
balance on the $250,000 loan between UMT HF II and FFB at the end of the month. UMT HF II is a wholly-owned subsidiary of UMT.
An affiliate of our general partner serves as the advisor to UMT. In connection therewith, as required by our Partnership Agreement
and the NASAA Mortgage Program Guidelines, we obtained an opinion from Jackson Claborn, Inc., an independent advisor, stating
that this credit enhancement is fair and at least as reasonable to us as a loan or credit enhancement to an unaffiliated borrower
in similar circumstances. The FFB loan was repaid in full by UMT HF II in May 2012 and thus the UMT HF II Guaranty was extinguished.
The credit enhancement fee of approximately $200 and $500, respectively, is included in mortgage and transaction service revenues
– related parties income for the three and six months ended June 30, 2012. There were no fees included in mortgage and transaction
service revenues – related parties income for the three and six months ended June 30, 2011.



36







In October 2011, in
consideration of us entering into the UMT HF II Green Bank Guaranty (as discussed in Note I), we entered into a letter agreement
with UMT HF II which provides for UMT HF II to pay us a monthly credit enhancement fee equal to one-twelfth of 1% of the outstanding
principal balance on a $5 million loan between UMT HF II and Green Bank at the end of the month. UMT HF II is a wholly-owned subsidiary
of UMT. An affiliate of our general partner serves as the advisor to UMT.  In connection therewith, as required by our
Partnership Agreement and the NASAA Mortgage Program Guidelines, we obtained an opinion from Jackson Claborn, Inc., an independent
advisor, stating that this credit enhancement is fair and at least as reasonable to us as a loan or credit enhancement to an unaffiliated
borrower in similar circumstances. This fee of approximately $200 and $500, respectively, is included in mortgage and transaction
service revenues – related parties income for the three and six months ended June 30, 2012. There were no fees included
in mortgage and transaction service revenues – related parties income for the three and six months ended June 30, 2011.



L. Concentration of Credit Risk



Financial instruments
that potentially expose the Partnership to concentrations of credit risk are primarily mortgage notes receivable, mortgage notes
receivable – related parties and participation interest – related party. The Partnership maintains deposits in financial
institutions that may at times exceed amounts covered by insurance provided by the U.S. Federal Deposit Insurance Corporation
(“FDIC”). The Partnership has not experienced any losses related to amounts in excess of FDIC limits.



At June 30, 2012 and
December 31, 2011, approximately 96% of the outstanding aggregate principal amount of mortgage notes originated by the Partnership
are secured by properties located throughout Texas, approximately 3% are secured by properties located in Colorado and approximately
1% are secured by properties located in Arizona. All of the Partnership’s mortgage investments are in the United States.



M. Subsequent Events



In
July 2012, our general partner approved and the Partnership redeemed approximately 4,748 units as a result of the deaths of limited
partnersfor $94,950 (an average repurchase price of approximately
$20.00 per unit).



Item 2. Management’s Discussion and Analysis of Financial
Condition and Results of Operations.



The following discussion
and analysis should be read in conjunction with our accompanying financial statements and the notes thereto:



Forward-Looking Statements



This section of the
quarterly report contains forward-looking statements, including discussion and analysis of us, our financial condition, amounts
of anticipated cash distributions to our limited partners in the future and other matters. These forward-looking statements are
not historical facts but are the intent, belief or current expectations of our management based on their knowledge and understanding
of our business and industry. Words such as “may,” “anticipates,” “expects,” “intends,”
“plans,” “believes,” “seeks,” “estimates,” “would,” “could,”
“should” and variations of these words and similar expressions are intended to identify forward-looking statements.
These statements are not guarantees of future performance and are subject to risks, uncertainties and other factors, some of which
are beyond our control, are difficult to predict and could cause actual results to differ materially from those expressed or forecasted
in the forward-looking statements.



37







Forward-looking
statements that were true at the time made may ultimately prove to be incorrect or false. We caution you not to place undue reliance
on forward-looking statements, which reflect our management’s view only as of the date of this Quarterly Report. We undertake
no obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events
or changes to future operating results. Factors that could cause actual results to differ materially from any forward-looking
statements made in this Form 10-Q include changes in general economic conditions, changes in real estate conditions, development
costs that may exceed estimates, development delays, increases in interest rates, residential lot take down or purchase rates
or our borrowers’ inability to sell residential lots, and the potential need to fund development costs not completed by
the initial borrower or other capital expenditures out of operating cash flows. The forward-looking statements should be read
in light of the risk factors identified in the “Risk Factors” sections of this Quarterly Report on Form 10-Q and ourAnnual Report on Form 10-K for the year ended December 31, 2011, which was filed with the Securities and Exchange Commission,
and the discussion of material trends affecting our business elsewhere in this report.



Overview



On May 15, 2006, our
Registration Statement on Form S-11, covering a public offering of our units of limited partnership interest, was declared effective
under the Securities Act of 1933, as amended. The aggregate offering price for the units under the Offering was $350 million.
At the time of effectiveness, the Registration Statement covered up to 12,500,000 units of limited partnership interest at a price
of $20.00 per unit pursuant to the Primary Offering and up to 5,000,000 units of limited partnership interest to be issued pursuant
to our DRIP for $20.00 per unit. On July 3, 2006, we accepted our initial public subscribers as limited partners. We had the right
to reallocate the units of limited partnership interest we were offering between the Primary Offering and our DRIP, and pursuant
to Supplement No. 8 to our prospectus regarding the Offering, which was filed with the Securities and Exchange Commission on September
4, 2008, we reallocated the units being offered such that 16,250,000 units were offered pursuant to the Primary Offering and 1,250,000
units were offered pursuant to the DRIP. Pursuant to Supplement No. 11 to our prospectus regarding the Offering, which was filed
with the Securities and Exchange Commission on March 6, 2009, we further reallocated the units being offered to be 16,500,000
units offered pursuant to the Primary Offering and 1,000,000 units offered pursuant to the DRIP. The aggregate offering price
for the units was $350 million. The Primary Offering was terminated on April 23, 2009. We extended the offering of our units of
limited partnership interest pursuant to our DRIP until the earlier of the sale of all units of limited partnership interest being
offered pursuant to our DRIP or May 15, 2010; provided, however, that our general partner was permitted to terminate the offering
of units pursuant to our DRIP at any earlier time.



On
June 9, 2009, we held a special meeting of our limited partners as of April 13, 2009, at which our limited partners approved three
proposals to amend certain provisions of our Partnership Agreement for the purpose of making available additional units of limited
partnership interest for sale pursuant to the Secondary DRIP. On June 12, 2009, we registered 5,000,000 additional units
to be offered pursuant to our Secondary DRIP for $20.00 per unit in a Registration Statement on Form S-3 (File No. 333-159939).
As such, we ceased offering units under the DRIP as of July 21, 2009and concurrently commenced our current offering of
units pursuant to the Secondary DRIP. The aggregate offering price for the units being offered pursuant to the Secondary DRIP
is $100,000,000. The Secondary DRIP will be available until we sell all $100,000,000 worth of units being offered; provided, however,
that our general partner may terminate the offering of units pursuant to the Secondary DRIP at any earlier time.



Our loan portfolio,
consisting of mortgage notes receivable, mortgage notes receivable – related parties and participation interest –
related party grew from approximately $343 million as of December 31, 2011 to approximately $344 million as of June 30, 2012.
With the increase in our loan portfolio, our revenues, the majority of which is from recognizing interest income associated with
our loan portfolio, also increased. Our expenses related to the portfolio also increased, including the loan loss expense, which
was approximately $140,000 and $280,000 for the three and six months ended June 30, 2012, respectively, and approximately $126,000
and $249,000 for the three and six months ended June 30, 2011, respectively. The increase in loan loss reserve expense primarily
related to increased reserves associated with growth in our loan portfolio as well as additional reserves recorded due to general
market conditions.



In September 2009,
we entered into a $15 million revolving credit facility, of which $15 million was included in notes payable as of both June 30,
2012 and December 31, 2011. The intent is to utilize the revolving credit facility as transitory indebtedness to provide liquidity
and to reduce and avoid the need for large idle cash reserves. As a result of this revolving credit facility and our desire to
avoid the need for large idle cash reserves, our cash balances were approximately $1.5 million and $2.7 million as of June 30,
2012 and December 31, 2011, respectively. Our interest expense associated with the revolving credit facility was approximately
$374,000 and $748,000 for the three and six months ended June 30, 2012, respectively, and approximately $374,000 and $744,000
for the three and six months ended June 30,2011, respectively.



38







Net income was approximately
$11.6 million and $23.3 million for the three and six months ended June 30, 2012, respectively, and $11.5 million and $22.9 million
for the three and six months ended June 30, 2011, respectively, and earnings per limited partnership unit, basic and diluted were
$0.56 and $1.13 for the three and six months ended June 30, 2012, respectively, and $0.57 and $1.14 for the three and six months
ended June 30, 2011, respectively. Our earnings per limited partnership unit, basic and diluted, are calculated based on earnings
allocated to the limited partners divided by the weighted average limited partnership units outstanding. Such earnings per limited
partnership unit, basic and diluted, have fluctuated since the Offering began with the raise of gross proceeds and the deployment
of funds available.



As of June 30, 2012,
we had originated or acquired 60 loans, including 32 loans that have been repaid in full by the respective borrower, totaling
approximately $540.9 million. Of the 28 loans outstanding as of June 30, 2012, seven of the loans totaling approximately $49.3
million and one loan totaling approximately $65.5 million are included in mortgage notes receivable – related parties and
participation interest – related party, respectively, on our balance sheet.



Approximately 96%
of the outstanding aggregate principal amount of mortgage notes originated by us as of June 30, 2012 are secured by properties
located throughout Texas, approximately 3% are secured by properties located in Colorado and approximately 1% are secured by properties
located in Arizona. Approximately 58% of the outstanding aggregate principal amount of mortgage notes originated by us as of June
30, 2012 are secured by properties located in the Dallas, Texas area; approximately 25% are secured by properties located in the
Austin, Texas area; approximately 8% are secured by properties located in the Houston, Texas area; approximately 4% are secured
by properties located in the Lubbock, Texas area; approximately 1% are secured by properties located in the San Antonio, Texas
area; approximately 3% are secured by properties located in the Denver, Colorado area; and approximately 1% are secured by properties
located in the Kingman, Arizona area.



11 of the 28 loans
outstanding as of June 30, 2012, representing approximately 14% of the aggregate principal amount of the outstanding loans, are
secured by a first lien on the respective property; 6 of the 28 loans outstanding as of June 30, 2012, representing approximately
4% of the aggregate principal amount of the outstanding loans, are secured by a second lien on the respective property; 3 of the
28 loans outstanding as of June 30, 2012, representing approximately 51% of the aggregate principal amount of the outstanding
loans, are secured by a co-investment (which are secured by multiple properties through second liens, pledges of ownership interests
and guarantees, as described below); 5 of the 28 loans outstanding as of June 30, 2012, representing approximately 5% of the aggregate
principal amount of the outstanding loans, are secured by a pledge of the ownership interest of the borrower or entity which holds
title to the property; and 3 of the 28 loans outstanding as of June 30, 2012, representing approximately 26% of the aggregate
principal amount of the outstanding loans, are secured by other types of security interests. Co-investments are mezzanine loans
that are secured by multiple projects in which an affiliate has also invested. Co-investment loans are cross-collateralized and
are secured by second liens in finished lots and entitled land, pledges of the ownership interests in the borrowing entities,
and guarantees. We enter into collateral-sharing arrangements with our affiliates and our borrowers that allocate the proceeds
of the co-investment collateral between us and our affiliates. Under these collateral-sharing arrangements, we are generally entitled
to receive 50-75% of collateral proceeds. In the event of a borrower’s bankruptcy, we are entitled to receive 100% of the
collateral proceeds after payment of the senior lenders, ahead of payment to our affiliates.



13 of the 28 loans
outstanding as of June 30, 2012, representing approximately 90% of the aggregate principal amount of the outstanding loans, are
made with respect to projects that are presently selling finished home lots to national public or regional private homebuilders,
or are made with respect to a project in which one of these homebuilders holds an option to purchase the finished home lots and
has made a forfeitable earnest money deposit. 17 of the 28 loans outstanding as of June 30, 2012, representing approximately 76%
of the aggregate principal amount of the outstanding loans, are made to developer entities which hold ownership interests in projects
other than the project funded by us. 10 of the 28 loans outstanding as of June 30, 2012, representing approximately 89% of the
aggregate principal amount of the outstanding loans, are secured by multiple single-family residential communities. 9 of the 28
loans outstanding as of June 30, 2012, representing approximately 66% of the aggregate principal amount of the outstanding loans,
are secured by a personal guarantee of the developer in addition to a lien on the real property or a pledge of the equity interests
in the entity that holds the real property.



As of June 30, 2012,
three entities and their affiliates were included in our mortgage notes receivables (including related party transactions) and
participation interest – related party that accounted for over 10% of the outstanding balance of our portfolio. These entities
include (i) CTMGT LLC, an unaffiliated Texas limited liability company, which comprises approximately 29% of the outstanding balance
of our portfolio, and certain of its affiliated entities, which comprise an additional 12% of the outstanding balance; (ii) Buffington
Land, Ltd., an unaffiliated Texas limited partnership, which comprises approximately 22% of the outstanding balance of our portfolio
with no additional loans to its affiliated entities; and (iii) UDF I, an affiliated Delaware limited partnership, which comprises
approximately 19% of the outstanding balance of our portfolio, and its affiliated entities, which comprise an additional 7% of
the outstanding balance. Our general partner is the asset manager for UDF I.



39







The average interest
rate payable with respect to the 28 loans outstanding as of June 30, 2012 is 17%, and the average term of each loan is approximately
50 months.



Critical Accounting Policies and Estimates



Management’s
discussion and analysis of financial condition and results of operations are based upon our financial statements, which have been
prepared in accordance with GAAP. GAAP consists of a set of standards issued by the FASB and other authoritative bodies in the
form of FASB Statements, Interpretations, FASB Staff Positions, Emerging Issues Task Force consensuses and American Institute
of Certified Public Accountants Statements of Position, among others. The FASB recognized the complexity of its standard-setting
process and embarked on a revised process in 2004 that culminated in the release on July 1, 2009 of the FASB ASC. The FASB ASC
does not change how the Partnership accounts for its transactions or the nature of related disclosures made. Rather, the FASB
ASC results in changes to how the Partnership references accounting standards within its reports. This change was made effective
by the FASB for periods ending on or after September 15, 2009. The Partnership has updated references to GAAP in this Quarterly
Report on Form 10-Q to reflect the guidance in the FASB ASC. The preparation of these financial statements requires our management
to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and related
disclosure of contingent assets and liabilities. On a regular basis, we evaluate these estimates, including investment impairment.
These estimates are based on management’s historical industry experience and on various other assumptions that management
believes to be reasonable under the circumstances. Actual results may differ from these estimates. We have identified our most
critical accounting policies to be the following:



Revenue Recognition



Interest income on
mortgage notes receivable, mortgage notes receivable – related parties and participation interest – related party
is recognized over the life of the loan and recorded on the accrual basis. Income recognition is suspended for loans at the date
at which, in the opinion of management, a full recovery of income and principal becomes more likely than not, but is no longer
probable, based upon our review of economic conditions, the estimated value of the underlying collateral, the guarantor, adverse
situations that may affect the borrower’s ability to pay or the value of the collateral and other relevant factors. Income
recognition is resumed when the loan becomes contractually current and performance is demonstrated to be resumed. Any payments
received on loans classified as non-accrual status are typically applied first to outstanding loan amounts and then to the recovery
of lost interest. As of both June 30, 2012 and December 31, 2011, we were suspending income recognition on two mortgage notes
receivable with an aggregate unpaid principal balance of approximately $2.2 million.



We generate mortgage
and transaction service revenues and mortgage and transaction service revenues – related parties by originating and acquiring
mortgage notes receivable and other loans. In accordance with FASB ASC 310-20, we defer recognition of income from nonrefundable
commitment fees paid by the borrowers and recognize such amount on a straight-line basis over the expected life of such notes.
In addition, credit enhancement fee income is generated by fees charged to parties for credit enhancements provided to lenders
by the Partnership on behalf of the parties. Income related to credit enhancements is earned as fees are paid, based on the terms
of the credit enhancement agreement. As of June 30, 2012, the Partnership was providing 9 credit enhancements to related parties
(see Note I to the accompanying financial statements).



The Partnership also
expenses Placement Fees paid to the general partner to provide for processing and origination costs (including, but not limited
to, legal fees and expenses, travel and communications expenses, costs of appraisals, accounting fees and expenses, and title
insurance funded by us) associated with mortgage notes receivable or participation interest held by the Partnership on a straight-line
basis. As of June 30, 2012 and December 31, 2011, approximately $3.0 million and $3.3 million, respectively, of such net deferred
fees are included in mortgage notes receivable. Approximately $749,000 and $779,000 of net deferred fees are included in mortgage
notes receivable – related parties as of June 30, 2012 and December 31, 2011, respectively. As of June 30, 2012 and December
31, 2011, approximately $568,000 and $647,000, respectively, of deferred fees are included in participation interest – related
party.



40







Determination of the Allowance for Loan Losses



The allowance for
loan losses is our estimate of incurred losses in our portfolio of mortgage notes receivable, mortgage notes receivable –
related parties and participation interest – related party. We periodically perform a detailed review of our portfolio of
mortgage notes and other loans to determine if impairment has occurred and to assess the adequacy of the allowance for loan losses.
Our review consists of evaluating economic conditions, the estimated value of the underlying collateral, the guarantor, adverse
situations that may affect the borrower’s ability to pay or the value of the collateral, and other relevant factors. This
review is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes
available.



In reviewing our portfolio,
we use cash flow estimates from the disposition of finished lots, paper lots (residential lots shown on a plat that has been accepted
by the city or county, but which is currently undeveloped or under development) and undeveloped land as well as cash flow received
from the issuance of bonds from municipal reimbursement districts. These estimates are based on current market metrics, including,
without limitation, the supply of finished lots, paper lots and undeveloped land, the supply of homes and the rate and price at
which land and homes are sold, historic levels and trends, executed purchase contracts, appraisals and discussions with third
party market analysts and participants, including homebuilders. We base our valuations on current and historic market trends on
our analysis of market events and conditions, including activity within our portfolio, as well as the analysis of third-party
services such as Metrostudy and Residential Strategies, Inc. Cash flow forecasts also are based on executed purchase contracts
which provide base prices, escalation rates, and absorption rates on an individual project basis. For projects deemed to have
an extended time horizon for disposition, we consider third-party appraisals to provide a valuation in accordance with guidelines
set forth in the Uniform Standards of Professional Appraisal Practice. In addition to cash flows from the disposition of property,
cost analysis is performed based on estimates of development and senior financing expenditures provided by developers and independent
professionals on a project-by-project basis. These amounts are reconciled with our best estimates to establish the net realizable
value of the portfolio.



We charge additions
to the allowance for loan losses to current period earnings through a provision for loan losses. Amounts determined to be uncollectible
are charged off, while amounts recovered on previously charged off accounts increase the allowance. In January 2011, we charged
off approximately $277,000 against the loan loss reserve on a loan with an unrelated party. As of June 30, 2012 and December 31,
2011, approximately $11.4 million and $11.1 million, respectively, of allowance for loan losses had been offset against mortgage
notes receivable (see Note D to the accompanying financial statements).



Mortgage Notes Receivable and Mortgage Notes Receivable
– Related Parties



Mortgage notes receivable
and mortgage notes receivable – related parties are recorded at the lower of cost or estimated net realizable value. The
mortgage investments are collateralized by land and related improvements to residential property owned by the borrowers and/or
the ownership interests of the borrower. Currently, the mortgage investments have terms ranging from five to 36 months. None of
such mortgages are insured or guaranteed by a federally owned or guaranteed mortgage agency. We originate and/or acquire all mortgage
notes receivable and intend to hold the mortgage notes receivable for the life of the notes.



Participation
Interest – Related Party



Participation interest
– related party is recorded at the lower of cost or net realizable value. Participation interest – related party represents
an Economic Interest Participation Agreement with UMT, pursuant to which we purchased (i) an economic interest in a $75 million
revolving credit facility from UMT to UDF I and (ii) a purchase option to acquire a full ownership participation interest in the
credit facility (see Note K to the accompanying financial statements).



Cash Flow Distributions



Cash available for
distributions represents the cash funds received by us from operations (other than net proceeds from a capital transaction) that
produces proceeds from (i) the repayment of principal or prepayment of a mortgage to the extent classified as a return of capital
for federal income tax purposes, (ii) the foreclosure, sale, exchange, condemnation, eminent domain taking or other disposition
of a mortgage loan or of a property subject to a mortgage, or (iii) insurance or a guarantee with respect to a mortgage, including,
without limitation, interest, points, revenue participations in property appreciation and interest or dividends from interim investments
or proceeds from borrowings, if appropriate, less all cash used to pay Partnership expenses and debt payments and amounts
set aside to create a retained earnings reserve (currently at 9.5% of our net income; the retained earnings reserve is intended
to recover some of the organization and offering expenses incurred in connection with our public offering of our units of limited
partnership interest). Our general partner receives a monthly distribution for promotional and carried interest from the cash
available for distributions, in addition to the payments made to our general partner and related parties that are described in
Note K of the accompanying notes to financial statements.



41







A “carried interest”
is an equity interest in us to participate in all distributions, other than distributions attributable to our general partner’s
promotional interest, of cash available for distribution and net proceeds from a capital transaction that are distributable under
the distribution priority for net proceeds from a capital transaction described below. If our general partner enters into commitments
to investments in mortgages in excess of 82% of the gross proceeds of the Offering, our general partner will be entitled to a
carried interest equal to (a) 1% for the first 2.5% of commitments to investments in mortgages above 82% of the gross proceeds
of the Offering (or if commitments to investments in mortgages are above 82% but no more than 84.5%, 1% multiplied by the fractional
amount of commitments to investments in mortgages above 82%), (b) 1% for the next 2% of additional commitments to investments
in mortgages above 84.5% of the gross proceeds of the Offering (or if commitments to investments in mortgages are above 84.5%
but no more than 86.5%, 1% multiplied by the fractional amount of commitments to investments in mortgages above 84.5%) and (c) 1%
for each additional 1% of additional commitments to investments in mortgages above 86.5% of the gross proceeds of the Offering
(or a fractional percentage equal to the fractional amount of any 1% of additional commitments to investments in mortgages). By
way of illustration, if 85.5% of the gross proceeds of the Offering are committed to investments in mortgages, then our general
partner would be entitled to a carried interest of 1.5% (1% for the first 2.5% of commitments to investments in mortgages above
82% of the gross proceeds of the Offering and 0.5% for the next 1% of additional commitments to investments in mortgages above
84.5% of the gross proceeds of the Offering) of any amount otherwise distributable to the limited partners after deduction of
any promotional interest payable to our general partner.



In order for proceeds
to be considered “committed” for purposes of calculation and payment of a carried interest, we must be obligated by
contract or other binding agreement to invest such proceeds in mortgages, to the exclusion of any other use for such proceeds
or no use at all.



“Investments
in mortgages” are the aggregate amount of capital contributions from investors used by us to make or invest in mortgage
loans or the amount actually paid or allocated to the purchase of mortgages, working capital reserves (but excluding working capital
reserves in excess of 3% of the aggregate capital contributions) and other cash payments such as interest and taxes but excluding
our organization and offering expenses, selling commissions, wholesaling fees, marketing support fees, due diligence fees, acquisition
and origination fees, and any other front-end fees.



Our general partner’s
“promotional interest” is our general partner’s right to receive:



| | · | prior
                                                                                                               to the return to
                                                                                                               the limited partners
                                                                                                               of all of their
                                                                                                               capital contributions
                                                                                                               plus an 8% per
                                                                                                               annum, non-compounding,
                                                                                                               cumulative return
                                                                                                               on their unreturned
                                                                                                               capital contributions,
                                                                                                               10% of all cash
                                                                                                               available for distribution;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | · | following
                                                                                                               the return to the
                                                                                                               limited partners
                                                                                                               of all of their
                                                                                                               capital contributions
                                                                                                               plus an 8% per
                                                                                                               annum, non-compounding,
                                                                                                               cumulative return
                                                                                                               on their unreturned
                                                                                                               capital contributions,
                                                                                                               15% of all cash
                                                                                                               available for distribution; and
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | · | following
                                                                                                               the return to the
                                                                                                               limited partners
                                                                                                               of all of their
                                                                                                               capital contributions
                                                                                                               plus an 8% per
                                                                                                               annum, non-compounding,
                                                                                                               cumulative return
                                                                                                               on their unreturned
                                                                                                               capital contributions,
                                                                                                               15% of all net
                                                                                                               proceeds from a
                                                                                                               capital transaction.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Monthly distributions,
which commenced in September 2006, are currently paid to our limited partners at a 9.75% annualized return, assuming a purchase
price of $20.00 per unit, on a pro rata basis based on the number of days in the Partnership. Retained earnings would contain
a surplus if the cash available for distributions less the 9.5% reserve exceeded the monthly distribution to the general and limited
partners. Retained earnings would contain a deficit if cash available for distributions less the 9.5% reserve is less than the
monthly distribution to general and limited partners. It is the intent of management to monitor and distribute such surplus, if
any, on an annual basis.



42













The chart below summarizes
the approximate aggregate amount of distributions to our general partner and limited partners and the retained earnings deficit
as of June 30, 2012 and December 31, 2011:





|                          |  | As of June 30, |             |     | As of December 31, |  
|------------------------- |  | -------------- | ----------- | --- | ------------------ | -
|                          |  | 2012           |             |     | 2011               |  
|General Partner           |  | $              | 17,398,000  | (1) |                    | $
|Limited Partners          |  |                | 142,445,000 | (3) |                    |  
|Retained Earnings Reserve |  |                | 8,204,000   |     |                    |  
|Retained Earnings Deficit |  |                | (8,080,000  | )   |                    |  



| | (1) | approximately $17.4 million paid
                                                                 in cash.
| | --- | ----------------------------------------------------------------------------------------------------------



| | (2) | approximately $13.7 million paid
                                                                 in cash and $1.6 million has been declared, but not paid.
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------



| | (3) | approximately $94.3 million paid
                                                                 in cash and approximately $48.1 million reinvested in 2,405,792
                                                                 units of limited partnership pursuant to our DRIP and Secondary
                                                                 DRIP.
| | --- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (4) | approximately $81.6 million paid
                                                                 in cash and approximately $42.9 million reinvested in 2,144,754
                                                                 units of limited partnership pursuant to our DRIP and Secondary
                                                                 DRIP.
| | --- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



The chart below summarizes
the payment of related party fees and reimbursements associated with the Offering and origination and management of assets, including
the distributions to our general partner described above, and general and administrative – related parties expenses for
the six months ended June 30, 2012 and 2011. We believe that these fees and reimbursements are reasonable and customary for comparable
mortgage programs.



|                                                                                 |  | For the Six Months Ended June 30, |          
|-------------------------------------------------------------------------------- |  | --------------------------------- | ---------
|                                                                                 |  | 2012                              |          
|Payments to General Partner and Related Parties                                  |  | $                                 | 4,680,000
|Total General and Administrative Expenses to General Partner and Related Parties |  |                                   | 1,377,000



For
the six months ended June 30, 2012, we have made the following distributions to our limited partners:



|Period Ended      |  | Date Paid         |  | Distribution Amount |           
|----------------- |  | ----------------- |  | ------------------- | ----------
|December 31, 2011 |  | January 24, 2012  |  | $                   | 3,030,091 
|January 31, 2012  |  | February 24, 2012 |  |                     | 3,036,865 
|February 29, 2012 |  | March 23, 2012    |  |                     | 2,847,457 
|March 31, 2012    |  | April 24, 2012    |  |                     | 3,051,709 
|April 30, 2012    |  | May 24, 2012      |  |                     | 2,958,253 
|May 31, 2012      |  | June 22, 2012     |  |                     | 3,063,606 
|                  |  |                   |  | $                   | 17,987,981



For the six months
ended June 30, 2012, we paid distributions to our limited partners of $17,987,981 ($12,767,230 in cash and $5,220,751 in limited
partnership units pursuant to our Secondary DRIP), as compared to cash flows from operations of $17,355,993. For the six months
ended June 30, 2011, we paid distributions to our limited partners of $17,369,053 ($11,876,195 in cash and $5,492,858 in limited
partnership units pursuant to our Secondary DRIP), as compared to cash flows from operations of $18,722,261. For the period from
our inception through June 30, 2012, we paid distributions to our limited partners of approximately $142.4 million (approximately
$94.3 million in cash and approximately $48.1 million in limited partnership units pursuant to our DRIP and Secondary DRIP), as
compared to cumulative cash flows from operations of approximately $168.5 million and cumulative net income of approximately $171.4
million.



43













The distributions
paid to our limited partners during the six months ended June 30, 2012 and 2011, along with the amount of distributions reinvested
pursuant to our Secondary DRIP and the sources of our distributions were as follows:





|                                  |  | Six Months Ended June 30, |           
|--------------------------------- |  | ------------------------- | ----------
|                                  |  | 2012                      |           
|Distributions paid in cash        |  | $                         | 12,767,230
|Distributions reinvested          |  |                           | 5,220,751 
|Total distributions               |  | $                         | 17,987,981
|Source of distributions:          |  |                           |           
|Cash flows from operations        |  | $                         | 17,355,993
|Cash flows from operating reserve |  |                           | 631,988   
|Total sources                     |  | $                         | 17,987,981



Results of Operations



The three months ended June 30, 2012 as compared
to the three months ended June 30, 2011



Revenues



Interest income (including related party interest income) for
each of the three months ended June 30, 2012 and 2011 was approximately $12.8 million and $12.2 million, respectively. The increase
in interest income for the three months ended June 30, 2012 is primarily the result of our increased mortgage notes receivable
(including related party transactions) and participation interest – related party portfolios of approximately $344.3 million
as of June 30, 2012, compared to approximately $338.6 million as of June 30, 2011.



Mortgage and transaction service revenues (including related
party mortgage and transaction service revenues) for each of the three months ended June 30, 2012 and 2011 were approximately
$332,000 and $676,000, respectively. The Partnership generates mortgage and transaction service revenues by originating and acquiring
mortgage notes receivable and other loans. In accordance with FASB ASC 310-20,we
defer recognition of income from nonrefundable commitment fees and recognizesuch income on a straight-line basis over the expected life of such notes. The decrease was primarily the result of decreased
commitment fee income on mortgage notes receivable.



We expect revenues to increase commensurate with the additional
proceeds raised from the offering of units pursuant to the Secondary DRIP, our continued deployment of funds available to the
borrowers and markets in which we have experience and as markets dictate in accordance with economic factors conducive for a stable
residential market, and our reinvestment of proceeds from loans that are repaid.



Expenses



Interest expense for each of the three months ended June 30,
2012 and 2011 was approximately $374,000, respectively. Interest expense represents interest associated with the Brockhoeft Credit
Facility discussed in Note E to the accompanying financial statements. The Brockhoeft Credit Facility, which was entered into
in September 2009 during the credit crisis in which financial institutions severely reduced the number of loans made to entities
involved in residential real estate, has been used as transitory indebtedness to provide liquidity and to reduce and avoid the
need for large idle cash reserves, including usage to fund identified investments pending receipt of proceeds from the partial
or full repayment of loans. This allows us to keep funds invested in loans, instead of holding such loan repayment proceeds idle
until new investments are identified. The Brockhoeft Credit Facility has been used as a portfolio administration tool and not
to provide long-term or permanent leverage on our investments. The Brockhoeft Credit Facility is secured by a first priority lien
on our existing and future assets, and carries an interest rate equal to 10% per annum.



Loan loss reserve
expense increased slightly to approximately $140,000 for the three months ended June 30, 2012 from approximately $126,000 for
three months ended June 30, 2011. The increase in loan loss reserve expense is primarily related to increased reserves associated
with growth in our loan portfolio.



44







General and administrative
expense was approximately $377,000 and $264,000 for the three months ended June 30, 2012 and 2011, respectively. The increase
in general and administrative expense was primarily the result of an increase in investor relations and printing expenses offset
by a reduction in legal expenses.



General and administrative
– related parties expense was approximately $689,000 and $671,000 for the three months ended June 30, 2012 and 2011, respectively.
The increase in general and administrative – related parties expense was primarily the result of an increase in Mortgage
Servicing Fees payable to our general partner.



We expect interest
expense, general and administrative expense and general and administrative expense – related parties to increase commensurate
with the growth of our portfolio as we continue to deploy funds available to the borrowers and markets in which we have experience
and as markets dictate in accordance with economic factors conducive for a stable residential market.



The chart below summarizes
the payment of related party fees and reimbursements associated with the Offering and origination and management of assets for
the three months ended June 30, 2012 and 2011. We believe that these fees and reimbursements are reasonable and customary for
comparable mortgage programs.



|                 |  |                                 |  | For the Three Months Ended |          
|---------------- |  | ------------------------------- |  | -------------------------- | ---------
|                 |  |                                 |  | June 30,                   |          
|Payee            |  | Purpose                         |  | 2012                       |          
|Land Development |  |                                 |  |                            |          
|                 |  | Placement Fees                  |  | $                          | 190,000  
|                 |  | Promotional Interest            |  |                            | 2,667,000
|                 |  | Carried Interest                |  |                            | 413,000  
|                 |  | Mortgage Servicing Fee          |  |                            | 711,000  
|General Services |  |                                 |  |                            |          
|                 |  | Operating Expense Reimbursement |  |                            | 1,000    
|Total Payments   |  |                                 |  | $                          | 3,982,000



The chart below summarizes
general and administrative – related parties expense for the three months ended June 30, 2012 and 2011. We believe that
these expenses are reasonable and customary for comparable mortgage programs.



|                                                           |  | For the Three Months Ended |        
|---------------------------------------------------------- |  | -------------------------- | -------
|                                                           |  | June 30,                   |        
|General and administrative expense – related parties       |  | 2012                       |        
|                                                           |  |                            |        
|Amortization of Placement Fees                             |  | $                          | 306,000
|Mortgage Servicing Fee                                     |  |                            | 239,000
|Amortization of debt financing fees                        |  |                            | 6,000  
|Operating Expense Reimbursement                            |  |                            | 138,000
|Total general and administrative expense – related parties |  | $                          | 689,000



The six months ended June 30, 2012 as compared
to the six months ended June 30, 2011



Revenues



Interest income (including related party interest income) for
each of the six months ended June 30, 2012 and 2011 was approximately $25.6 million and $24.4 million, respectively. The increase
in interest income for the six months ended June 30, 2012 is primarily the result of our increased mortgage notes receivable (including
related party transactions) and participation interest – related party portfolios of approximately $344.3 million as of
June 30, 2012, compared to approximately $338.6 million as of June 30, 2011.



Mortgage and transaction service revenues (including related
party mortgage and transaction service revenues) for each of the six months ended June 30, 2012 and 2011 were approximately $631,000
and $1.3 million, respectively. The Partnership generates mortgage and transaction service revenues by originating and acquiring
mortgage notes receivable and other loans. In accordance with FASB ASC 310-20,we
defer recognition of income from nonrefundable commitment fees and recognizesuch income on a straight-line basis over the expected life of such notes. The decrease was primarily the result of decreased
commitment fee income on mortgage notes receivable.



45







We expect revenues to increase commensurate with the additional
proceeds raised from the offering of units pursuant to the Secondary DRIP, our continued deployment of funds available to the
borrowers and markets in which we have experience and as markets dictate in accordance with economic factors conducive for a stable
residential market, and our reinvestment of proceeds from loans that are repaid.



Expenses



Interest expense for each of the six months ended June 30,
2012 and 2011 was approximately $748,000 and $744,000, respectively. Interest expense represents interest associated with the
Brockhoeft Credit Facility discussed in Note E to the accompanying financial statements. The Brockhoeft Credit Facility, which
was entered into in September 2009 during the credit crisis in which financial institutions severely reduced the number of loans
made to entities involved in residential real estate, has been used as transitory indebtedness to provide liquidity and to reduce
and avoid the need for large idle cash reserves, including usage to fund identified investments pending receipt of proceeds from
the partial or full repayment of loans. This allows us to keep funds invested in loans, instead of holding such loan repayment
proceeds idle until new investments are identified. The Brockhoeft Credit Facility has been used as a portfolio administration
tool and not to provide long-term or permanent leverage on our investments. The Brockhoeft Credit Facility is secured by a first
priority lien on our existing and future assets, and carries an interest rate equal to 10% per annum.



Loan loss reserve
expense increased slightly to approximately $280,000 for the six months ended June 30, 2012 from approximately $249,000 for the
six months ended June 30, 2011. The increase in loan loss reserve expense is primarily related to increased reserves associated
with growth in our loan portfolio.



General and administrative
expense was approximately $562,000 and $468,000 for the six months ended June 30, 2012 and 2011, respectively. The increase in
general and administrative expense was primarily the result of an increase in investor relations, postage and printing expenses
offset by a reduction in legal expenses.



General and administrative
– related parties expense was approximately $1.4 million and $1.3 million for the six months ended June 30, 2012 and 2011,
respectively. The increase in general and administrative – related parties expense was primarily the result of an increase
in Mortgage Servicing Fees payable to our general partner.



We expect interest
expense, general and administrative expense and general and administrative expense – related parties to increase commensurate
with the growth of our portfolio as we continue to deploy funds available to the borrowers and markets in which we have experience
and as markets dictate in accordance with economic factors conducive for a stable residential market.



The chart below summarizes
the payment of related party fees and reimbursements associated with the Offering and origination and management of assets for
the six months ended June 30, 2012 and 2011. We believe that these fees and reimbursements are reasonable and customary for comparable
mortgage programs.



|                 |  |                                 |  | For the Six Months Ended |          
|---------------- |  | ------------------------------- |  | ------------------------ | ---------
|                 |  |                                 |  | June 30,                 |          
|Payee            |  | Purpose                         |  | 2012                     |          
|Land Development |  |                                 |  |                          |          
|                 |  | Placement Fees                  |  | $                        | 272,000  
|                 |  | Promotional Interest            |  |                          | 3,146,000
|                 |  | Carried Interest                |  |                          | 462,000  
|                 |  | Mortgage Servicing Fee          |  |                          | 799,000  
|General Services |  |                                 |  |                          |          
|                 |  | Operating Expense Reimbursement |  |                          | 1,000    
|Total Payments   |  |                                 |  | $                        | 4,680,000



The chart below summarizes
general and administrative – related parties expense for the six months ended June 30, 2012 and 2011. We believe that these
expenses are reasonable and customary for comparable mortgage programs.



46







|                                                           |  | For the Six Months Ended |          
|---------------------------------------------------------- |  | ------------------------ | ---------
|                                                           |  | June 30,                 |          
|General and administrative expense – related parties       |  | 2012                     |          
|                                                           |  |                          |          
|Amortization of Placement Fees                             |  | $                        | 611,000  
|Mortgage Servicing Fee                                     |  |                          | 479,000  
|Amortization of debt financing fees                        |  |                          | 11,000   
|Operating Expense Reimbursement                            |  |                          | 276,000  
|Total general and administrative expense – related parties |  | $                        | 1,377,000



Cash Flow Analysis



Cash flows provided
by operating activities for the six months ended June 30, 2012 and 2011 were approximately $17.4 million and $18.7 million, respectively,
and were comprised primarily of net income offset by accrued interest receivable, accrued interest receivable – related
parties, and accrued liabilities – related parties.



Cash flows used in
investing activities for the six months ended June 30, 2012 and 2011 were approximately $2.0 million and $5.6 million, respectively,
resulting primarily from origination of mortgage notes receivable (including related party) and participation interest –
related party, offset by receipts from mortgage notes receivable (including related party) and participation interest –
related party.



Cash flows used in
financing activities for the six months ended June 30, 2012 and 2011 were approximately $16.6 million and $13.3 million, respectively,
and were primarily the result of distributions to partners.



Our cash and cash
equivalents were approximately $1.5 million and $647,000 as of June 30, 2012 and 2011, respectively.



Liquidity and Capital Resources



Our liquidity requirements
will be affected by (1) outstanding loan funding obligations, (2) our administrative expenses, (3) debt service on senior indebtedness
required to preserve our collateral position, and (4) utilization of the Brockhoeft Credit Facility. We expect that our liquidity
will be provided by (1) loan interest, transaction fees and credit enhancement fee payments, (2) loan principal payments, (3)
sale of loan pools through securitization and direct sale of loans, (4) proceeds from our Secondary DRIP, and (5) credit lines
available to us.



In most cases, loan
interest payments will be funded by an interest reserve. Interest reserve accounts are funded as loan proceeds and are intended
to provide cash for monthly interest payments until such time that revenue from the sale of land or developed lots is sufficient
to meet the debt service obligations. In the event that interest reserves are exhausted prior to realization of sufficient cash
from land or lot sales, a loan default may occur. If the loan agreement does not include interest reserve provisions, interest
payments are due and payable monthly. Payment defaults and decreasing land and lot sales may result in less liquidity and affect
our ability to meet our obligations and make distributions. Limited credit facilities may impact our ability to meet our obligations
or expand our loan portfolio when other sources of cash are not sufficient.



Increased liquidity
needs could result in the liquidation of loans to raise cash, thereby reducing the number and amount of loans outstanding and
the resultant earnings realized. We have secured the Brockhoeft Credit Facility that is utilized as transitory indebtedness to
provide liquidity and to reduce the need for large idle cash reserves.



We expect our liquidity
and capital resources to increase commensurate with the additional proceeds raised from the offering of units pursuant to the
Secondary DRIP. We will continue to deploy funds available to the borrowers and markets in which we have experience and as markets
dictate in accordance with economic factors conducive for a stable residential market.



We will experience
a relative decrease in liquidity as available funds are expended in connection with the funding and acquisition of mortgage loans
and as amounts that may be drawn under the Brockhoeft Credit Facility are repaid.



We believe that the
resources stated above will be sufficient to satisfy our operating requirements for the foreseeable future, and we do not anticipate
a need to raise funds from other than the sources described above within the next 12 months.



47







Material Trends
Affecting Our Business



We believe that the
housing market has reached a bottom and continues to recover. This recovery will continue to be regional in its early stages,
led by those housing markets with balanced supply, affordable and stable home prices, lower levels of foreclosures, strong economies,
and strong demand fundamentals. Nationally, we expect the housing recovery will continue to slowly strengthen as excess inventories
of new and existing homes get absorbed and household balance sheets are restored in each market. The Federal Reserve has indicated
that it intends to keep reserve interest rates at historic lows through the end of 2014. This easing policy coupled with extensive
price correction over the past several years has restored housing affordability across the country. We believe that continued
strengthening of the recovery depends on the continued recovery of consumer health and confidence. The national consumer confidence
index, which fell to record lows during the economic downturn, has recovered somewhat, but remains closer to levels historically
associated with recession than to normalized conditions. We believe consumers continue to remain cautious due to uncertainty present
in many economic sectors, particularly with regards to the European debt crisis and the anticipated federal fiscal tightening
scheduled for January 2013, and we expect the markets that participated most heavily in the housing bubble will continue to lag
the overall recovery, as consumers in those markets have generally suffered greater losses of household wealth from the declines
in home prices and equity and continue to experience higher levels of unemployment relative to the nation as a whole.



Unemployment remains
elevated and access to conventional real estate and commercial financing remains challenging in many parts of the country. These
factors continue to pose obstacles to a robust recovery on a national scale, which, we believe, is contingent upon the reengagement
of the consumer and the return of final demand. However, as inventory levels continue to decline and housing prices stabilize,
we expect the recovery to gain strength. We continue to believe that the recovery will be stronger in markets such as Texas, where
consumer confidence averaged more than 22 points higher than the national index from June 2011 to June 2012; where the job growth
rate over the past 12 months was approximately 80 basis points higher than the national rate; and where approximately 15.7% of
all single-family homebuilding permits in the country were issued in 2011. Further, according to the Bureau of Labor Statistics,
nearly 20% of the total net new jobs created in the United States since the official end of the national recession were created
in Texas (from June 2009 to June 2012). Currently, 96% of our portfolio relates to property located in the state of Texas, and
we intend to invest in markets that demonstrate similarly sound economic and demand fundamentals – fundamentals that we
believe will be the drivers of the recovery – and balanced supplies of homes and finished lots. We believe the fact that
new single-family home permits, starts, and sales have all risen from their respective lows reflects a continued return of real
demand for new homes. However, we anticipate the former bubble market states – principally California, Arizona, Nevada and
Florida – will be slower to recover, as those markets have seen overbuilding and extensive price correction and are experiencing
weakened economies and continued foreclosures. These conditions have caused significant weakness among consumers in these markets,
and losses of property tax revenue, sales and use tax revenue, and budget imbalances have, in many cases, led to significant fiscal
difficulties at the state and municipal levels associated with these former bubble markets.



From a national perspective,
ongoing credit constriction, a less robust economic recovery, continued high unemployment, and housing price instability have
made potential new home purchasers and real estate lenders cautious. As a result of these factors, the national housing market
experienced a protracted decline, and the time necessary to correct the market likely means a corresponding slower recovery for
the housing industry relative to historical trends. However, improving fundamentals such as price stability, high home affordability,
and continued inventory absorption indicates to us that the recovery will continue to gain strength in the coming quarters.



Nationally, capital
constraints at the heart of the credit crisis have reduced the number of real estate lenders able or willing to finance development,
construction or the purchase of homes and have increased the number of undercapitalized or failed builders and developers. In
correlation, the number of new homes and finished lots developed has decreased and remains near historic lows, which may result
in a shortage of new homes and developed lots in select real estate markets in 2012. We believe this shortage will be most prominent
in markets that did not participate in the housing bubble, avoiding overbuilding and maintaining balanced supplies and affordable
and stable home prices. With lenders imposing stricter underwriting standards, mortgages to purchase homes have become more difficult
to obtain in some markets. To support the secondary residential mortgage market and prevent further deterioration of mortgage
lending, the Federal Reserve began an unprecedented program to purchase approximately $1.25 trillion of residential mortgage backed
securities between January 5, 2009 and March 31, 2010. This program ended on March 31, 2010, as scheduled by the Federal Reserve.
On September 21, 2011, the Federal Reserve announced that it would begin reinvesting the principal payments from its mortgage-backed
securities holdings into additional purchases of agency mortgage-backed securities to help further support conditions in mortgage
markets. Any limitations or restrictions on the availability of financing or on the liquidity provided in the secondary residential
mortgage market by Government Sponsored Enterprises such as Fannie Mae and Freddie Mac could adversely affect interest rates and
mortgage availability, which could cause the number of homebuyers to decrease, which could increase the likelihood of borrowers
defaulting on our loans and, consequently, reduce our ability to pay distributions to our limited partners.



48







Nationally, new home
sales rose slightly during the second quarter of 2012 from the pace of sales in the first quarter of 2012, though levels remain
near historical lows. National fundamentals that drive home sales continue to improve in most markets and home affordability remains
near record-highs, so we expect the pace of home sales will continue to increase over 2012. The U.S. Census Bureau reports that
the sales of new single-family residential homes in June 2012 were at a seasonally adjusted annual rate of 350,000 units. While
this number is down approximately 0.57% from the revised March 2012 figure of 352,000, it is up approximately 15.1% year-over-year
from the June 2011 estimate of 304,000.



Nationally, new single-family
home inventory continued to improve in the second quarter of 2012 as it has done consistently since the second quarter of 2007.
Through much of the downturn, homebuilders reduced their starts and focused on selling their existing new home inventory. The
number of new homes for sale fell by approximately 22,000 units from June 2011 to June 2012 and by 1,000 units in the second quarter
of 2012. We believe that, with such reductions, the new home market has been restored to equilibrium in most markets, even at
lower levels of demand; and the new home market is experiencing shortages in certain markets that did not participate in the housing
bubble. The seasonally adjusted estimate of new homes for sale at the end of June 2012 was 144,000 — a generally short supply
of 4.9 months at the June 2012 sales rate and the second lowest number of homes available for sale since the U.S. Census Bureau
began keeping records of this statistic in 1963, up from the record-low of 143,000 new homes for sale reported in May 2012. We
believe that what is necessary now to regain prosperity in housing markets is the return of healthy levels of demand.



According to the U.S.
Census Bureau, new single-family residential home permits and starts fell nationally from 2006 through early 2009, as a result
and in anticipation of an elevated supply of and decreased demand for new single-family residential homes in that period. Since
bottoming in early 2009, however, single-family permits and starts have improved significantly. Single-family homes authorized
by building permits in June 2012 were at a seasonally adjusted annual rate of 493,000 units. This was an increase year-over-year
of approximately 19.7% from the rate of 412,000 in June 2011, and is approximately 46.3% higher than the low of 337,000 set in
January 2009. Single-family home starts for June 2012 stood at a seasonally adjusted annual rate of 539,000 units. This pace is
up approximately 21.7% from the June 2011 estimate of 443,000 units. Further, the June 2012 pace of home starts is 52.7% higher
than the low of 353,000 set in March 2009. Such increases suggest to us that new home inventories are generally in balance and
the homebuilding industry now anticipates greater demand for new homes in coming months relative to the demand evident at the
bottom of the new homebuilding cycle.



The primary factors
affecting new home sales are home price stability, home affordability, and housing demand. Housing supply may affect both new
home prices and the demand for new homes. When the supply of new homes exceeds new home demand, new home prices may generally
be expected to decline. Also, home foreclosures cause the inventory of existing homes to increase, which may add additional downward
price pressure on home prices. Declining new home prices may result in diminished new home demand as people postpone a new home
purchase until such time as they are comfortable that stable price levels have been reached. The converse point is also true and
equally important. When new home demand exceeds new home supply, new home prices may generally be expected to increase; and rising
new home prices, particularly at or near the bottom of the housing cycle, may result in increased new home demand as people become
confident in home prices and accelerate their timing of a new home purchase. We believe this bottom has been reached and expect
the housing recovery to slowly accelerate over the coming quarters, led by those markets that did not participate in the housing
bubble and which demonstrate stronger demand fundamentals. We intend to concentrate our investments in housing markets with affordable
and stable home prices, balanced supply, lower incidences of foreclosures, and strong demand fundamentals. These demand fundamentals
are generally job growth, the relative strength of the economy and consumer confidence, household formations, and population growth
– both immigration and in-migration.



The U.S. Census Bureau
forecasts that California, Florida and Texas will account for nearly one-half of the total U.S. population growth between 2000
and 2030 and that the total population of Arizona and Nevada will double during that period. The U.S. Census Bureau projects that
between 2000 and 2030 the total populations of Arizona and Nevada will grow from approximately 5 million to more than 10.7 million
and from approximately 2 million to nearly 4.3 million, respectively; Florida’s population will grow nearly 80% between
2000 and 2030, from nearly 16 million to nearly 28.7 million; Texas’ population will increase 60% between 2000 and 2030,
from nearly 21 million to approximately 33.3 million; and California’s population will grow 37% between 2000 and 2030, from
approximately 34 million to nearly 46.5 million.



49







In 2009, the Harvard
Joint Center for Housing Studies forecasted that an average of between approximately 1.25 million and 1.48 million new households
will be formed per year over the next ten years. Likewise, The Homeownership Alliance, a joint project undertaken by the chief
economists of Fannie Mae, Freddie Mac, the Independent Community Bankers of America, the National Association of Home Builders,
and the National Association of Realtors, has projected that 1.3 million new households will be formed per year over the next
decade and approximately 1.8 million housing units per year should be started to meet such new demand, including approximately
1.3 million new single-family homes per year based on the estimation of the Homeownership Alliance that 72% of all housing units
built will be single-family residences. The U.S. Census Bureau estimates that approximately 1.14 million new households were formed
in 2011.



While housing woes
have beleaguered the national economy, Texas housing markets have held up as some of the healthiest in the country. Furthermore,
Texas is the largest homebuilding market in the country based on the U.S. Census Bureau’s measurements of housing permits
and starts. We have concentrated our initial investment portfolio in Texas as we believe Texas markets, though weakened from their
highs in 2007, have remained fairly healthy due to strong demographics, economies and job growth, balanced housing inventories,
stable home prices and high housing affordability ratios. Texas did not experience the dramatic price appreciation (and subsequent
depreciation) that states such as California, Florida, Arizona, and Nevada experienced. The following graph, created with data
from the first quarter 2012Federal Housing Finance Agency’s (“FHFA”) Purchase
Price Only Index, illustrates the rises and declines in home prices nationally, as well as in California, Florida, Arizona, and
Nevada over the past few years. Price declines have begun to moderate in those states in recent quarters, though. Further, the
graph illustrates how Texas has maintained relative home price stability throughout the downturn. The Purchase Price Only Index indicates
that Texas had a home price appreciation of 2.82% between the first quarter of 2011 and the first quarter of 2012. Texas’
home prices continue to demonstrate greater health than the national average appreciation of 0.48%, which was the first national
year-over-year home price appreciation since the fourth quarter of 2007. Further, the index also reports that over the past five
years, Texas home prices have demonstrated significantly more home price stability than the national average, as home prices in
Texas appreciated 2.92% compared to a national depreciation of -19.37% over the same time period.







50







FHFA’s Purchase
Price Only Index tracks average house price changes in repeat sales on the same single-family properties. The Purchase Price Only
Index is based on more than 6 million repeat sales transactions and is based on data obtained from Fannie Mae and Freddie Mac
for mortgages originated over the past 37 years. FHFA analyzes the combined mortgage records of Fannie Mae and Freddie Mac, which
form the nation’s largest database of conventional, conforming mortgage transactions. The conforming loan limit for mortgages
purchased since the beginning of 2006 has been $417,000. Loan limits for mortgages originated in the latter half of 2007 through
December 31, 2008 were raised to as much as $729,750 in high-cost areas in the contiguous United States. Legislation generally
extended those limits for 2009-originated mortgages. An appropriations act (PL111-88) further extended those limits for 2010 originations
in places where the limits were higher than those that would have been calculated under pre-existing rules.



Median new home prices
in the four major Texas markets have begun to rise. According to Metrostudy, a leading provider of primary and secondary market
information, the median new home prices for the second quarter of 2012 in the metropolitan areas of Austin, Houston, Dallas-Fort
Worth, and San Antonio are $220,466, $221,672, $230,313 and $192,932, respectively.



Using the Department
of Housing and Urban Development’s estimated 2012 median family income for the respective metropolitan areas of Austin,
Houston, Dallas and San Antonio, the median income earner in those areas has 1.56 times, 1.36 times, 1.38 times, and 1.42 times
the income required to qualify for a mortgage to purchase the median priced new home in the respective metropolitan area. These
numbers illustrate the affordability of Texas homes, as each of these markets has higher affordability than the national average.
Our measurement of housing affordability, as referenced above, is determined as the ratio of median family income to the income
required to qualify for a 90 percent, 30-year fixed-rate mortgage to purchase the median-priced new home, based on the average
interest rate over the second quarter of 2012 and assuming an annual mortgage insurance premium of 80 basis points for private
mortgage insurance, plus a cost that includes estimated property taxes and insurance for the home. Using the Department of Housing
and Urban Development’s 2012 income data to project an estimated median income for the United States of $65,000 and the
June 2012 national median sales prices of new homes sold of $232,600, we conclude that the national median income earner has 1.23
times the income required to qualify for a mortgage loan to purchase the median-priced new home in the United States. This estimation
reflects the increase in home affordability in housing markets outside of Texas over the past 63 months, as new home prices in
housing markets outside of Texas generally have fallen. Recently, however, such price declines have begun to stabilize. We believe
that such price stabilization indicates that new home affordability has been restored to the national housing market.



Since the national
recession’s official end, Texas employment markets have experienced strong job growth. According to the United States Department
of Labor, Texas added approximately 231,800 jobs in the 12 months ended June 2012. Texas’ employment levels have now exceeded
pre-recession levels by more than 144,000 jobs. Furthermore, Texas added an even greater amount of jobs in the private sector
(281,800) over the past 12 months, which was the largest private sector job increase of any state over the past 12 months and
is a growth rate of 3.2%. Since the national recession’s end in June 2009, Texas has added 502,300 net new jobs, which is
nearly 20% of all net jobs added nationwide over that 36 month period. Further, Texas has added approximately 1.3 million new
jobs over the past 10 years and approximately 1.2 million in the private sector, comparing well to national employment growth
that added approximately 2.7 million total jobs over that ten-year period and 2.3 million private sector jobs in those ten years.
From June 2011 to June 2012, Austin added 25,800 jobs year-over-year. Dallas-Fort Worth added 54,200 jobs over that same time
period. Houston added 87,300 jobs over that period and San Antonio added 12,600 jobs in that time.



Texas’ unemployment
rate fell year-over-year to 7.0% in June 2012 from 8.1% in June 2011. The decrease in the state unemployment rate occurred in
spite of significant growth in Texas’ labor force. Texas has added approximately 195,295 workers to its labor force over
the past 12 months, which stands at an all-time high. The growth in Texas’ labor force stands in contrast with the national
labor force, which has risen only by approximately 288,000 workers, as of June 2012, from its peak in October 2008. The national
unemployment rate fell year-over-year from June 2011 (9.1%) to June 2012 (8.2%). In addition, all four major Texas labor markets
have unemployment rates below the national unemployment rate.



We believe that Texas
cities will continue to be among the first in the country to recover based on employment figures, consumer confidence, gross metropolitan
product, and new home demand. According to the Texas Workforce Commission, Texas tends to enter into recessions after the national
economy has entered a recession and usually leads among states in the economic recovery. The National Bureau of Economic Research
has concluded that the U.S. economy entered into a recession in December 2007, ending an economic expansion that began in November
2001. We believe, based on transitions in the Texas Leading Index as prepared monthly by the Federal Reserve Bank of Dallas, that
Texas entered into recession in late Fall 2008, trailing the national recession by nearly a year, and emerged from the recession
in the late spring of 2009. We believe the Texas economy is now leading the national economic recovery. The Texas Leading Index
combines eight measures that tend to anticipate changes in the Texas business cycle by approximately three to nine months, has
risen significantly since reaching a low of 100.5 in March 2009 and, as of May 2012, was 123.2. The Index’s six-month moving
average now stands at its highest reading since September 2008.



51







Further, we believe
Texas consumers are beginning to return to their normal consumption habits. The aggregate value of state sales tax receipts in
Texas increased 15.2% year-over-year in June 2012 from June 2011 – the 27th consecutive month in which Texas has experienced
year-over-year improvement in sales tax receipts.



The U.S. Census Bureau
reported in its 2011 Estimate of Population Change for the period from July 1, 2010 to July 1, 2011 that Texas led the country
in population growth during that period. The estimate concluded that Texas’ population grew by 421,215 people, or 2%, a
number that was 1.19 times greater than the next closest state in terms of raw population growth, California, and nearly twice
as great as the second closest state in terms of raw population growth, North Carolina. Over the last decade, July 1, 2000 to
July 1, 2010, Texas grew by nearly 4.3 million residents, averaging nearly 427,000 new residents per year. This population growth
was 1.17 times greater in terms of raw population growth than the next closest state, California, and 2.63 times greater than
the second closest state, Florida. The U.S. Census Bureau also reported that among the 100 largest counties in the country, six
of the top 20 counties for raw population growth between July 1, 2010 and July 1, 2011 were in Texas: Harris (Houston), Tarrant
(Fort Worth), Bexar (San Antonio), Collin (North Dallas), Dallas (Dallas) and Travis (Austin). In April 2011, the U.S. Census
Bureau reported that Texas’ four major metro areas – Austin, Houston, San Antonio, and Dallas-Fort Worth – were
among the top 15 in the nation for population growth from 2010 to 2011. Dallas-Fort Worth-Arlington led the nation in numerical
population growth with a combined estimated population increase of 126,037. Houston-Sugarland-Baytown was second in the nation
with a population increase of 110,068 from July 1, 2010 to July 1, 2011. Austin-Round Rock had an estimated population growth
of 55,272 and San Antonio had an estimated population growth of 41,036 over the same period. The percentage increase in population
for each of these major Texas cities ranged from 1.8% to 3.2%.



The national foreclosure
tracking service, RealtyTrac, estimates that the Texas foreclosure rate continues to be significantly healthier than the national
average. We do not expect the four major Texas housing markets to be materially adversely affected by foreclosures and anticipate
that home foreclosures will continue to be mostly concentrated in the bubble market states of California, Florida, Arizona and
Nevada. The mortgage analytic company, CoreLogic, reports that, through the first quarter of 2012, approximately 42.9% of all
homes with negative equity were located in one of those four states compared to approximately just 2.9% of all the negative equity
homes in the country that were located in the state of Texas. Homebuilding and residential construction employment will likely
remain generally weak in 2012, but we believe that Texas will continue to outperform the national standards. We believe that Texas’
housing sector is healthier, the cost of living and doing business is lower, and its economy is more dynamic and diverse than
the national average.



In contrast to the
conditions of many homebuilding markets in the country, new home sales were consistently greater than new home starts in Texas
markets over the downturn, which indicates that homebuilders in Texas were focused on preserving a balance between new home demand
and new home supply. We believe that homebuilders and developers in Texas remained disciplined on new home construction and project
development. Inventories of finished new homes and total new housing (finished vacant, under construction, and model homes) remain
at generally healthy and balanced levels in all major Texas markets: Austin, Dallas-Fort Worth, Houston, and San Antonio. Each
major Texas market experienced a rise in the number of months of finished lot inventories as homebuilders began reducing the number
of new home starts in 2008, causing each major Texas market to reach elevated levels. However, the number of finished lots available
in each market has fallen significantly even though the months’ supply remains generally elevated. Furthermore, finished
lot shortages are beginning to emerge in many desirable submarkets in the major Texas markets. Over the second quarter, homebuilders
in Houston and San Antonio have started more homes than they have sold as they address constriction in home inventory levels.
These increased start levels will likely result in greater shortages of finished lots in these markets, particularly in the most
desirable submarkets. This is a trend that we expect to continue as the lack of commercial financing for development has constrained
finished lot development over the past four years even as new home demand and sales continued. We believe that such demand and
sales will increase and these finished lot shortages will become more pronounced in coming quarters. As of June 2012, Houston
has an estimated inventory of finished lots of approximately 26.3 months, Austin has an estimated inventory of finished lots of
approximately 30.1 months, San Antonio has an estimated inventory of finished lots of approximately 28.6 months and Dallas-Fort
Worth has an estimated inventory of finished lots of approximately 44.4 months. A 24-28 month supply is considered equilibrium
for finished lot supplies.



52







As stated previously,
the elevation in months’ supply of finished lot inventory in Texas markets owes itself principally to the decrease in the
pace of annual starts rather than an increase in the raw number of developed lots, and as the homebuilders increase their pace
of home starts, we expect to see the months’ supply of lot inventory continue to improve. Indeed, the raw number of finished
lots available in each Texas market has been significantly reduced from their peaks. Since peaking in the first quarter of 2008,
Houston’s finished lot supply is down 37.1% from 73,047 to 45,963 in the second quarter of 2012. San Antonio’s finished
lot inventory has fallen 37.4% to 17,495 since peaking at 27,937 in the second quarter of 2008. Austin’s finished lot inventory
peaked in the first quarter of 2009 at 27,176, and is down 35.4% to 17,544. The finished lot inventory for Dallas-Fort Worth peaked
in the first quarter of 2008 at 91,787 lots and has fallen 39.1% to 55,919 lots. Such inventory reduction continued in the second
quarter of 2012 in all four of these markets as the number of finished lots dropped by more than 900 in Austin, more than 1,900
in Dallas-Fort Worth, more than 2,700 in Houston, and more than 1,000 in San Antonio. Annual starts in each of the Austin, San
Antonio, Houston and Dallas-Fort Worth markets are outpacing lot deliveries, and we expect to see increased finished lot sales
through 2012 as homebuilders replenish their inventory.



Texas markets continue
to be some of the strongest homebuilding markets in the country, though the pace of homebuilding in Texas slowed over the past
four years as a result of the national economic downturn and reduced availability of construction financing. According to the
Federal Deposit Insurance Corporation, banks in the Dallas region1 reduced their construction and development
loans by 3.1% from the fourth quarter of 2011 to the first quarter of 2012 – the 16th straight quarterly decline in the
region’s construction and development outstanding loan portfolio. While the decline in housing starts has caused the month
supply of vacant lot inventory to become elevated from its previously balanced position, it has also preserved a balance in housing
inventory. Annual new home sales in Austin outpaced starts 7,201 versus 7,001, with annual new home sales rising year-over-year
by approximately 9.7%. Finished housing inventory stands at a slightly elevated level of 2.9 months, while total new housing inventory
(finished vacant, under construction and model homes) rose to a slightly elevated supply of 7.2 months. The generally accepted
equilibrium levels for finished housing inventory and total new housing inventory are a 2.0-to-2.5 month supply and a 6.0-to-6.5
month supply, respectively. Annual new home starts in San Antonio outpaced sales 7,340 versus 7,060, with annual new home sales
declining year-over-year by approximately 2.8%. Finished housing inventory declined to a healthy 2.2 month supply. Total new housing
inventory rose to a 7.0 month supply. While the month supply would typically indicate a slightly elevated inventory level, we
believe that this increase in supply coupled with the incidence of new home starts exceeding new home sales indicates that homebuilders
in this market anticipate greater demand for homes in coming months. As a result, we believe this increase in supply reflects
an expanding sales pipeline rather than an imbalance of supply. Houston annual new home starts outpaced sales 20,936 versus 20,258,
with annual new home sales increasing year-over-year by approximately 11.3%. Finished housing inventory fell to a healthy 2.1
month supply while total new housing inventory rose to a 6.8 month supply, which again indicates to us that homebuilders anticipate
a strengthening housing market and growing demand for new homes. Annual new home sales in Dallas-Fort Worth outpaced starts 15,291
versus 15,124, with annual new home sales declining year-over-year by approximately 0.86%. Finished housing inventory fell to
a healthy 2.1 month supply, while total new housing inventory remains at a generally healthy 6.7 month supply. All numbers are
as released by Metrostudy, a leading provider of primary and secondary market information.



The Real Estate Center
at Texas A&M University has reported that existing housing inventory levels are healthy and, in most instances, supply is
constrained. Through June 2012, the number of months of home inventory for sale in Austin, Houston, Dallas, Fort Worth, Lubbock,
and San Antonio was 4.5 months, 5.5 months, 4.6 months, 5.2 months, 6.5 months, and 7.0 months, respectively. Like new home inventory,
a 6-month supply of inventory is considered a balanced market with more than 6 months of inventory generally being considered
a buyer’s market and less than 6 months of inventory generally being considered a seller’s market. Through June 2012,
the number of existing homes sold to date in (a) Austin was 12,223, up 19% year-over-year; (b) San Antonio was 9,680, up 6% year-over-year;
(c) Houston was 32,302, up 13% year-over-year, (d) Dallas was 24,016, up 16% year-over-year, (e) Fort Worth was 4,353, up 8% year-over-year,
and (f) Lubbock was 1,615, up 22% year-over-year.



In managing and understanding
the markets and submarkets in which we make loans, we monitor the fundamentals of supply and demand. We monitor the economic fundamentals
in each of the respective markets in which we make loans by analyzing demographics, household formation, population growth, job
growth, migration, immigration and housing affordability. We also monitor movements in home prices and the presence of market
disruption activity, such as investor or speculator activity that can create false demand and an oversupply of homes in a market.
Further, we study new home starts, new home closings, finished home inventories, finished lot inventories, existing home sales,
existing home prices, foreclosures, absorption, prices with respect to new and existing home sales, finished lots and land and
the presence of sales incentives, discounts, or both, in a market.










1 FDIC
Dallas Region is composed of Arkansas, Colorado, Louisiana, Mississippi, New Mexico, Oklahoma, Tennessee, and Texas.



53







We face a risk of
loss resulting from deterioration in the value of the land purchased by the developer with the proceeds of loans from us, a diminution
of the site improvement and similar reimbursements used to repay loans made by us, and a decrease in the sales price of the single-family
residential lots developed with the proceeds of loans from us. Deterioration in the value of the land, a diminution of the site
improvement and similar reimbursements and a decrease in the sales price of the residential lots can occur in cases where the
developer pays too much for the land to be developed, the developer is unable or unwilling to develop the land in accordance with
the assumptions required to generate sufficient income to repay the loans made by us, or is unable to sell the residential lots
to home builders at a price that allows the developer to generate sufficient income to repay the loans made by us.



Our general partner
actively monitors the markets and submarkets in which we make loans, including mortgage markets, homebuilding economies, the supply
and demand for homes, finished lots and land and housing affordability to mitigate such risks. Our general partner also actively
manages our loan portfolio in the context of events occurring with respect to the loan and in the market and submarket in which
we made the loan. We anticipate that there may be defaults on development loans made by us and that we will take action with respect
to such defaults at any such time that we determine it prudent to do so, including such time as we determine it prudent to maintain
and protect the value of the collateral securing a loan by originating another development loan to another developer with respect
to the same project to maintain and protect the value of the collateral securing our initial loan.



We face a risk of
loss resulting from adverse changes in interest rates. Changes in interest rates may affect both demand for our real estate finance
products and the rate of interest on the loans we make. In most instances, the loans we make will be junior in the right of repayment
to senior lenders, who will provide loans representing 70% to 80% of total project costs. As senior lender interest rates available
to our borrowers increase, demand for our mortgage loans may decrease, and vice versa.



Developers to whom
we make mortgage loans use the proceeds of such loans to develop raw real estate into residential home lots. The developers obtain
the money to repay these development loans by selling the residential home lots to home builders or individuals who will build
single-family residences on the lots, receiving qualifying site improvement reimbursements, and by obtaining replacement financing
from other lenders. If interest rates increase, the demand for single-family residences may decrease. Also, if mortgage financing
underwriting criteria become stricter, demand for single-family residences may decrease. In such an interest rate and/or mortgage
financing climate, developers may be unable to generate sufficient income from the resale of single-family residential lots to
repay loans from us, and developers’ costs of funds obtained from lenders in addition to us may increase as well. If credit
markets deteriorate, developers may not be able to obtain replacement financing from other lenders. Accordingly, increases in
single-family mortgage interest rates, decreases in the availability of mortgage financing, or decreases in the availability of
replacement financing could increase the number of defaults on development loans made by us.



Our general partner
is not aware of any material trends or uncertainties, favorable or unfavorable, other than national economic conditions affecting
real estate and interest rates generally, that it reasonably anticipates to have a material impact on either the income to be
derived from our investments in mortgage loans or entities that make mortgage loans, other than those referred to in this Quarterly
Report on Form 10-Q and our Annual Report on Form 10-K. The disruption of mortgage markets, in combination with a significant
amount of negative national press discussing constriction in mortgage markets and the poor condition of the national housing industry,
including declining home prices, have made potential new home purchasers and real estate lenders very cautious. The economic downturn,
the failure of highly respected financial institutions, significant volatility in equity markets around the world, unprecedented
administrative and legislative actions in the United States, and actions taken by central banks around the globe to stabilize
the economy have further caused many prospective home purchasers to postpone their purchases. In summary, we believe there is
a general lack of urgency to purchase homes in these times of economic uncertainty. We believe that this has further slowed the
sales of new homes and finished lots developed in certain markets; however, we do not anticipate the prices of those lots changing
materially. We also expect that the decrease in the availability of replacement financing may increase the number of defaults
on real estate loans made by us or extend the time period anticipated for the repayment of our loans. Our future results could
be negatively impacted by prolonged weakness in the economy, high levels of unemployment, a significant increase in mortgage interest
rates or further tightening of mortgage lending standards.



54







Off-Balance
Sheet Arrangements



From time to time,
we enter into guarantees of debtor’s borrowings and provide credit enhancements for the benefit of senior lenders in connection
with our debtors and investments in partnerships (collectively referred to as “guarantees”), and account for such
guarantees in accordance with FASB ASC 460-10, Guarantees. Guarantees generally have fixed expiration dates or other termination
clauses and may require payment of a fee by the debtor. A guarantee involves, to varying degrees, elements of credit risk in excess
of the amount recognized in the balance sheets. Our exposure to credit loss in the event of non-performance by the other party
to the instrument is represented by the contractual notional amount of the guarantee.



In August 2009, we
entered into the TCB Guaranty for the benefit of UMT Home Finance, or its permitted successors and assigns, by which we guaranteed
the repayment of up to $5 million owed to Texas Capital Bank with respect to that certain promissory note between UMT Home Finance
and Texas Capital Bank. UMT Home Finance is a wholly owned subsidiary of UMT. An affiliate of our general partner serves as the
advisor to UMT. In connection therewith, as required by our Partnership Agreement and the NASAA Mortgage Program Guidelines, we
obtained an opinion from Jackson Claborn, Inc., an independent advisor, stating that this credit enhancement is fair and at least
as reasonable to us as a loan or credit enhancement to an unaffiliated borrower in similar circumstances. In connection with the
TCB Guaranty, we entered into a letter agreement with UMT Home Finance, which provides for UMT Home Finance to pay us annually,
in advance, an amount equal to 1% of our maximum exposure under the TCB Guaranty (i.e., $50,000 per annum). In conjunction
with this agreement, no amount is included in mortgage and transaction service revenues – related parties income for the
three and six months ended June 30, 2012 and 2011.



In April 2010, we
entered into the UDF IV HF Guaranty for the benefit of CTB pursuant to which we guaranteed the repayment of up to $6 million owed
to CTB with respect to a revolving line of credit loan between UDF IV Home Finance and CTB. UDF IV Home Finance is a wholly-owned
subsidiary of UDF IV. Our general partner serves as the asset manager for UDF IV, and an affiliate of the Partnership’s
general partner serves as the advisor for UDF IV. In connection therewith, as required by our Partnership Agreement and the NASAA
Mortgage Program Guidelines, we obtained an opinion from Jackson Claborn, Inc., an independent advisor, stating that this credit
enhancement is fair and at least as reasonable to us as a loan or credit enhancement to an unaffiliated borrower in similar circumstances.
In connection with the UDF IV HF Guaranty, we entered into a letter agreement with UDF IV Home Finance which provides for UDF
IV Home Finance to pay us an annual credit enhancement fee equal to 1% of the maximum loan amount (i.e., $60,000 per annum),
to be paid in 12 equal monthly installments. This fee of approximately $15,000 for each of the three months ended June 30, 2012
and 2011 and approximately $30,000 for each of the six months ended June 30, 2012 and 2011 is included in mortgage and transaction
service revenues – related parties.



In April 2010, we
entered into the UMT 15th Street Guaranty for the benefit of CTB pursuant to which we guaranteed the repayment of up to $1.6 million
owed to CTB with respect to a loan between UMT 15th Street and CTB. UMT 15th Street is a wholly owned subsidiary of UMT. An affiliate
of our general partner serves as the advisor to UMT. In connection therewith, as required by our Partnership Agreement and the
NASAA Mortgage Program Guidelines, we obtained an opinion from Jackson Claborn, Inc., an independent advisor, stating that this
credit enhancement is fair and at least as reasonable to us as a loan or credit enhancement to an unaffiliated borrower in similar
circumstances. In connection with the UMT 15th Street Guaranty, we entered into a letter agreement with UMT 15th Street which
provides for UMT 15th Street to pay us a monthly credit enhancement fee equal to one-twelfth of 1% of the outstanding principal
balance on the loan at the end of each month. This fee of approximately $3,000 and $6,000, respectively, is included in mortgage
and transaction service revenues – related parties income for the three and six months ended June 30, 2012. Approximately
$3,000 and $5,000, respectively, is included in mortgage and transaction service revenues – related parties income for the
three and six months ended June 30, 2011. Approximately $1,000 and $8,000 related to these fees is included in accounts receivable
– related parties as of June 30, 2012 and December 31, 2011, respectively.



55







In June 2010, UDF
I obtained the $15 million UDF I – Brockhoeft Loan from the Lender, as agent for a group of lenders. As security for the
UDF I – Brockhoeft Loan, we provided the Lender with a guaranty of repayment on the UDF I – Brockhoeft Loan, which
is secured by a lien on all of our existing and future assets. Our general partner serves as the asset manager of UDF I. In connection
therewith, as required by our Partnership Agreement and the NASAA Mortgage Program Guidelines, we obtained an opinion from Jackson
Claborn, Inc., an independent advisor, stating that this credit enhancement is fair and at least as reasonable to us as a loan
or credit enhancement to an unaffiliated borrower in similar circumstances. In consideration of our secured guaranty, commencing
July 31, 2010, UDF I agreed to pay us a monthly fee equal to 3% per annum of the outstanding balance of the UDF I – Brockhoeft
Loan. Effective June 21, 2012, the agreement was modified and UDF I agreed to pay us a monthly fee equal to one-twelfth of 1%
of the outstanding principal balance of the UDF I – Brockhoeft Loan. This fee of approximately $60,000 and $168,000, respectively,
is included in mortgage and transaction service revenues – related parties income for the three and six months ended June
30, 2012. Approximately $113,000 and $225,000, respectively, is included in mortgage and transaction service revenues –
related parties income for the three and six months ended June 30, 2011. Approximately $280,000 and $113,000 related to these
fees is included in accounts receivable – related parties as of June 30, 2012 and December 31, 2011, respectively.



In August 2010, we
entered into the UDF IV Acquisitions Guaranty for the benefit of CTB pursuant to which we guaranteed the repayment of up to $8
million owed to CTB with respect to a revolving line of credit loan between UDF IV Acquisitions and CTB. UDF IV Acquisitions is
a wholly owned subsidiary of UDF IV. Our general partner serves as the asset manager for UDF IV, and an affiliate of the Partnership’s
general partner serves as the advisor for UDF IV. In connection therewith, as required by our Partnership Agreement and the NASAA
Mortgage Program Guidelines, we obtained an opinion from Jackson Claborn, Inc., an independent advisor, stating that this credit
enhancement is fair and at least as reasonable to us as a loan or credit enhancement to an unaffiliated borrower in similar circumstances.
In connection with the UDF IV Acquisitions Guaranty, we entered into a letter agreement with UDF IV Acquisitions which provides
for UDF IV Acquisitions to pay us a monthly credit enhancement fee equal to one-twelfth of 1% of the outstanding principal balance
on the revolving line of credit at the end of each month. This fee of approximately $14,000 and $28,000, respectively, is included
in mortgage and transaction service revenues – related parties income for the three and six months ended June 30, 2012.
Approximately $10,000 and $19,000, respectively, is included in mortgage and transaction service revenues – related parties
income for the three and six months ended June 30, 2011. Approximately $5,000 related to these fees is included in accounts receivable
– related parties as of each of June 30, 2012 and December 31, 2011.



In December 2010,
we entered into the UDF IV Finance II Guaranty for the benefit of F&M pursuant to which we guaranteed the repayment of up
to $7.5 million owed to F&M with respect to a loan between UDF IV Finance II and F&M. UDF IV Finance II is a wholly owned
subsidiary of UDF IV. Our general partner serves as the asset manager for UDF IV, and an affiliate of the Partnership’s
general partner serves as the advisor for UDF IV. In connection therewith, as required by our Partnership Agreement and the NASAA
Mortgage Program Guidelines, we obtained an opinion from Jackson Claborn, Inc., an independent advisor, stating that this credit
enhancement is fair and at least as reasonable to us as a loan or credit enhancement to an unaffiliated borrower in similar circumstances.
In connection with the UDF IV Finance II Guaranty, we entered into a letter agreement with UDF IV Finance II which provides for
UDF IV Finance II to pay us a monthly credit enhancement fee equal to one-twelfth of 1% of the outstanding principal balance on
the loan at the end of each month. This fee of approximately $15,000 and $29,000, respectively, is included in mortgage and transaction
service revenues – related parties income for the three and six months ended June 30, 2012. Approximately $13,000 and $26,000,
respectively, is included in mortgage and transaction service revenues – related parties income for the three and six months
ended June 30, 2011. Approximately $5,000 related to these fees is included in accounts receivable – related parties as
of each of June 30, 2012 and December 31, 2011.



In May 2011, we entered
into the UMT HF III Guaranty for the benefit of Veritex pursuant to which we guaranteed the repayment of up to $4.3 million owed
to Veritex with respect to a loan between UMT HF III and Veritex. UMT HF III is a wholly owned subsidiary of UMT. An affiliate
of the Partnership’s general partner serves as the advisor to UMT. In connection therewith, as required by our Partnership
Agreement and the NASAA Mortgage Program Guidelines, we obtained an opinion from Jackson Claborn, Inc., an independent advisor,
stating that this credit enhancement is fair and at least as reasonable to us as a loan or credit enhancement to an unaffiliated
borrower in similar circumstances. In connection with the UMT HF III Guaranty, we entered into a letter agreement with UMT HF
III which provides for UMT HF III to pay us a monthly credit enhancement fee equal to one-twelfth of 1% of the outstanding principal
balance on the loan at the end of the month. This fee of approximately $7,000 and $12,000, respectively, is included in mortgage
and transaction service revenues – related parties income for the three and six months ended June 30, 2012. Approximately
$1,000 is included in mortgage and transaction service revenues – related parties income for each of the three and six months
ended June 30, 2011. Approximately $3,000 and $7,000 related to these fees is included in accounts receivable – related
parties as of June 30, 2012 and December 31, 2011, respectively.



56







In August 2011, we
entered into the UMT HF II Guaranty for the benefit of FFB pursuant to which we guaranteed the repayment of up to $250,000 owed
to FFB with respect to a loan between UMT HF II and FFB. UMT HF II is a wholly owned subsidiary of UMT. An affiliate of our general
partner serves as the advisor to UMT. In connection therewith, as required by our Partnership Agreement and the NASAA Mortgage
Program Guidelines, we obtained an opinion from Jackson Claborn, Inc., an independent advisor, stating that this credit enhancement
is fair and at least as reasonable to us as a loan or credit enhancement to an unaffiliated borrower in similar circumstances.
In connection with the UMT HF II Guaranty, we entered into a letter agreement with UMT HF II which provides for UMT HF II to pay
us a monthly credit enhancement fee equal to one-twelfth of 1% of the outstanding principal balance on the loan at the end of
the month. The FFB loan was repaid in full by UMT HF II in May 2012 and thus the UMT HF II Guaranty was extinguished. The credit
enhancement fee of approximately $200 and $500, respectively, is included in mortgage and transaction service revenues –
related parties income for the three and six months ended June 30, 2012. There were no fees included in mortgage and transaction
service revenues – related parties income for the three and six months ended June 30, 2011.



In October 2011, we
entered into the UMT HF II Green Bank Guaranty for the benefit of Green Bank pursuant to which we guaranteed the repayment of
up to $5 million owed to Green Bank with respect to a loan between UMT HF II and Green Bank. UMT HF II is a wholly owned subsidiary
of UMT. An affiliate of our general partner serves as the advisor to UMT. In connection therewith, as required by our Partnership
Agreement and the NASAA Mortgage Program Guidelines, we obtained an opinion from Jackson Claborn, Inc., an independent advisor,
stating that this credit enhancement is fair and at least as reasonable to us as a loan or credit enhancement to an unaffiliated
borrower in similar circumstances. In connection with the UMT HF II Green Bank Guaranty, we entered into a letter agreement with
UMT HF II which provides for UMT HF II to pay us a monthly credit enhancement fee equal to one-twelfth of 1% of the outstanding
principal balance on the loan at the end of the month. This fee of approximately $200 and $500, respectively, is included in mortgage
and transaction service revenues – related parties income for the three and six months ended June 30, 2012. There were no
fees included in mortgage and transaction service revenues – related parties income for the three and six months ended June
30, 2011.



As of June 30, 2012,
we had 11 outstanding limited repayment guarantees with total credit risk to us of approximately $63.1 million, of which approximately
$42.2 million has been borrowed against by the debtor.



As of December 31,
2011, we had 14 outstanding guarantees, including: (1) 13 limited repayment guarantees with total credit risk to us of approximately
$65.4 million, of which approximately $47.8 million has been borrowed against by the debtor and (2) one letter of credit issued
on behalf of a borrower with total credit risk to us of approximately $400,000, of which no amount has been borrowed against by
the debtor.



To date, we have not
incurred losses from guarantees entered into, and the debt that is guaranteed is also collateralized by real estate. The value
of such real estate may or may not be sufficient to settle such obligations if liquidated.



Contractual Obligations



As of June 30, 2012,
we had originated 60 loans, including 32 loans that have been repaid in full by the respective borrower, totaling approximately
$540.9 million. We had approximately $35.0 million of commitments to be funded, including approximately $13.4 million of commitments
for mortgage notes receivable – related parties and $9.5 million for participation interest – related party. For the
six months ended June 30, 2012, we did not originate or purchase any loans, sold 1 loan participation, and did not acquire any
additional participation interests.



As of December 31,
2011, we had originated 60 loans, including 31 loans that have been repaid in full by the respective borrower, totaling approximately
$537.3 million. We have approximately $35.1 million of commitments to be funded, including approximately $12.3 million of commitments
for mortgage notes receivable – related parties and $9.5 million for participation interest – related party. For the
year ended December 31, 2011, we originated 2 loans, sold 3 loan participations, and did not purchase any loans or acquire any
additional participation interests.



In addition, we have
entered into a credit facility as discussed in Notes E, I and K to the accompanying financial statements, which is set to mature
in June 2014.



The Partnership has
no other outstanding debt or contingent payment obligations, other than approximately $63.1 million of certain loan guarantees
or letters of credit discussed above in “Off-Balance Sheet Arrangements,” that we may be obligated to make to or for
the benefit of third-party lenders.



57







Subsequent Events



For a discussion of
subsequent events, see Note M, Subsequent Events, to our accompanying financial statements.



Item 3. Quantitative and Qualitative Disclosures About Market
Risk.



Market risk is the
exposure to loss resulting from adverse changes in market prices, interest rates, foreign currency exchange rates, commodity prices
and equity prices. A significant market risk to which we are exposed is interest rate risk, which is sensitive to many factors,
including governmental monetary and tax policies, domestic and international economic and political considerations, and other
factors beyond our control. Changes in interest rates may impact both demand for our real estate finance products and the rate
of interest on the loans we make. Another significant market risk is the market price of finished lots. The market price of finished
lots is driven by the demand for new single-family homes and the supply of unsold homes and finished lots in a market. The change
in one or both of these factors can have a material impact on the cash realized by our borrowers and resulting collectability
of our loans and interest.



Demand for our mortgage
loans and the amount of interest we collect with respect to such loans depends on the ability of borrowers of real estate development
loans to sell single-family lots acquired with the proceeds of the loans to homebuilders.



The single-family
lot and residential homebuilding market is highly sensitive to changes in interest rate levels. As interest rates available to
borrowers increase, demand for mortgage loans decreases, and vice versa. Housing demand is also adversely affected by increases
in housing prices and unemployment and by decreases in the availability of mortgage financing. In addition, from time to time,
there are various proposals for changes in the federal income tax laws, some of which would remove or limit the deduction for
home mortgage interest. If effective mortgage interest rates increase and/or the ability or willingness of prospective buyers
to purchase new homes is adversely affected, the demand for new homes may also be negatively affected. As a consequence, demand
for and the performance of our real estate finance products may also be adversely impacted.



As of June 30, 2012
and December 31, 2011, our mortgage notes receivable of approximately $228.4 million and $224.5 million, respectively, mortgage
notes receivable – related parties of approximately $49.8 million and $52.0 million, respectively, and participation interest
– related party of approximately $66.1 million and $66.2 million, respectively, were all at fixed interest rates, and thus,
such assets are not subject to change in future earnings, fair values or cash flows.



We seek to mitigate
our single-family lot and residential homebuilding market risk by closely monitoring economic, project market, and homebuilding
fundamentals. We review a variety of data and forecast sources, including public reports of homebuilders, mortgage originators
and real estate finance companies; financial statements of developers; project appraisals; proprietary reports on primary and
secondary housing market data, including land, finished lot, and new home inventory and prices and concessions, if any; and information
provided by government agencies, the Federal Reserve Bank, the National Association of Home Builders, the National Association
of Realtors, public and private universities, corporate debt rating agencies, and institutional investment banks regarding the
homebuilding industry and the prices of and supply and demand for single-family residential homes.



In addition, we further
seek to mitigate our single-family lot and residential homebuilding market risk by assigning an asset manager to each mortgage
note. This asset manager is responsible for monitoring the progress and performance of the developer and the project as well as
assessing the status of the marketplace and value of our collateral securing repayment of our mortgage loan.



See the “Management’s
Discussion and Analysis of Financial Condition and Results of Operations” section of this Form 10-Q for further discussion
regarding our exposure to market risks.



58







Item 4. Controls and Procedures.



Evaluation
of Disclosure Controls and Procedures



We maintain disclosure
controls and procedures that are designed to ensure that information required to be disclosed in our reports under the Securities
Exchange Act of 1934, as amended (the “Exchange Act”), is recorded, processed, summarized and reported within the
time periods specified in the rules and forms, and that such information is accumulated and communicated to us, including the
chief executive officer and chief financial officer of Land Development, our general partner, as appropriate, to allow timely
decisions regarding required disclosure.



As required by Rule
13a-15(b) and Rule 15d-15(b) under the Exchange Act, the management of our general partner, including its principal executive
officer and principal financial officer, evaluated, as of June 30, 2012, the effectiveness of our disclosure controls and procedures
as defined in Exchange Act Rule 13a-15(e) and Rule 15d-15(e). Based on that evaluation, the principal executive officer and the
principal financial officer of our general partner concluded that our disclosure controls and procedures, as of June 30, 2012,
were effective for the purpose of ensuring that information required to be disclosed by us in this report is recorded, processed,
summarized and reported within the time periods specified by the rules and forms of the Exchange Act and is accumulated and communicated
to management, including the principal executive officer and the principal financial officer of our general partner, as appropriate
to allow timely decisions regarding required disclosures.



Changes in
Internal Control over Financial Reporting



There have been no
changes in our internal controls over financialreporting that occurred during the three months ended
June 30, 2012 that have materially affected, or are reasonably likely to materially affect, our internal control over financial
reporting.



59







PART II
OTHER INFORMATION

Item 1. Legal Proceedings.



We are not a party
to, and none of our assets are subject to, any material pending legal proceedings.



Item 1A. Risk Factors.



There have been no
material changes from the risk factors set forth in our Annual Report on Form 10-K for the year ended December 31, 2011, as filed
with the Securities and Exchange Commission, except as noted below.



We
will face risks relating to joint ventures with our affiliates and third parties that are not present with other methods of investing
in mortgage loans.



We may enter into
joint ventures with certain of our affiliates, as well as third parties, for the funding of loans. We may also purchase loans
in joint ventures or in partnerships or other co-ownership arrangements with our affiliates, the sellers of the loans, affiliates
of the sellers, developers or other persons. Such investments may involve risks not otherwise present with other methods of investment
in mortgages, including, for example:



| | · | the
                                                                                                              possibility that
                                                                                                              our co-venturer
                                                                                                              or partner in an
                                                                                                              investment might
                                                                                                              become bankrupt,
                                                                                                              in which case our
                                                                                                              investment might
                                                                                                              become subject to
                                                                                                              the rights of the
                                                                                                              co-venturer or partner’s
                                                                                                              creditors and we
                                                                                                              may be forced to
                                                                                                              liquidate our investment
                                                                                                              before we otherwise
                                                                                                              would choose to
                                                                                                              do so;
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | · | that
                                                                                                              such co-venturer
                                                                                                              or partner may at
                                                                                                              any time have economic
                                                                                                              or business interests
                                                                                                              or goals that are
                                                                                                              or that become inconsistent
                                                                                                              with our business
                                                                                                              interests or goals,
                                                                                                              which may cause
                                                                                                              us to disagree with
                                                                                                              our co-venturer
                                                                                                              or partner as to
                                                                                                              the best course
                                                                                                              of action with respect
                                                                                                              to the investment
                                                                                                              and which disagreements
                                                                                                              may not be resolved
                                                                                                              to our satisfaction;
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | · | that
                                                                                                              such co-venturer
                                                                                                              or partner may be
                                                                                                              in a position to
                                                                                                              take action contrary
                                                                                                              to our instructions
                                                                                                              or requests or contrary
                                                                                                              to our policies
                                                                                                              or objectives, which
                                                                                                              may cause us not
                                                                                                              to realize the return
                                                                                                              anticipated from
                                                                                                              our investment;
                                                                                                              or
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | · | that
                                                                                                              it may be difficult
                                                                                                              for us to sell our
                                                                                                              interest in any
                                                                                                              such co-venture
                                                                                                              or partnership.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Moreover, in the event
we determine to foreclose on the collateral underlying a non-performing loan, we may be required to obtain the cooperation of
our co-venturer or partner to do so. We anticipate that we will co-invest with our affiliates in certain loans, in which case
we expect to enter into an inter-creditor agreement that will define our rights and priority with respect to the underlying collateral.
Our inability to foreclose on a property acting alone may cause significant delay in the foreclosure process, in which time the
value of the property may decline.



As of June 30, 2012,
we have not entered into any joint ventures. As of June 30, 2012, we have co-invested in one loan originated by an affiliate,
UMT, with an outstanding balance of approximately $65.5 million. In addition, as of June 30, 2012, one affiliate, UDF IV, has
participated in six loans we have originated for approximately $14.0 million, and another affiliate, UDF LOF, has participated
in three loans we have originated for approximately $17.2 million.



Investments
in land development loans present additional risks compared to loans secured by operating properties.



We may invest up to
25% of the gross offering proceeds in loans to purchase unimproved land, and as of June 30, 2012, we have invested 1% of the gross
offering proceeds in such loans. For purposes of this limitation, “unimproved real property” is defined as real property
which has the following three characteristics: (a) an equity interest in real property which was not acquired for the purpose
of producing rental or other income; (b) has no development or construction in process on such land; and (c) no development or
construction on such land is planned in good faith to commence within one year. Land development mortgage loans may be riskier
than loans secured by improved properties, because:



| | · | the
                                                                                                              application of the
                                                                                                              loan proceeds to
                                                                                                              the development
                                                                                                              project must be
                                                                                                              assured;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | · | during
                                                                                                              development, the
                                                                                                              property does not
                                                                                                              generate income
                                                                                                              for the borrower
                                                                                                              to make loan payments;
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | · | the
                                                                                                              completion of the
                                                                                                              planned development
                                                                                                              may require additional
                                                                                                              development financing
                                                                                                              by the borrower
                                                                                                              and may not be available;
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



60







| | · | depending
                                                                                                              on the sale of lots
                                                                                                              to homebuilders,
                                                                                                              demand for lots
                                                                                                              may decrease, causing
                                                                                                              the price of the
                                                                                                              lots to decrease;
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | · | there
                                                                                                              is no assurance
                                                                                                              that we will be
                                                                                                              able to sell unimproved
                                                                                                              land promptly if
                                                                                                              we are forced to
                                                                                                              foreclose upon it;
                                                                                                              and
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | · | lot
                                                                                                              sale contracts are
                                                                                                              generally not “specific
                                                                                                              performance”
                                                                                                              contracts, and the
                                                                                                              developer may have
                                                                                                              no recourse if a
                                                                                                              homebuilder elects
                                                                                                              not to purchase
                                                                                                              lots.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Investments
in second, mezzanine and wraparound mortgage loans present additional risks compared to loans secured by first deeds of trust.



We expect that we
will be the junior lender with respect to many of our loans. We may invest in (a) second mortgage loans (some of which are also
secured by pledges), which investments represent 5% of the gross offering proceeds as of June 30, 2012; (b) co-investment loans
(which are secured by pledges and collateral-sharing arrangements permitting us to share in the proceeds of second liens held
by affiliates), which investments represent 54% of the gross offering proceeds as of June 30, 2012; (c) mezzanine loans (which
are secured by pledges), which investments represent 27% of the gross offering proceeds as of June 30, 2012; and (d) wraparound
mortgage loans, which investments represent 0% of the gross offering proceeds as of June 30, 2012. A wraparound, or all-inclusive,
mortgage loan is a loan in which the lender combines the remainder of an old loan with a new loan at an interest rate that blends
the rate charged on the old loan with the current market rate. In a second mortgage loan and in a mezzanine loan, our rights as
a lender, including our rights to receive payment on foreclosure, will be subject to the rights of the prior mortgage lender.
In a wraparound mortgage loan, our rights will be similarly subject to the rights of any prior mortgage lender, but the aggregate
indebtedness evidenced by our loan documentation will be the prior mortgage loans in addition to the new funds we invest. Under
a wraparound mortgage loan, we would receive all payments from the borrower and forward to any senior lender its portion of the
payments we receive. Because all of these types of loans are subject to the prior mortgage lender’s right to payment on
foreclosure, we incur a greater risk when we invest in each of these types of loans.



Many
of our loans will require balloon payments or reductions to principal tied to net cash, which are riskier than loans with fully
amortized payments.



We anticipate that
substantially all of our loans will have balloon payments or reductions to principal tied to net cash from the sale of developed
lots and the release formula created by the senior lender (i.e., the conditions under which principal is repaid to the
senior lender, if any), and as of June 30, 2012, 100% of our loans have balloon payments or reductions to principal tied to net
cash. A balloon payment is a large principal balance that is payable after a period of time during which the borrower has repaid
none or only a small portion of the principal balance. Loans with balloon payments are riskier than loans with even payments of
principal over an extended time period, such as 15 or 30 years, because the borrower’s repayment often depends on its ability
to refinance the loan or sell the developed lots profitably when the loan comes due. There are no specific criteria used in evaluating
the credit quality of borrowers for mortgage loans requiring balloon payments. Furthermore, a substantial period of time may elapse
between the review of the financial statements of the borrower and the date when the balloon payment is due. As a result, there
is no assurance that a borrower will have sufficient resources to make a balloon payment when due.



The
interest-only loans we make or acquire may be subject to a greater risk of default and there may not be sufficient funds or assets
remaining to satisfy our loans, which may result in losses to us.



We have made and will
continue to make and acquire interest-only loans or loans requiring reductions to accrued interest tied to net cash, and as of
June 30, 2012, 100% of the loans we have made and acquired are interest-only loans or loans requiring reductions to accrued interest
tied to net cash. Interest-only loans typically cost the borrower less in monthly loan payments than fully-amortizing loans, which
require a payment on principal as well as interest. This lower cost may enable a borrower to acquire a more expensive property
than if the borrower was entering into a fully-amortizing mortgage loan. Borrowers utilizing interest-only loans are dependent
on the appreciation of the value of the underlying property, and the sale or refinancing of such property, to pay down the interest-only
loan since none of the principal balance is being paid down with the borrower’s monthly payments. If the value of the underlying
property declines due to market or other factors, it is likely that the borrower would hold a property that is worth less than
the mortgage balance on the property. Thus, there may be greater risk of default by borrowers who enter into interest-only loans.
In addition, interest-only loans include an interest reserve in the loan amount. If such reserve is required to be funded due
to a borrower’s non-payment, the loan-to-value ratio for that loan will increase, possibly above generally acceptable levels.
In the event of a defaulted interest-only loan, we would acquire the underlying collateral which may have declined in value. In
addition, there are significant costs and delays associated with the foreclosure process. Any of these factors may result in losses
to us.



61







Larger
loans result in less diversity and may increase risk.



We intend to invest
in loans that individually constitute an average amount equal to the lesser of (a) 1% to 5% of the total amount raised in the
Offering, or (b) $2.5 million to $12.5 million. However, we may invest in larger loans depending on such factors as our performance
and the value of the collateral. These larger loans are riskier because they may reduce our ability to diversify our loan portfolio.
Loans to or from any one borrower will not exceed an amount greater than 20% of the total capital contributions raised in the
Offering, and as of June 30, 2012, our largest loan to or from any one borrower is equal to 20% of the total capital contributions
raised in the Offering.



The
concentration of loans with a common borrower may increase our risks.



We may invest in multiple
mortgage loans that share a common borrower or loans to related borrowers. As of June 30, 2012, we have invested 45% of our offering
proceeds in 11 loans to our largest group of related borrowers. The bankruptcy, insolvency or other inability of any borrower
that is the subject of multiple loans to pay interest or repay principal on its loans would have adverse consequences on our income
and reduce the amount of funds available for distribution to investors. In addition, we expect to be dependent on a limited number
of borrowers for a large portion of our business. The more concentrated our portfolio is with one or a few borrowers, the greater
credit risk we face. The loss of any one of these borrowers would have a material adverse effect on our financial condition and
results of operations.



If
we were found to have violated applicable usury laws, we would be subject to penalties and other possible risks.



Usury laws generally
regulate the amount of interest that may lawfully be charged on indebtedness. Each state has its own distinct usury laws. We believe
that our loans will not violate applicable usury laws (as of June 30, 2012, the highest interest rate we have charged on an annualized
basis is 18%). There is a risk, however, that a court could determine that our loans do violate applicable usury laws. If we were
found to have violated applicable usury laws, we could be subject to penalties, including fines equal to three times the amount
of usurious interest collected and restitution to the borrower. Additionally, usury laws often provide that a loan that violates
usury laws is unenforceable. If we are subject to penalties or restitution or if our loan agreements are adjudged unenforceable
by a court, it would have a material, adverse effect on our business, financial condition and results of operations and we would
have difficulty making distributions to our limited partners.



Item 2. Unregistered Sales of Equity Securities and Use
of Proceeds.



Use of Proceeds
from Registered Securities



On May 15, 2006, our
Registration Statement on Form S-11 (Registration No. 333-127891), covering a public offering of 17,500,000 of our units of limited
partnership interest, was declared effective under the Securities Act of 1933, as amended. The aggregate offering price for the
units under the Offering was $350 million. At the time of effectiveness, the Registration Statement covered up to 12,500,000 units
of limited partnership interest at a price of $20.00 per unit pursuant to the Primary Offering and up to 5,000,000 units of limited
partnership interest to be issued pursuant to our DRIP at a price of $20.00 per unit. We had the right to reallocate the units
of limited partnership interest we were offering between the Primary Offering and our DRIP and, pursuant to Supplement No. 8 to
our prospectus regarding the Offering, which was filed with the Securities and Exchange Commission on September 4, 2008, we reallocated
the units being offered such that 16,250,000 units were offered pursuant to the Primary Offering and 1,250,000 units were offered
pursuant to the DRIP. Pursuant to Supplement No. 11 to our prospectus regarding the Offering, which was filed with the Securities
and Exchange Commission on March 6, 2009, we further reallocated the units being offered such that 16,500,000 units were offered
pursuant to the Primary Offering and 1,000,000 units were offered pursuant to the DRIP. The Primary Offering was terminated on
April 23, 2009. We extended the offering of our units of limited partnership interest pursuant to our DRIP until the earlier of
the sale of all units of limited partnership interest being offered pursuant to our DRIP or May 15, 2010; provided, however, that
our general partner was permitted to terminate the offering of units pursuant to our DRIP at any earlier time.



62







On June 9, 2009, we
held a special meeting of our limited partners as of April 13, 2009, at which our limited partners approved three proposals to
amend certain provisions of our Partnership Agreement for the purpose of making available additional units of limited partnership
interest for sale pursuant to the Secondary DRIP. On June 12, 2009, we registered 5,000,000 additional units to be offered pursuant
to our Secondary DRIP for $20.00 per unit in a Registration Statement on Form S-3 (File No. 333-159939), which became effective
immediately upon filing with the Securities and Exchange Commission. As such, we ceased offering units under the DRIP as of July
21, 2009 and concurrently commenced our current offering of units pursuant to the Secondary DRIP. The aggregate offering price
for the units being offered pursuant to the Secondary DRIP is $100 million. The Secondary DRIP will be available until we sell
all $100 million worth of units being offered; provided, however, that our general partner may terminate the offering of units
pursuant to the Secondary DRIP at any earlier time.



Our limited partnership
units are not currently listed on a national exchange, and we do not expect any public market for the units to develop.



On July 3, 2006, we
accepted our initial public subscribers as limited partners. Since such time, we admitted new investors at least monthly until
the Primary Offering was terminated on April 23, 2009. As of June 30, 2012, we had issued an aggregate of 18,575,098 units of
limited partnership interest in the Primary Offering, the DRIP and the Secondary DRIP, consisting of 16,499,994 units that have
been issued to our limited partners pursuant to the Primary Offering in exchange for gross proceeds of approximately $330.3 million
(approximately $290.7 million, net of costs associated with the Primary Offering), 716,260 units of limited partnership interest
issued to limited partners in accordance with our DRIP in exchange for gross proceeds of approximately $14.3 million, and 1,689,531
units of limited partnership interest issued to limited partners in accordance with our Secondary DRIP in exchange for gross proceeds
of approximately $33.8 million, minus 330,687 units of limited partnership interest that have been repurchased pursuant to our
unit redemption program for approximately $6.6 million. Of the offering costs paid as of June 30, 2012, approximately $11.2 million
was paid to our general partner or its affiliates for organizational and offering expenses, and approximately $28.4 million was
paid to non-affiliates for commissions and dealer fees.



As of June 30, 2012,
we had used the proceeds from the Primary Offering, the DRIP and the Secondary DRIP to originate 60 loans, including 32 loans
that have been repaid in full by the respective borrower, totaling approximately $540.9 million. We have approximately $35.0 million
of commitments to be funded, including approximately $13.4 million of commitments for mortgage notes receivable – related
parties and $9.5 million for participation interest – related party. As of June 30, 2012, we have paid our general partner
approximately $10.2 million for acquisition and origination fee expenses associated with the mortgage notes receivable.



Unregistered
Sales of Equity Securities



During the three months
ended June 30, 2012, we did not sell any equity securities that were not registered or otherwise exempt under the Securities Act
of 1933, as amended.



Purchases of
Equity Securities by the Partnership and Affiliated Purchasers



For the three months
ended June 30, 2012, we received valid redemption requests pursuant to our unit redemption program relating to approximately 32,000
units, and we redeemed approximately 12,450 units as a result of the deaths of limited partners for $249,000 (an average repurchase
price of approximately $20.00 per unit), as follows:





|2012  |  | Total number of  units repurchased |        |  | Average  price paid per  unit |   |       | Total number of units  repurchased as part  of publicly  announced plan |  |  | Maximum number  of units that may  yet be purchased  under the plan | 
|----- |  | ---------------------------------- | ------ |  | ----------------------------- | - | ----- | ----------------------------------------------------------------------- |  |  | ------------------------------------------------------------------- | 
|April |  |                                    | 12,450 |  |                               | $ | 20.00 |                                                                         |  |  | 12,450                                                              | 
|May   |  |                                    | -      |  |                               |   | -     |                                                                         |  |  | -                                                                   | 
|June  |  |                                    | -      |  |                               |   | -     |                                                                         |  |  | -                                                                   | 
|      |  |                                    | 12,450 |  |                               | $ | 20.00 |                                                                         |  |  | 12,450                                                              | 





| | (1) | A description of the maximum number
                                                               of units that may be purchased under our redemption program is
                                                               included under “Unit Redemption Program” as discussed
                                                               in Note H to the accompanying financial statements.
| | --- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



63







We funded these unit
redemptions with cash flows from operations.



For the year ended
December 31, 2011, we received valid redemption requests relating to approximately 217,000 units. We did not redeem any units
during the year ended December 31, 2011.



A valid redemption
request is one that complies with the applicable requirements and guidelines of our current unit redemption program set forth
in the prospectus related to the Offering.



Item 3. Defaults Upon Senior Securities.



None.



Item 4. Mine Safety Disclosures.



Not applicable.



Item 5. Other Information.



None.



Item 6. Exhibits.



The exhibits filed
in response to Item 601 of Regulation S-K are listed on the Index to Exhibits attached hereto.



64







SIGNATURES



Pursuant to the requirements of the Securities Exchange Act
of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.



| | United Development Funding III, L.P.
| | ------------------------------------
| |                                     
| | By:                                 
| |                                     



|Dated:  August 14, 2012 | By: | /s/ Hollis M. Greenlaw                                                                                                                           
|----------------------- | --- | -------------------------------------------------------------------------------------------------------------------------------------------------
|                        |     | Hollis M. Greenlaw                                                                                                                               
|                        |     | Chief Executive Officer, and President and Chief Executive Officer of UMT Services, Inc.,
    sole general partner of UMTH Land Development, L.P.
|                        |     | (Principal Executive Officer)                                                                                                                    
|                        |     |                                                                                                                                                  
|Dated:  August 14, 2012 | By: | /s/ Cara D. Obert                                                                                                                                
|                        |     | Cara D. Obert                                                                                                                                    
|                        |     | Chief Financial Officer                                                                                                                          
|                        |     | (Principal Financial Officer)                                                                                                                    



65







Index to
Exhibits



|Exhibit Number |  | Description                                                                                                                                                                                                                                                                                                                                                                                 
|-------------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|               |  |                                                                                                                                                                                                                                                                                                                                                                                             
|3.1            |  | Second Amended and Restated Agreement of Limited Partnership of Registrant (previously filed
    in and incorporated by reference to Exhibit B to prospectus dated May 15, 2006, filed pursuant to Rule 424(b)(3) on May 18,
    2006)                                                                                                                                                      
|               |  |                                                                                                                                                                                                                                                                                                                                                                                             
|3.2            |  | Certificate of Limited Partnership of Registrant (previously filed in and incorporated by
    reference to Registrant’s Registration Statement on Form S-11, Commission File No. 333-127891, filed on August 26, 2005)                                                                                                                                                                      
|               |  |                                                                                                                                                                                                                                                                                                                                                                                             
|3.3            |  | First Amendment to Second Amended and Restated Agreement of Limited Partnership of Registrant
    (previously filed in and incorporated by reference to Exhibit B to Supplement No. 12 to prospectus dated May 15, 2006, contained
    within Post-Effective Amendment No. 4 to Registrant’s Registration Statement on Form S-11, Commission File No. 333-127891,
    filed on May 12, 2009)
|               |  |                                                                                                                                                                                                                                                                                                                                                                                             
|3.4            |  | Second Amendment to Second Amended and Restated Agreement of Limited Partnership of Registrant
    (previously filed in and incorporated by reference to Form 8-K filed on June 10, 2009)                                                                                                                                                                                                   
|               |  |                                                                                                                                                                                                                                                                                                                                                                                             
|4.1            |  | Subscription Agreement (previously filed in and incorporated by reference to Exhibit C to
    Supplement No. 12 to prospectus dated May 15, 2006, contained within Post-Effective Amendment No. 4 to Registrant’s
    Registration Statement on Form S-11, Commission File No. 333-127891, filed on May 12, 2009)                                                                           
|               |  |                                                                                                                                                                                                                                                                                                                                                                                             
|4.2            |  | Amended and Restated Distribution Reinvestment Plan (previously filed in and incorporated
    by reference to Registrant’s Registration Statement on Form S-3, Commission File No. 333-159939, filed on June 12, 2009)                                                                                                                                                                      
|               |  |                                                                                                                                                                                                                                                                                                                                                                                             
|10.1*          |  | Second Amendment to Loan and Security Agreement between Registrant, as Borrower, and Wesley
    J. Brockhoeft, as Lender, dated June 21, 2012                                                                                                                                                                                                                                               
|               |  |                                                                                                                                                                                                                                                                                                                                                                                             
|31.1*          |  | Rule 13a-14(a)/15d-14(a) Certification of Principal Executive Officer                                                                                                                                                                                                                                                                                                                       
|               |  |                                                                                                                                                                                                                                                                                                                                                                                             
|31.2*          |  | Rule 13a-14(a)/15d-14(a) Certification of Principal Financial Officer                                                                                                                                                                                                                                                                                                                       
|               |  |                                                                                                                                                                                                                                                                                                                                                                                             
|32.1**         |  | Section 1350 Certifications                                                                                                                                                                                                                                                                                                                                                                 
|               |  |                                                                                                                                                                                                                                                                                                                                                                                             
|101.SCH***     |  | XBRL Taxonomy Extension Schema Document                                                                                                                                                                                                                                                                                                                                                     
|               |  |                                                                                                                                                                                                                                                                                                                                                                                             
|101.INS***     |  | XBRL Instance Document                                                                                                                                                                                                                                                                                                                                                                      
|               |  |                                                                                                                                                                                                                                                                                                                                                                                             
|101.CAL***     |  | XBRL Taxonomy Extension Calculation Linkbase Document                                                                                                                                                                                                                                                                                                                                       
|               |  |                                                                                                                                                                                                                                                                                                                                                                                             
|101.DEF***     |  | XBRL Taxonomy Extension Definition Linkbase Document                                                                                                                                                                                                                                                                                                                                        
|               |  |                                                                                                                                                                                                                                                                                                                                                                                             
|101.LAB***     |  | XBRL Taxonomy Extension Label Linkbase Document                                                                                                                                                                                                                                                                                                                                             
|               |  |                                                                                                                                                                                                                                                                                                                                                                                             
|101.PRE***     |  | XBRL Taxonomy Extension Presentation Linkbase Document                                                                                                                                                                                                                                                                                                                                      



66







|*   | Filed herewith.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|**  | In accordance with Item 601(b)(32) of Regulation S-K, this Exhibit is not deemed “filed”
    for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, or otherwise subject to the liabilities of
    that section.  Such certifications will not be deemed incorporated by reference into any filing under the Securities
    Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, except to the extent that the registrant specifically
    incorporates it by reference.                                      
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|*** | XBRL (Extensible Business Reporting Language) information is deemed not filed or a part of a registration
statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, is deemed not filed for purposes
of Section 18 of the Securities Exchange Act of 1934, as amended, and otherwise is not subject to liability under these sections.
XBRL information will be furnished by amendment to this Form 10-Q within 30 days of the filing date of this Form 10-Q, as permitted
by Rule 405(a)(2)(ii) of Regulation S-T.



67