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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549



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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 September 30, 2006

OR



| ̈ | 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 000-51860



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PALADIN REALTY INCOME PROPERTIES, INC.

(Exact Name of Registrant as Specified
in Its Charter)



|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Maryland                                                       |  | 20-0378980                          
|(State or Other Jurisdiction of Incorporation or Organization) |  | (I.R.S. Employer Identification No.)



|                                                         |  |           
|-------------------------------------------------------- |  | ----------
|10880 Wilshire Blvd., Suite 1400 Los Angeles, California |  | 90024     
|(Address of Principal Executive Offices)                 |  | (Zip Code)



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(310) 996-8704

(Registrants Telephone Number, Including Area Code)

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

Indicate by check mark whether the registrant is a large accelerated filed, an accelerated filer, or a non-accelerated filer. See definition of
accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act.

Large Accelerated
Filer ̈Accelerated Filer ̈Non-Accelerated Filer  þ

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

As of October 25, 2006, there were 687,318 outstanding shares of common stock of Paladin Realty Income Properties, Inc.



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##### Table of Contents

PALADIN REALTY INCOME PROPERTIES, INC.

INDEX



|                             |  |                                                                                                                                                                                     |  |     
|---------------------------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----
|                             |  |                                                                                                                                                                                     |  | Page
|                             | 
|PART I FINANCIAL INFORMATION |  |                                                                                                                                                                                    
|                             |  |                                                                                                                                                                                    
|Item 1.                      |  | Financial Statements                                                                                                                                                                |  | 1   
|                             |  |                                                                                                                                                                                    
|                             |  | Paladin Realty Income Properties, Inc. and Subsidiaries Condensed Consolidated Balance Sheets as of September 30, 2006 (unaudited) and December 31, 2005                            |  | 1   
|                             |  |                                                                                                                                                                                    
|                             |  | Paladin Realty Income Properties, Inc. and Subsidiaries Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2006 and 2005 (unaudited) |  | 2   
|                             |  |                                                                                                                                                                                    
|                             |  | Paladin Realty Income Properties, Inc. and Subsidiaries Condensed Consolidated Statement of Shareholders Equity for the nine months ended September 30, 2006 (unaudited)           |  | 3   
|                             |  |                                                                                                                                                                                    
|                             |  | Paladin Realty Income Properties, Inc. and Subsidiaries Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2006 and 2005 (unaudited)           |  | 4   
|                             |  |                                                                                                                                                                                    
|                             |  | Notes to Condensed Consolidated Financial Statements                                                                                                                                |  | 5   
|                             |  |                                                                                                                                                                                    
|Item 2.                      |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                                                                                               |  | 14  
|                             |  |                                                                                                                                                                                    
|Item 3.                      |  | Quantitative and Qualitative Disclosures About Market Risk                                                                                                                          |  | 22  
|                             |  |                                                                                                                                                                                    
|Item 4.                      |  | Controls and Procedures                                                                                                                                                             |  | 23  
|                             | 
|PART II OTHER INFORMATION    |  |                                                                                                                                                                                    
|                             |  |                                                                                                                                                                                    
|Item 1.                      |  | Legal Proceedings                                                                                                                                                                   |  | 24  
|                             |  |                                                                                                                                                                                    
|Item 1A.                     |  | Risk Factors                                                                                                                                                                        |  | 24  
|                             |  |                                                                                                                                                                                    
|Item 2.                      |  | Unregistered Sales of Equity Securities and Use of Proceeds                                                                                                                         |  | 25  
|                             |  |                                                                                                                                                                                    
|Item 3.                      |  | Defaults Upon Senior Securities                                                                                                                                                     |  | 25  
|                             |  |                                                                                                                                                                                    
|Item 4.                      |  | Submission of Matters to a Vote of Security Holders                                                                                                                                 |  | 25  
|                             |  |                                                                                                                                                                                    
|Item 5.                      |  | Other Information                                                                                                                                                                   |  | 25  
|                             |  |                                                                                                                                                                                    
|Item 6.                      |  | Exhibits                                                                                                                                                                            |  | 26  



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##### Table of Contents

PART I  FINANCIAL INFORMATION



|ITEM 1. | FINANCIAL STATEMENTS
|------- | --------------------

PALADIN REALTY INCOME
PROPERTIES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)



|                                                                                                                                                                                     |  |                    |            |   |                   |   |           |  
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ |  | ------------------ | ---------- | - | ----------------- | - | --------- | -
|                                                                                                                                                                                     |  | September 30, 2006 |            |   | December 31, 2005 |  
|ASSETS                                                                                                                                                                               |  |                    |            |   |                   |   |           |  
|Building and improvements                                                                                                                                                            |  | $                  | 17,858,945 |   |                   | $ |          |  
|Land                                                                                                                                                                                 |  |                    | 2,335,545  |   |                   |   |          |  
|Furniture, fixtures and equipment                                                                                                                                                    |  |                    | 501,387    |   |                   |   |          |  
|In-place leases                                                                                                                                                                      |  |                    | 444,349    |   |                   |   |          |  
|                                                                                                                                                                                     |  |                    |            |   |                   |   |           |  
|                                                                                                                                                                                     |  |                    | 21,140,226 |   |                   |   |          |  
|Less: Accumulated depreciation and amortization                                                                                                                                      |  |                    | (312,497   | ) |                   |   |          |  
|                                                                                                                                                                                     |  |                    |            |   |                   |   |           |  
|Total real estate, net                                                                                                                                                               |  |                    | 20,827,729 |   |                   |   |          |  
|Investment in real estate joint venture                                                                                                                                              |  |                    | 1,793,909  |   |                   |   | 1,838,534 |  
|Cash and cash equivalents                                                                                                                                                            |  |                    | 373,449    |   |                   |   | 71,131    |  
|Restricted cash                                                                                                                                                                      |  |                    | 297,893    |   |                   |   | 50,000    |  
|Prepaid insurance and other assets                                                                                                                                                   |  |                    | 306,739    |   |                   |   | 16,532    |  
|                                                                                                                                                                                     |  |                    |            |   |                   |   |           |  
|TOTAL ASSETS                                                                                                                                                                         |  | $                  | 23,599,719 |   |                   | $ | 1,976,197 |  
|                                                                                                                                                                                     |  |                    |            |   |                   |   |           |  
|LIABILITIES AND SHAREHOLDERS EQUITY                                                                                                                                                 |  |                    |            |   |                   |   |           |  
|Mortgage payable                                                                                                                                                                     |  | $                  | 16,350,000 |   |                   | $ |          |  
|Note payable to affiliate                                                                                                                                                            |  |                    | 1,400,000  |   |                   |   |          |  
|Due to affiliates                                                                                                                                                                    |  |                    | 515,439    |   |                   |   | 181,013   |  
|Unaccepted subscriptions for common shares                                                                                                                                           |  |                    | 148,519    |   |                   |   | 50,000    |  
|Other liabilities                                                                                                                                                                    |  |                    | 299,352    |   |                   |   | 45,279    |  
|Dividends payable                                                                                                                                                                    |  |                    | 61,956     |   |                   |   | 17,639    |  
|                                                                                                                                                                                     |  |                    |            |   |                   |   |           |  
|Total liabilities                                                                                                                                                                    |  |                    | 18,775,266 |   |                   |   | 293,931   |  
|                                                                                                                                                                                     |  |                    |            |   |                   |   |           |  
|Minority interest                                                                                                                                                                    |  |                    | 175,074    |   |                   |   | 192,800   |  
|                                                                                                                                                                                     |  |                    |            |   |                   |   |           |  
|Shareholders equity                                                                                                                                                                 |  |                    |            |   |                   |   |           |  
|Preferred shares, $0.01 par value, 100,000,000 shares authorized; none issued or outstanding                                                                                         |  |                    |           |   |                   |   |          |  
|Common shares, $0.01 par value, 750,000,000 shares authorized; 613,215 shares and 173,527 shares issued and outstanding as of
September 30, 2006 and December 31, 2005, respectively |  |                    | 6,132      |   |                   |   | 1,735     |  
|Additional paid-in-capital                                                                                                                                                           |  |                    | 5,331,329  |   |                   |   | 1,566,911 |  
|Distributions in excess of earnings                                                                                                                                                  |  |                    | (688,082   | ) |                   |   | (79,180   | )
|                                                                                                                                                                                     |  |                    |            |   |                   |   |           |  
|Total shareholders equity                                                                                                                                                           |  |                    | 4,649,379  |   |                   |   | 1,489,466 |  
|                                                                                                                                                                                     |  |                    |            |   |                   |   |           |  
|TOTAL LIABILITIES AND SHAREHOLDERS EQUITY                                                                                                                                           |  | $                  | 23,599,719 |   |                   | $ | 1,976,197 |  
|                                                                                                                                                                                     |  |                    |            |   |                   |   |           |  

See notes to condensed consolidated financial statements



1



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##### Table of Contents

PALADIN REALTY INCOME PROPERTIES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)



|                                                                     |  |                                  |          |                                 |      |   |       |  |   |           |   |  |   |      
|-------------------------------------------------------------------- |  | -------------------------------- | -------- | ------------------------------- | ---- | - | ----- |  | - | --------- | - |  | - | -----
|                                                                     |  | Three months ended September 30, |          | Nine months ended September 30,
|                                                                     |  | 2006                             |          |                                 | 2005 |   | 2006  |  |   | 2005     
|Revenues                                                             |  |                                  |          |                                 |      |   |       |  |   |           |   |  |   |      
|Rental income                                                        |  | $                                | 516,867  |                                 |      | $ |      |  | $ | 690,999   |   |  | $ |     
|Other income                                                         |  |                                  | 41,405   |                                 |      |   |      |  |   | 60,676    |   |  |   |     
|Interest income                                                      |  |                                  | 7,904    |                                 |      |   | 1,772 |  |   | 12,784    |   |  |   | 6,140
|                                                                     |  |                                  |          |                                 |      |   |       |  |   |           |   |  |   |      
|Total Revenues                                                       |  |                                  | 566,176  |                                 |      |   | 1,772 |  |   | 764,459   |   |  |   | 6,140
|                                                                     |  |                                  |          |                                 |      |   |       |  |   |           |   |  |   |      
|Expenses                                                             |  |                                  |          |                                 |      |   |       |  |   |           |   |  |   |      
|Property operating expenses                                          |  |                                  | 197,221  |                                 |      |   |      |  |   | 252,205   |   |  |   |     
|Real property taxes                                                  |  |                                  | 34,548   |                                 |      |   |      |  |   | 46,064    |   |  |   |     
|General and administrative expenses                                  |  |                                  | 126,141  |                                 |      |   |      |  |   | 228,462   |   |  |   |     
|Interest expense, including amortization of deferred financing costs |  |                                  | 309,064  |                                 |      |   |      |  |   | 412,385   |   |  |   |     
|Depreciation and amortization expense                                |  |                                  | 234,621  |                                 |      |   |      |  |   | 312,497   |   |  |   |     
|                                                                     |  |                                  |          |                                 |      |   |       |  |   |           |   |  |   |      
|Total Expenses                                                       |  |                                  | 901,595  |                                 |      |   |      |  |   | 1,251,613 |   |  |   |     
|                                                                     |  |                                  |          |                                 |      |   |       |  |   |           |   |  |   |      
|Income / (loss) before equity in earnings and minority interest      |  |                                  | (335,419 | )                               |      |   | 1,772 |  |   | (487,154  | ) |  |   | 6,140
|Equity in earnings from real estate joint venture                    |  |                                  | 20,804   |                                 |      |   |      |  |   | 62,106    |   |  |   |     
|Minority interest                                                    |  |                                  | (10,621  | )                               |      |   | 1,729 |  |   | (10,790   | ) |  |   | 5,990
|                                                                     |  |                                  |          |                                 |      |   |       |  |   |           |   |  |   |      
|Net Income (Loss)                                                    |  | $                                | (303,994 | )                               |      | $ | 43    |  | $ | (414,258  | ) |  | $ | 150  
|                                                                     |  |                                  |          |                                 |      |   |       |  |   |           |   |  |   |      
|Net income (loss) per common share                                   |  |                                  |          |                                 |      |   |       |  |   |           |   |  |   |      
|Basic                                                                |  | $                                | (0.60    | )                               |      | $ | 0.09  |  | $ | (1.10     | ) |  | $ | 0.30 
|                                                                     |  |                                  |          |                                 |      |   |       |  |   |           |   |  |   |      
|Diluted                                                              |  | $                                | (0.60    | )                               |      |   | N/A   |  | $ | (1.10     | ) |  |   | N/A  
|                                                                     |  |                                  |          |                                 |      |   |       |  |   |           |   |  |   |      
|Weighted average number of common shares outstanding                 |  |                                  |          |                                 |      |   |       |  |   |           |   |  |   |      
|Basic                                                                |  |                                  | 507,081  |                                 |      |   | 500   |  |   | 375,335   |   |  |   | 500  
|                                                                     |  |                                  |          |                                 |      |   |       |  |   |           |   |  |   |      
|Diluted                                                              |  |                                  | 507,081  |                                 |      |   | N/A   |  |   | 375,335   |   |  |   | N/A  
|                                                                     |  |                                  |          |                                 |      |   |       |  |   |           |   |  |   |      

See notes to condensed consolidated financial statements



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##### Table of Contents

PALADIN REALTY INCOME PROPERTIES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENT OF SHAREHOLDERS EQUITY

For the nine months ended September 30,
2006

(Unaudited)



|                                            |  |               |  |                           |       |  |                                    |           |   |                          |   |          |   |  |   |           |  
|------------------------------------------- |  | ------------- |  | ------------------------- | ----- |  | ---------------------------------- | --------- | - | ------------------------ | - | -------- | - |  | - | --------- | -
|                                            |  | Common Shares |  | AdditionalPaid-in Capital |       |  | Distributionsin Excess of Earnings |           |   | TotalShareholdersEquity |  
|                                            |  | Commonshares  |  | Amount                    |       |  |                                   
|BALANCE, December 31, 2005                  |  | 173,527       |  | $                         | 1,735 |  | $                                  | 1,566,911 |   |                          | $ | (79,180  | ) |  | $ | 1,489,466 |  
|Issuance of common shares                   |  | 427,688       |  |                           | 4,277 |  |                                    | 4,260,967 |   |                          |   |         |   |  |   | 4,265,244 |  
|Selling commissions and dealer manager fees |  |              |  |                           |      |  |                                    | (398,666  | ) |                          |   |         |   |  |   | (398,666  | )
|Offering costs                              |  |              |  |                           |      |  |                                    | (127,957  | ) |                          |   |         |   |  |   | (127,957  | )
|Issuance of common shares to directors      |  | 12,000        |  |                           | 120   |  |                                    | (120      | ) |                          |   |         |   |  |   |          |  
|Share-based compensation expense            |  |              |  |                           |      |  |                                    | 30,194    |   |                          |   |         |   |  |   | 30,194    |  
|Dividends declared                          |  |              |  |                           |      |  |                                    |          |   |                          |   | (194,644 | ) |  |   | (194,644  | )
|Net loss                                    |  |              |  |                           |      |  |                                    |          |   |                          |   | (414,258 | ) |  |   | (414,258  | )
|                                            |  |               |  |                           |       |  |                                    |           |   |                          |   |          |   |  |   |           |  
|BALANCE, September 30, 2006                 |  | 613,215       |  | $                         | 6,132 |  | $                                  | 5,331,329 |   |                          | $ | (688,082 | ) |  | $ | 4,649,379 |  
|                                            |  |               |  |                           |       |  |                                    |           |   |                          |   |          |   |  |   |           |  

See notes to condensed consolidated financial statements



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##### Table of Contents

PALADIN REALTY INCOME PROPERTIES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)



|                                                                                                   |  |                                 |             |   |      |   |        
|-------------------------------------------------------------------------------------------------- |  | ------------------------------- | ----------- | - | ---- | - | -------
|                                                                                                   |  | Nine months ended September 30,
|                                                                                                   |  | 2006                            |             |   | 2005
|CASH FLOWS FROM OPERATING ACTIVITIES                                                               |  |                                 |             |   |      |   |        
|Net income (loss)                                                                                  |  | $                               | (414,258    | ) |      | $ | 150    
|Adjustments to reconcile net income (loss) to net cash provided by / (used in)operating activities |  |                                 |             |   |      |   |        
|Equity in earnings from joint venture                                                              |  |                                 | (62,106     | ) |      |   |       
|Depreciation and amortization expense                                                              |  |                                 | 312,497     |   |      |   |       
|Amortization of deferred financing costs                                                           |  |                                 | 5,734       |   |      |   |       
|Amortization of deferred compensation                                                              |  |                                 | 30,194      |   |      |   |       
|Minority interest                                                                                  |  |                                 | (10,790     | ) |      |   | 5,990  
|Changes in operating assets and liabilities:                                                       |  |                                 |             |   |      |   |        
|Increase in restricted cash                                                                        |  |                                 | (149,374    | ) |      |   |       
|Increase in due to affiliates                                                                      |  |                                 | 33,690      |   |      |   |       
|Increase in prepaid expenses and other assets                                                      |  |                                 | (115,741    | ) |      |   |       
|Increase in other liabilities                                                                      |  |                                 | 294,867     |   |      |   |       
|                                                                                                   |  |                                 |             |   |      |   |        
|Net cash provided by / (used in) operating activities                                              |  |                                 | (75,287     | ) |      |   | 6,140  
|                                                                                                   |  |                                 |             |   |      |   |        
|CASH FLOWS FROM INVESTING ACTIVITIES                                                               |  |                                 |             |   |      |   |        
|Purchase of real estate and improvements                                                           |  |                                 | (21,140,226 | ) |      |   |       
|Increase in due to affiliates                                                                      |  |                                 | 263,464     |   |      |   |       
|Investment in real estate joint venture                                                            |  |                                 | (40,794     | ) |      |   |       
|Distributions from real estate joint venture                                                       |  |                                 | 106,731     |   |      |   |       
|                                                                                                   |  |                                 |             |   |      |   |        
|Net cash used in investing activities                                                              |  |                                 | (20,810,825 | ) |      |   |       
|                                                                                                   |  |                                 |             |   |      |   |        
|CASH FLOWS FROM FINANCING ACTIVITIES                                                               |  |                                 |             |   |      |   |        
|Borrowings from mortgage payable                                                                   |  |                                 | 16,350,000  |   |      |   |       
|Borrowings from note payable to affiliate                                                          |  |                                 | 3,100,000   |   |      |   |       
|Payments on note payable to affiliate                                                              |  |                                 | (1,700,000  | ) |      |   |       
|Deferred loan costs                                                                                |  |                                 | (180,200    | ) |      |   |       
|Proceeds from issuance of common shares                                                            |  |                                 | 4,265,244   |   |      |   |       
|Increase in escrowed investor proceeds                                                             |  |                                 | (98,519     | ) |      |   |       
|Increase in unaccepted subscriptions for common stock in restricted cash                           |  |                                 | 98,519      |   |      |   |       
|Selling commissions and dealer manager fees                                                        |  |                                 | (398,666    | ) |      |   |       
|Offering costs                                                                                     |  |                                 | (127,957    | ) |      |   |       
|Increase in due to affiliates                                                                      |  |                                 | 37,272      |   |      |   |       
|Dividends paid                                                                                     |  |                                 | (150,327    | ) |      |   |       
|Distributions to minority interest                                                                 |  |                                 | (6,936      | ) |      |   |       
|                                                                                                   |  |                                 |             |   |      |   |        
|Net cash provided by financing activities                                                          |  |                                 | 21,188,430  |   |      |   |       
|                                                                                                   |  |                                 |             |   |      |   |        
|Net increase in cash and cash equivalents                                                          |  |                                 | 302,318     |   |      |   | 6,140  
|Cash and cash equivalents - beginning of period                                                    |  |                                 | 71,131      |   |      |   | 205,000
|                                                                                                   |  |                                 |             |   |      |   |        
|Cash and cash equivalents - end of period                                                          |  | $                               | 373,449     |   |      | $ | 211,140
|                                                                                                   |  |                                 |             |   |      |   |        
|Supplemental disclosure of noncash investing and financing activities                              |  |                                 |             |   |      |   |        
|Dividends payable                                                                                  |  | $                               | 61,956      |   |      | $ |       
|Issuance of common stock for compensation plan                                                     |  | $                               | 120,000     |   |      | $ |       
|Supplemental disclosure of cashflow information                                                    |  |                                 |             |   |      |   |        
|Cash paid during the period for interest                                                           |  | $                               | 322,993     |   |      | $ |       

See notes to condensed consolidated financial statements



4



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##### Table of Contents

Paladin Realty Income Properties, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements
(Unaudited)

September 30, 2006 and 2005

1.Organization

Paladin Realty Income Properties, Inc., a Maryland corporation
(Paladin REIT), was formed on October 31, 2003 and intends to provide investors the potential for income through investment in a diversified portfolio of real estate properties, focusing primarily on investments that produce current
income. Paladin REIT intends to invest in a variety of real estate product types, including apartments, office buildings, industrial buildings, shopping centers and hotels. Paladin REIT may also make real estate related investments, which include
first mortgages or second mortgages, mezzanine loans or preferred equity investments relating to the same types of properties that Paladin REIT may acquire directly. Paladin REIT intends to qualify as a REIT and to elect to be taxed as a REIT for
U.S. federal income tax purposes beginning with the taxable year ending December 31, 2006. Subject to certain restrictions and limitations, the business of Paladin REIT is managed by Paladin Realty Advisors, LLC (Paladin Advisors),
an affiliate of Paladin REIT, pursuant to an advisory agreement dated February 28, 2005, as amended February 28, 2006 (the Advisory Agreement). Paladin Advisors supervises and manages the day-to-day operations of Paladin REIT
and selects the real estate and real estate related investments it acquires, subject to oversight by the board of directors. Paladin Advisors also provides marketing, sales and client services on behalf of Paladin REIT.

On February 23, 2005, Paladin REITs initial public offering (the Offering) was declared effective and Paladin REIT commenced its
offering efforts. As of September 30, 2006, Paladin REIT had received proceeds of $5,974,713 for 613,215 shares, including 500 shares purchased by its sponsor, Paladin Realty Partners, LLC (Paladin Realty) on November 26, 2003.

Paladin REIT intends to own substantially all of its assets and conduct its operations through Paladin Realty Income Properties, L.P., its
operating partnership (Paladin OP). As of September 30, 2006 and December 31, 2005, Paladin Advisors holds a 3.2% and 10.5% limited partnership interest, respectively, and Paladin REIT holds a 96.8% and 89.5% general
partnership interest, respectively, in Paladin OP. Management expects Paladin REITs ownership percentage in Paladin OP to continue to increase as Paladin REIT invests net proceeds from the Offering in Paladin OP. Paladin REIT and its
consolidated subsidiaries are together referred to as the Company.

2.Summary of Significant Accounting Policies

Basis of Presentation

These condensed
consolidated financial statements are unaudited; however, amounts presented in the consolidated balance sheet as of December 31, 2005 are derived from the Companys audited financial statements as of that date. For further information,
refer to the financial statements and footnotes for the year ended December 31, 2005 included in the Companys Form 10-K for the fiscal year ended December 31, 2005 filed on March 28, 2006. In the opinion of the Companys
management, the unaudited statements as of September 30, 2006 and for the periods ended September 30, 2006 and 2005 presented in this Form 10-Q include all adjustments necessary to present a fair presentation of such periods. Such
adjustments consist of normal recurring items.

The condensed consolidated financial statements include the accounts of Paladin REIT and
its wholly-owned and controlled entities. All intercompany balances and transactions have been eliminated in consolidation.

Real Estate and
Depreciation

Real estate is stated at cost, less accumulated depreciation. The Company allocates the cost of newly acquired
properties between net tangible and identifiable intangible assets. The primary intangible asset associated with an apartment property acquisition is the value of the existing lease agreements. When allocating cost to an acquired property, the
Company allocates costs to the estimated value of the land, building and fixtures assuming the property is vacant and to the estimated intangible value of the existing



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lease agreements. The Company estimates the intangible value of the lease agreements by determining the lost revenue associated with a hypothetical lease-up.
The Company depreciates the building and fixtures based on the expected useful life of the asset, which is 45 years for the building and improvements and a range of 5 to 7 years for furniture, fixtures and equipment. The intangible value of the
lease agreements is amortized over the average remaining life of the existing leases, which ranges from one year to twenty four months. This amortization is included in depreciation and amortization expense on the accompanying condensed consolidated
statements of operations. Expenditures for repairs and maintenance are expensed as incurred.

The Company reviews long-lived assets and
related identifiable intangibles for impairment whenever events or changes in circumstances indicate the carrying amount of the assets may not be recoverable. When such events or changes in circumstances occur, recoverability of the asset to be held
and used is measured by a comparison of the carrying amount of the asset to future net cash flows, undiscounted and without interest, expected to be generated by the asset. If the sum of the expected future cash flows (undiscounted and without
interest) is less than the Companys carrying amount for the asset, an impairment loss is recognized based upon the assets fair value.

Investments

The Company evaluates its investments in accordance with Financial Accounting Standards Board,
Interpretation No. 46 (revised December 2003), Consolidation of Variable Interest Entities, which is referred to as FIN 46R. If the Company determines that the joint venture is a variable interest entity
(VIE) and that the Company is the primary beneficiary as defined in FIN 46R, it will account for such investment as if it were a consolidated subsidiary. For a joint venture investment which is not a VIE or in which the
Company is not the primary beneficiary, the Company considers other relevant accounting literature including Accounting Principles Board Opinion 18The Equity Method of Accounting for Investments in Common Stock, Statement of
Position 78-9Accounting for Investments in Real Estate Ventures, and Emerging Issues Task Force Issue 04-5 to determine the method of accounting for each of the partially-owned entities. In accordance with the above pronouncements,
the Company determines whether it should consolidate the entity or account for it on the equity method or cost method. Factors considered in determining whether or not the Company exercises control include substantive participating rights of
partners on significant business decisions, including dispositions and acquisitions of assets, financing and operating and capital budgets, board and management representatives and authority and other contractual rights of the Companys
partners. To the extent that the Company is deemed to control these entities, these entities will be consolidated.

As of
September 30, 2006, Paladin REIT holds a 96.8% ownership interest in Paladin OP and through Paladin OP holds a 70% ownership interest in Springhurst Housing Partners, LLC (Springhurst) and a 74% ownership interest in PRIP 801, LLC
as described in Note 3. Paladin REIT has determined that Paladin OP and its investments in Springhurst and PRIP 801, LLC are not VIEs. Paladin REIT consolidates Paladin OP and Springhurst, as it is the majority owner and exercises control over all
significant decisions. Paladin REIT accounts for its investment in PRIP 801, LLC under the equity method of accounting, as the other member has substantive participating rights as defined in EITF 04-5 and SOP 78-9. This investment is recorded
initially at cost, and subsequently adjusted for equity in earnings or losses and cash contributions and distributions.

On a periodic
basis the Company will evaluate whether there are any indicators that the value of its investments in partially-owned entities are impaired. An investment is impaired if the Companys estimate of the value of the investment is less than the
carrying amount. The ultimate realization of the Companys investment in partially-owned entities is dependent on a number of factors including the performance of that entity and market conditions. If the Company determines that a decline in
the value of a partially-owned entity is other than temporary, then the Company would record an impairment charge.

Deferred Loan Costs

Loan costs are capitalized and amortized on a straight-line basis over the life of the related loan. The amortization is recorded
as a component of interest expense.



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Revenue Recognition

The Company primarily leases residential apartments to tenants under non-cancellable operating lease with terms ranging from 3 to 24 months. Rental income related to leases is recognized in the period earned over the
lease term in accordance with Statement of Financial Accounting Standards No. 13, Accounting for Leases.

Other income
consists of various tenant related charges and are recognized as revenue in the period in which the applicable charge is incurred.

Accounts
Receivable

Bad debts are recorded under the specific identification method, whereby, uncollectible receivables are directly written
off when identified.

Use of Estimates

The presentation of the condensed consolidated financial statements requires management to make estimates and assumptions relating to the reported amount of assets and liabilities and the disclosure of contingent assets and liabilities at
the date of the condensed consolidated financial statements and the reported amounts of revenues and expenses during the period. Actual results could differ from those estimates.

Cash Equivalents

Cash equivalents represent highly liquid investments with maturities at the
date of purchase of three months or less.

Income Taxes

For the year ending December 31, 2006, the Company intends to make an election to be taxed for such year as a REIT, under Sections 856 through 860 of the Internal Revenue Code of 1986, as amended. The Company
believes that it will be organized and operate in such a manner as to qualify for treatment as a REIT and intends to operate in such a manner so that the Company will remain qualified as a REIT for federal income tax purposes.

Organization and Offering Costs

Organization
and offering costs of the Company are paid by Paladin Advisors or its affiliates, including Paladin Realty, on behalf of the Company and directly by the Company. Organization and offering costs consist of actual legal, accounting, printing and other
offering expenses, including amounts to reimburse Paladin Advisors, its affiliates or Prospect Financial Advisors, LLC (Prospect), its dealer manager, for all marketing related costs and expenses, including, but not limited to, expenses
relating to registering and marketing the shares and other marketing and organization costs, technology costs and expenses attributable to the Offering, and payment or reimbursement of bona fide due diligence expenses of Prospect and broker-dealers
participating in the Offering. Pursuant to the Advisory Agreement, the Company is obligated to reimburse Paladin Advisors or its affiliates for amounts advanced for organization and offering costs, provided that Paladin Advisors and its affiliates
are responsible for the payment of organization and offering costs to the extent they exceed 3.0% of gross proceeds from the Offering and will be required to return to the Company any amount the Company reimburses them in excess of 3.0% of the gross
proceeds from the Offering.

The Company had incurred organization and offering costs of $4,192,495 and $3,038,095 as of September 30,
2006 and December 31, 2005, respectively, which includes $4,101,810 and $3,038,095, respectively, paid by Paladin Advisors as described in Note 6. Following receipt of the minimum offering on December 2, 2005, such costs only become a
liability of the Company to the extent they do not exceed 3.0% of the gross proceeds of the Offering. When recorded by the Company, organization costs are expensed as incurred and offering costs are charged to stockholders equity. For the nine
months ended September 30, 2006, the Company has recognized $127,957 of organization and offering costs.



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During the nine months ended September 30, 2006 and 2005, the Company recognized no organization
costs in its condensed consolidated statements of operations but did recognize $51,134 in organization costs in its condensed consolidated statement of operations for the period ended December 31, 2005.

As of September 30, 2006 and 2005, $127,957 and $0 in offering costs were charged to stockholders equity, respectively.

Subject to the 3% limitation, the remaining $4,013,404 in organization and offering costs, as of September 30, 2006 will be recognized in future
periods as the Company receives additional proceeds of the Offering.

Expense Reimbursement

Pursuant to the Advisory Agreement, Paladin Advisors is entitled to reimbursement of actual expenses incurred for administrative and other services
provided to Paladin REIT by Paladin Advisors and its affiliates for which they do not otherwise receive a fee. Paladin REIT will not reimburse Paladin Advisors for operating expenses that in the fiscal year then ended exceeded the greater of
(1) 2% of the average invested assets of Paladin REIT or (2) 25% of the net income of Paladin REIT (the 2%/25% Rule), and Paladin Advisors must reimburse Paladin REIT quarterly for any amounts by which the operating expenses of
Paladin REIT exceeds the 2%/25% Rule in the previous four consecutive fiscal quarters (the Expense Period).

The average
invested assets of Paladin REIT for any period are equal to the average book value of Paladin REITs assets invested in equity interests in, and loans secured by, real estate before reserves for depreciation or bad debts or other similar
non-cash reserves computed by taking the average of such values at the end of each month during the period. The net income of Paladin REIT for any period is equal to Paladin REITs total revenue less total expenses other than additions to
reserves for depreciation, bad debts or other similar non-cash reserves for such period. Operating expenses include all expenses incurred by Paladin REIT under general accepted accounting principles (including the asset management fee), but
excluding organization and offering expenses, selling commissions and dealer manager fees, interest payments, taxes, non-cash expenditures such as depreciation, amortization and bad debt reserves, the subordinated disposition fee, acquisition and
advisory fees and expenses and distributions pursuant to Paladin Advisors subordinated participation interest in Paladin OP.

Paladin
Advisors must reimburse the excess expenses to Paladin REIT within 60 days after the end of each fiscal quarter unless the independent directors determine that the excess expenses were justified based on unusual and nonrecurring factors which they
deem sufficient. Within 60 days after the end of any Expense Period for which total operating expenses exceed the 2%/25% Rule, Paladin REIT will send its stockholders a written disclosure, together with an explanation of the factors the independent
directors considered in arriving at the conclusion that the excess expenses were justified. However, at Paladin Advisors option, Paladin Advisors or its affiliate, as applicable may defer receipt of any portion of the asset management fee or
reimbursement of expenses and elect to receive such payments, without interest, in any subsequent fiscal year that Paladin Advisors designates.

During the Expense Period ended September 30, 2006, Paladin REITs operating expenses including expenses incurred on behalf of Paladin REIT by Paladin Advisors and its affiliates exceeded the 2%/25% Rule by $475,338. In accordance
with the Advisory Agreement, Paladin REIT recognizes on a quarterly basis amounts not exceeding the 2%/25% Rule and the remaining amounts are recorded as due from affiliates, as described in Note 6 to our condensed consolidated financial statements.

Per Share Data

The Company
presents both basic and diluted earnings (loss) per share, or EPS. Basic EPS excludes potentially dilutive securities and is computed by dividing net income (loss) available to common stockholders by the weighted average number of common shares
outstanding during the period. Dilutive EPS reflects the potential dilution that could occur if securities or other contracts to issue common stocks were exercised, where such exercise would result in a lower EPS amount. The diluted EPS would
include weighted average unvested restricted shares issued to certain independent directors totaling 12,000 shares for the three and nine months ended September 30, 2006 but are excluded from the calculation as their effect would be
antidilutive. At September 30, 2005, the Company had not issued any potentially dilutive securities. Accordingly, no diluted earnings per share was computed in 2005.



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Unaccepted Subscriptions for Common Shares

Unaccepted subscriptions for common shares includes proceeds related to subscriptions which were held in escrow but had not been accepted by the Company
as of September 30, 2006 and December 31, 2005.

Fair Value of Financial Instruments

The fair values of the Companys cash and cash equivalents, restricted cash, other assets, dividends payable and other liabilities approximate the
carrying values due to the short-term nature of these financial instruments. The fair value of the mortgage and note payable to affiliates approximates the carrying value.

Stock-based Compensation

Under the terms of the Independent Director Incentive Stock Plan,
the Company granted 3,000 shares at fair value of $10 of restricted common stock to each of the four independent directors on March 21, 2006. One-third of the restricted common stock will vest on each of the first three anniversaries of
December 2, 2005, the date the Company reached its minimum offering. There are 60,000 shares in total authorized under the Independent Director Incentive Stock Plan, which expires on February 28, 2015.

On March 21, 2006, the Company started recording compensation expense for restricted common stock as required by Statement of Financial Accounting
Standards (SFAS) No. 123(R), Share-Based Payment, revised 2004 (SFAS No. 123(R)). Compensation expense for common stock unvested at March 21, 2006 is based on the grant date fair value of the common shares
calculated under SFAS No. 123(R) and will be recognized using the straightline attribution method. Compensation expense is only recorded for common shares expected to be vested. The Company recognizes the expense related to these shares over
the vesting period. For the three and nine months ended September 30, 2006, the Company recorded $14,319 and $30,194, respectively, of related compensation expense and included such amounts in general and administrative expenses in the
accompanying condensed consolidated statements of operations. Total compensation costs on nonvested shares on September 30, 2006 is $89,806, and the weighted average period over which it is expected to be recognized is three years,

Reportable Segments

FASB Statement of
Financial Accounting Standards No. 131, Disclosures About Segments of Enterprise and Related Information, establishes standards for reporting financial and descriptive information about an enterprises reportable segments.
Management has determined that the Company has one reportable segment, which is owning interests in real estate investments.

Recent Accounting
Pronouncements

In September 2006, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting
Standards (SFAS) No. 157, Fair Value Measurements which defines fair value, establishes a framework for measuring fair value, and expands the related disclosure requirements. This statement is effective for fiscal years beginning
after November 15, 2007 and for interim periods within those years. The Company is currently evaluating the potential impact of this statement.

In July 2006, the FASB issued Interpretation No. 48 (FIN 48), Accounting for Uncertainty in Income Taxes  An Interpretation of FASB Statement No. 109. FIN 48 increases the relevancy and
comparability of financial reporting by clarifying the way companies account for uncertainty in measuring income taxes. FIN 48 prescribes a comprehensive model for how a company should recognize, measure, present, and disclose in its financial
statements uncertain tax positions that the company has taken or expects to take on a tax return. This Interpretation only allows a favorable tax position to be included in the calculation of tax liabilities and expenses if a company concludes that
it is more likely than not that its adopted tax position will prevail if challenged by tax authorities. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company does not expect the adoption of FIN 48 to have an impact
on its consolidated financial position, results of operations and cash flows.



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3.Investments

Investment in Real Estate

On June 5, 2006, a wholly owned subsidiary of Paladin OP, PRIP
3700, LLC, purchased a 70% interest in Springhurst, a joint venture between PRIP 3700, LLC and Buckingham Springhurst, LLC which owns Champion Farms Apartments. Champion Farms Apartments is a 264-unit luxury multifamily rental community built in
2000. The apartment complex is located in a neighborhood of Louisville, Kentucky. The property was approximately 96% occupied as of September 30, 2006. The operating leases of each residential apartment ranges from three to 24 months.

Paladin REIT consolidates the financial statements of Springhurst.

The cost of Paladin OPs investment in Springhurst was $4,790,000 (including $310,000 of closing costs). Under Statement of Financial Accounting
Standards No. 141, Business Combinations, the Company recorded on its consolidated balance sheets the purchase of the 70% membership interest in Springhurst based on the pro rata allocation of the fair values of the assets acquired
and the liabilities assumed and the historical financial statement carrying amounts of such net assets. The remaining portion of the values assigned to the assets and liabilities represent the minority interests ownership in Springhurst. As a
result, the real estate assets were recorded at $20,835,000.

Investment in Unconsolidated Joint Venture

Paladin OP also has a 74% interest in PRIP 801, LLC, a joint venture between Paladin OP and 801 FO, LLC, which owns 801 Fiber Optic Drive. 801 Fiber Optic
Drive consists of approximately 10.95 acres of real property and a 56,336 square foot building that was completed in 2001, which is 100% leased to FedEx Ground Package System, Inc., (FedEx Ground), pursuant to a ten year net lease that
commenced on August 1, 2001 and expires on July 31, 2011. FedEx Ground is a subsidiary of FedEx Corporation, a provider of transportation, e-commerce and supply management services. FedEx Ground also has the option to extend the lease for
two additional five year periods. The first option is through July 31, 2016 at $405,792 per annum. The second option is through July 31, 2021 at $446,376 per annum.

Paladin OP accounts for its investment in PRIP 801, LLC under the equity method of accounting.

Condensed financial information of PRIP 801, LLC is summarized as follows:

Condensed Balance Sheets



|                                      |  |                                 |           |   |                  |   |          
|------------------------------------- |  | ------------------------------- | --------- | - | ---------------- | - | ---------
|                                      |  | September 30,2006               |           |   | December 31,2005
|ASSETS                                |  |                                 |           |   |                  |   |          
|Investment in real estate, net        |  | $                               | 4,035,882 |   |                  | $ | 4,096,524
|Other assets, net                     |  |                                 | 200,462   |   |                  |   | 196,401  
|                                      |  |                                 |           |   |                  |   |          
|Total Assets                          |  | $                               | 4,236,344 |   |                  | $ | 4,292,925
|                                      |  |                                 |           |   |                  |   |          
|LIABILITIES AND MEMBERS EQUITY       |  |                                 |           |   |                  |   |          
|Mortgage loan payable                 |  | $                               | 1,950,000 |   |                  | $ | 1,950,000
|Other liabilities                     |  |                                 | 29,680    |   |                  |   | 28,680   
|Members equity                       |  |                                 | 2,256,664 |   |                  |   | 2,314,245
|                                      |  |                                 |           |   |                  |   |          
|Total Liabilities and Members Equity |  | $                               | 4,236,344 |   |                  | $ | 4,292,925
|                                      |  |                                 |           |   |                  |   |          
|Companys share of Members Equity    |  | $                               | 1,669,939 |   |                  | $ | 1,712,548
|                                      |  |                                 |           |   |                  |   |          
|                                      |  |                                
|Condensed Statements of Operations    |  |                                 |           |   |                  |   |          
|                                      |  | Nine months ended September 30,
|                                      |  | 2006                            |           |   | 2005            
|Revenues and interest income          |  | $                               | 254,473   |   |                  | $ | N/A      
|Expenses                              |  |                                 | (167,822  | ) |                  |   | N/A      
|                                      |  |                                 |           |   |                  |   |          
|Net income                            |  | $                               | 86,651    |   |                  | $ | N/A      
|                                      |  |                                 |           |   |                  |   |          
|Companys share of net income         |  | $                               | 64,122    |   |                  | $ | N/A      
|                                      |  |                                 |           |   |                  |   |          



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The mortgage loan pays interest only at a fixed interest rate of 5.498% through November 1, 2010,
the anticipated repayment date. If the mortgage loan is not repaid or refinanced as of the anticipated repayment date, interest will accrue at a rate per annum equal to the greater of (a) 8.498% and (b) the treasury rate plus three
percentage points. Pursuant to the terms of a cash management agreement, the borrower is required to post a $550,000 letter of credit by the 25thmonth anniversary of the loan date, or the lender will sweep and retain all cash flow from the Property. If the borrower does not pay off the loan on November 1, 2010, the lender can apply the
letter of credit (or retained cash flow) and will continue to sweep all cash flow to repay the loan. In the event of a default under the loan documents, the cash management agreement further provides that the lender may sweep cash from all accounts
maintained by the borrower with the lender (including rent accounts from the property). The estimated principal balance to be due at the anticipated repayment date is $1,950,000.

In general, the mortgage loan may not be prepaid until the earlier of (a) three years or (b) two years after the loan is sold into a
securitization pool and the note cannot be retired or paid off except through a defeasance. In general, no sale, encumbrance or other transfer of an interest in the property is permitted without the lenders prior written consent. Alex Gilbert,
the managing member of 801 FO, LLC has guaranteed the non-recourse standard loan carve outs, and in exchange for his guarantee, Paladin Realty has agreed to fully indemnify Mr. Gilbert against any defaults caused by the borrower through
standard default provisions such as bankruptcy, fraud, misapplication of proceeds and certain environmental violations. The loan agreement obligation is secured by a mortgage on the property and an assignment of rents and personal property. In
addition PRIP 801, LLC has entered into an environmental and hazardous substance indemnification agreement.

The agreements contain various
covenants, which among other things, limit the ability of the borrowers to incur indebtedness, engage in certain business activities, enter into material leases on the property and transfer its interest in the property among others. The loan
agreements also contain customary events of default, including, without limitation, payment defaults, cross-defaults to certain other agreements with respect to the property and bankruptcy-related defaults. In the event of a default, the loan may be
accelerated and all amounts due under the loan will become immediately due and payable.

Pro Forma Financial Information

The following table summarizes on an unaudited pro forma basis, the results of operations for the nine month periods ended September 30, 2005 and
2006 and has been prepared to give effect as if the investments in PRIP 801, LLC and Springhurst occurred on January 1, 2005. The unaudited pro forma results of operations was prepared for informational purposes only and is not necessarily
indicative of future results or of actual results that would have been achieved had the acquisition been consummated as of January 1, 2005.



|                                |  |                    |           |   |                    |   |           |  
|------------------------------- |  | ------------------ | --------- | - | ------------------ | - | --------- | -
|                                |  | September 30, 2005 |           |   | September 30, 2006 |  
|Pro forma revenues              |  | $                  | 1,676,870 |   |                    | $ | 1,723,449 |  
|Pro forma net loss              |  |                    | (655,112  | ) |                    |   | (551,985  | )
|Pro forma loss per common share |  |                    | (1,310.22 | ) |                    |   | (1.47     | )

For the nine months ended September 30, 2005, diluted loss per common share has not been presented as there
were no dilutive potential common shares for the period ended September 30, 2005. For the nine months ended September 30, 2006, diluted loss per common share has been excluded as its effect would be antidilutive.



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4.Mortgage and Note Payable

Mortgage Payable

In connection with
the acquisition of Springhurst mortgage loan in an amount of $16,350,000 on the property was put in place. The mortgage loan pays interest only at a fixed interest rate of 6.14% through July 1, 2016, the maturity date, at which time all
remaining principal and interest shall become due and payable. In general, the mortgage loan may be voluntarily or involuntarily prepaid subject to certain prepayment penalties. The balance to be due at the maturity date is $16,350,000. The loan
agreement obligation is secured by a mortgage on the property and an assignment of rents and personal property.

The agreements contain
various covenants, which among other things, limit the ability of the borrower to incur indebtedness, engage in certain business activities, enter into material leases on the property and transfer their interest in the property among others. The
loan agreements also contain certain customary events of default, including, without limitation, payment defaults, cross-defaults to certain other agreements with respect to the property and bankruptcy-related defaults. In the event of default, the
loan may be accelerated and all amounts due under the loan will become immediately due and payable.

Note Payable to Affiliate

The acquisition of the interest in Springhurst was also partially funded through the assignment of proceeds from a note by and between
Paladin Realty and Wachovia Bank, N.A. dated May 30, 2006 (the Paladin Realty note) to Paladin REIT in the amount of $3,100,000, the proceeds of which were contributed to Paladin OP and used to make Paladin OPs investment in
Springhurst. The Paladin Realty note is personally guaranteed by James R. Worms, Paladin REITs President, John A. Gerson, Paladin REITs Chief Financial Officer, and Michael B. Lenard, Paladin REITs Executive Vice President,
Secretary and Counselor. Paladin Realty is Paladin REITs sponsor and Paladin REITs executive officers are also officers and principals of Paladin Realty. Assignment of the proceeds was made pursuant to a note by and between Paladin
Realty and Paladin REIT (the Company note) on substantially similar terms as the Paladin Realty note. The Company note provides for a loan in the amount of $3,100,000, with an interest rate based on LIBOR plus 2.25%, which was 7.57% on
September 30, 2006. Payments on the Company note are due in consecutive monthly payments of accrued interest only, commencing on July 1, 2006, and continuing on the same day of each month thereafter until fully paid. The term of the
Company note is 180 days from its execution on June 1, 2006. In the event of a default by Paladin REIT under the Company note including nonpayment, false warranty, bankruptcy or certain changes in Paladin REITs structure or business,
Paladin Realty may accelerate the maturity of the Company note, and charge additional interest at a rate of 3%. During the three months ended September 30, 2006, the Company made repayments of $1,700,000 on the Paladin Realty note. As of
September 30, 2006 the outstanding balance of the Paladin Realty note is $1,400,000.

5.Shareholders Equity

Dividends

The board of directors has declared
dividends for the periods listed below to stockholders of record as the close of business each day during the applicable period and paid on the dates listed below.



|                                        |  |                             |   |  |                     
|--------------------------------------- |  | --------------------------- | - |  | --------------------
|Period                                  |  | Annualized RateDeclared (1) |   |  | Date Paid/To be Paid
|August 1, 2006 to August 31, 2006       |  | 6.0                         | % |  | September 15, 2006  
|September 1, 2006 to September 30, 2006 |  | 6.0                         | % |  | October 16, 2006    
|October 1, 2006 to October 31, 2006     |  | 6.0                         | % |  | November 15, 2006   



|(1) | Dividends were declared in the amount of $0.0016438 per share per day, representing an annualized rate of return of 6.0% on an investment of $10.00 per share if paid each day over a
365-day period.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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6.Related Party Transactions

The Advisory Agreement entitles Paladin Advisors to specified fees upon the provision of certain services with regard to the Offering and investment of
funds in real estate and real estate related investments, among other services, as well as reimbursement for organization and offering costs incurred by Paladin Advisors on behalf of the Company (as discussed in Note 2) and certain costs incurred by
Paladin Advisors and its affiliates in providing services to the Company.

Amounts due to Affiliate



|                                                              |  |                    |           |                   |   |          
|------------------------------------------------------------- |  | ------------------ | --------- | ----------------- | - | ---------
|                                                              |  | September 30, 2006 |           | December 31, 2005
|General and administrative expenses due to affiliate (1)      |  | $                  | 69,577    |                   | $ | 35,887   
|Organization and offering costs due to affiliate (2)          |  |                    | 88,406    |                   |   | 51,134   
|Acquisition fees due to affiliate (3)                         |  |                    | 357,456   |                   |   | 93,992   
|                                                              |  |                    |           |                   |   |          
|Total due to affiliate                                        |  | $                  | 515,439   |                   | $ | 181,013  
|Deferred general and administrative expenses due to affiliate |  | $                  | 980,400   |                   | $ | 662,640  
|Deferred organization and offering costs due to affiliate     |  | $                  | 4,101,810 |                   | $ | 3,038,095



|(1) | During the nine months ended September 30, 2006 the Company incurred $239,156 of general and administrative expenses. Due to the application of the 2%/25% Rule (as discussed in
Note 2), the Company recognized $198,269 of general and administrative expenses in its condensed consolidated statement of operations with the difference recorded as due to affiliate. During the three months ended September 30, 2006 the Company
paid $88,496 of general and administrative expenses. Due to the application of the 2%/25% Rule (as discussed in Note 2), the Company recognized $111,940 of general and administrative expenses in its condensed consolidated statement of operations
with the remaining $23,444 recorded as due to affiliate. As of December 31, 2005, the Company had accrued $35,887 in general and administrative expenses due to affiliate. Paladin Advisors has elected to defer (without interest) the net balance
of $69,577 in general and administrative expenses due to affiliate.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(2) | During the nine months ended September 30, 2006, the Company paid $90,685 of offering costs. Due to the application of the 3% limitation (as discussed in Note 2), the Company
recognized $127,957 as a charge to stockholders equity with the remaining $37,272 recorded as due to affiliate. As of December 31, 2005, the Company had accrued $51,134 in organization and offering costs due to affiliate. Paladin Advisors
has elected to defer (without interest) the net balance of $88,406 in organization and offering costs due to affiliate.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(3) | Paladin Advisors was entitled to acquisition and advisory fees related to 801 Fiber Optic Drive and Champion Farms Apartments.
|--- | ------------------------------------------------------------------------------------------------------------------------------

7.Subsequent Events

Sale of Common
Shares

Since September 30, 2006, the Company has raised $737,980 in offering proceeds through the sale of 74,103 common shares in
the offering.

Declaration of Dividends

On October 26, 2006 the board of directors declared dividends for the month of November 2006 in the amount of a 6% annualized return on an investment of $10.00 per share to be paid on December 15, 2006. These dividends are payable
to stockholders of record at the close of business on each day during the period, commencing November 1, 2006 and continuing each day thereafter through and including November 30, 2006.



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|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 the accompanying condensed consolidated financial statements of Paladin Realty
Income Properties, Inc. and the notes thereto. As used herein, the terms we, our and us refer to Paladin Realty Income Properties Inc., a Maryland corporation, and its consolidated subsidiaries.

Forward-Looking Statements

Certain information
included in this Quarterly Report on Form 10-Q contains, and other materials filed or to be filed by us with the Securities and Exchange Commission, or the SEC, contain or will contain, forward-looking statements. All statements, other
than statements of historical facts, including, among others, statements regarding our possible or assumed future results of our business, financial condition, liquidity, results of operations, plans and objectives, are forward-looking statements.
Those statements include statements regarding the intent, belief or current expectations of Paladin Realty Income Properties, Inc., which we refer to as Paladin REIT or the Company, and members of our management team, as well
as the assumptions on which such statements are based, and generally are identified by the use of words such as may, will, seeks, anticipates, believes, estimates,
expects, plans, intends, should or similar expressions. You should not place undue reliance on these forward-looking statements. Statements regarding the following subjects are forward-looking by their
nature:



| |  |  | our business strategy;
| | - |  | ----------------------



| |  |  | our projected operating results;
| | - |  | --------------------------------



| |  |  | our ability to obtain future financing arrangements;
| | - |  | ----------------------------------------------------



| |  |  | estimates relating to our future distributions;
| | - |  | -----------------------------------------------



| |  |  | our understanding of our competition;
| | - |  | -------------------------------------



| |  |  | market trends;
| | - |  | --------------



| |  |  | projected capital expenditures; and
| | - |  | -----------------------------------



| |  |  | use of the proceeds of our Offering.
| | - |  | ------------------------------------

The forward-looking
statements are based on our beliefs, assumptions and expectations of our future performance, taking into account all information currently available to us. These beliefs, assumptions and expectations can change as a result of many possible events or
factors, not all of which are known to us. If a change occurs, our business, financial condition, liquidity and results of operations may vary materially from those expressed in our forward-looking statements. You should carefully consider these
risks before you make an investment decision with respect to our common stock, along with the following factors that could cause actual results to vary from our forward-looking statements:



| |  |  | the factors referenced in Part II, Item 1A. Risk Factors of this Quarterly Report on Form 10-Q;
| | - |  | -----------------------------------------------------------------------------------------------



| |  |  | the factors referenced in Item 1A. Risk Factors of our Annual Report on Form 10-K for the year ended December 31, 2005;
| | - |  | -----------------------------------------------------------------------------------------------------------------------



| |  |  | changes in our business strategy;
| | - |  | ---------------------------------



| |  |  | availability, terms and deployment of capital;
| | - |  | ----------------------------------------------



| |  |  | availability of qualified personnel;
| | - |  | ------------------------------------



| |  |  | changes in our industry, interest rates or the general economy; and
| | - |  | -------------------------------------------------------------------



| |  |  | the degree and nature of our competition.
| | - |  | -----------------------------------------

We believe these
forward-looking statements are reasonable; however, undue reliance should not be placed on any forward-looking statements, which are based on current expectations. All written and oral forward-looking statements attributable to us or persons acting
on our behalf are qualified in their entirety by these cautionary statements. Further, forward-looking statements speak only as of the date they are made, and 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 over time unless required by law.



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##### Table of Contents

Overview

The following Managements Discussion and Analysis of Financial Condition and Results of Operations (MD&A) is intended to help the reader understand Paladin Realty Income Properties, Inc., our operations and our present
business environment. MD&A is provided as a supplement toand should be read in conjunction withour condensed consolidated financial statements and the accompanying notes thereto contained in Item 1 of this report. This
discussion contains forward-looking statements based upon current expectations that involve risks and uncertainties, such as our plans, objectives, expectations and intentions. Actual results and timing of events could differ materially from those
anticipated in these forward-looking statements, as a result of a number of factors, including those factors set forth in Item 1A of Part II of this Quarterly Report and Item 1A of our Annual Report on Form 10-K for the fiscal year
ended December 31, 2005 and other factors presented throughout this report.

We are a Maryland corporation formed on October 31,
2003 that intends to invest in a diversified portfolio of real estate properties, focusing primarily on properties that produce current income. In addition, we may make or acquire mortgage loans secured by, or preferred equity investments in
entities that own, the same types of properties that we may acquire directly, which we refer to collectively as real estate related investments. We intend to qualify as a real estate investment trust, or REIT, and to elect to be taxed as a REIT
beginning with the taxable year ending December 31, 2006.

We plan to own substantially all of our assets and conduct our operations
through Paladin Realty Income Properties, L.P., our operating partnership, which we refer to as Paladin OP. As of September 30, 2006, we have acquired two real estate investments: (1) an interest in 801 Fiber Optic Drive in the
Central Arkansas I-440 Business Park in North Little Rock, Arkansas, which we hold through Paladin OPs 74% interest in PRIP 801, LLC and (2) a 70% membership interest in a single-purpose limited liability company that owns Champion Farms
Apartments at 3700 Springhurst Boulevard in Louisville, Kentucky, which we hold through Paladin OPs wholly owned subsidiary, PRIP 3700, LLC.

On February 23, 2005, we commenced our initial public offering of 35,000,000 common shares of the Company, par value $0.01 per share to the public on a best efforts basis at a price of $10.00 per share. We also registered up to
3,500,000 common shares under the Registration Statement to be issued during the offering pursuant to our dividend reinvestment plan at a price of $10.00 per share. On December 2, 2005, we reached our minimum offering by receiving $1,246,670 in
subscriptions, excluding subscriptions received from Pennsylvania investors. As of September 30, 2006, we had sold 613,215 shares of our common stock in the offering for aggregate gross proceeds of $5,974,713, including shares purchased by
Paladin Realty.

We intend to make an election to be taxed as a REIT under sections 856 through 860 of the Internal Revenue Code, beginning
with the taxable year ending December 31, 2006. If we qualify as a REIT for federal income tax purposes, we generally will not be subject to federal income tax on income that we distribute to our stockholders. If we fail to qualify as a REIT in
any taxable year, we will be subject to federal income tax on our taxable income at regular corporate rates and, if at such time we have previously qualified as a REIT, we will not be permitted to qualify for treatment as a REIT for federal income
tax purposes for four years following the year in which our qualification is lost, unless the Internal Revenue Service grants us relief under certain statutory provisions. Such an event could materially and adversely affect our net income and net
cash available for distribution to stockholders. However, we believe that we are organized and will operate in a manner that will enable us to qualify for treatment as a REIT for federal income tax purposes during the year ending December 31,
2006, and thereafter we intend to continue to operate so as to remain qualified as a REIT for federal income tax purposes.

Critical Accounting Policies

We believe our most critical accounting policies are the accounting for lease revenues (including straight-line rent), the regular
evaluation of whether the value of a real estate asset has been impaired, real estate purchase price allocations and accounting for joint ventures. Each of these items involves estimates that require management to make judgments that are subjective
in nature. We rely on our experience, we collect historical data and current market data, and we analyze these assumptions in order to arrive at what we believe to be reasonable estimates. Under different conditions or assumptions, materially
different amounts could be reported related to the accounting policies described below. In addition, application of these accounting policies involves the exercise of judgments on the use of assumptions as to future uncertainties and, as a result,
actual results could materially differ from these estimates.



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##### Table of Contents

Real Estate and Depreciation

Real estate is stated at cost, less accumulated depreciation. We allocate the cost of newly acquired properties between net tangible and identifiable
intangible assets. The primary intangible asset associated with an apartment property acquisition is the value of the existing lease agreements. When allocating cost to an acquired property, we allocate costs to the estimated value of the land,
building and fixtures assuming the property is vacant, and to the estimated intangible value of the existing lease agreements. We estimate the intangible value of the lease agreements by determining the lost revenue associated with a hypothetical
lease-up. We depreciate the building and fixtures based on the expected useful life of the asset, which is 45 years for the building and improvements and a range of three to seven years for furniture, fixtures and equipment. The intangible value of
the lease agreements is amortized over the average remaining life of the existing leases, which range from twelve to twenty four months. This amortization is included in depreciation and amortization expense on the accompanying condensed
consolidated statements of operations. Expenditures for repairs and maintenance are expensed as incurred.

We review long-lived assets and
related identifiable intangibles for impairment whenever events or changes in circumstances indicate the carrying amount of the assets may not be recoverable. When such events or changes in circumstances occur, recoverability of the asset to be held
and used is measured by a comparison of the carrying amount of the asset to future net cash flows, undiscounted and without interest, expected to be generated by the asset. If the sum of the expected future cash flows (undiscounted and without
interest) is less than our carrying amount for the asset, an impairment loss is recognized based upon the assets fair value.

Revenue Recognition and Collectibility of Related Receivables

Our revenue, which will be comprised largely of rental
income, will include rents that tenants pay in accordance with the terms of their respective leases reported on a straight-line basis over the initial term of the lease. Since our leases may provide for rental increases at specified intervals,
straight-line basis accounting will require us to record as an asset, and include in revenue, unbilled rent that we will only receive if the tenant makes all rent payments required through the expiration of the initial term of the lease.
Accordingly, we must determine, in our judgment, to what extent the unbilled rent receivable applicable to each specific tenant is collectible. We will review unbilled rent receivables on a quarterly basis and take into consideration the
tenants payment history, the financial condition of the tenant, business conditions in the industry in which the tenant operates and economic conditions in the area in which the property is located. In the event that the collectibility of
unbilled rent with respect to any given tenant is in doubt, we would be required to record an increase in our allowance for doubtful accounts or record a direct write-off of the specific rent receivable, which would have an adverse effect on our net
income for the year in which the allowance is increased or the direct write-off is recorded and would decrease our total assets and stockholders equity.

Investments in Real Estate

We record investments in real estate at cost and capitalize improvements
and replacements when they extend the useful life or improve the efficiency of the asset. We expense costs of repairs and maintenance as incurred. We compute depreciation using the straight-line method over the estimated useful lives of our real
estate assets, which we expect will be approximately 45 years for building and improvements, three to seven years for equipment and fixtures and the shorter of the useful life or the remaining lease term for tenant improvements and leasehold
interests.



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##### Table of Contents

We are required to make subjective assessments as to the useful lives of our properties for purposes of
determining the amount of depreciation to record on an annual basis with respect to our investments in real estate. These assessments have a direct impact on our net income because, if we were to shorten the expected useful lives of our investments
in real estate, we would depreciate these investments over fewer years, resulting in more depreciation expense and lower net income on an annual basis.

We apply Statement of Financial Accounting Standard No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, which we refer to as SFAS 144 and which establishes a single
accounting model for the impairment or disposal of long-lived assets including discontinued operations. SFAS 144 requires that the operations related to properties that have been sold or that we intend to sell be presented as discontinued operations
in the statement of income for all periods presented, and properties we intend to sell be designated as held for sale on our balance sheet.

When circumstances such as adverse market conditions indicate a possible impairment of the value of a property, we will review the recoverability of the propertys carrying value. The review of recoverability
will be based on our estimate of the future undiscounted cash flows, excluding interest charges, expected to result from the propertys use and eventual disposition. Our forecast of these cash flows will consider factors such as expected future
operating income, market and other applicable trends and residual value, as well as the effects of leasing demand, competition and other factors. If impairment exists due to the inability to recover the carrying value of a property, an impairment
loss will be recorded to the extent that the carrying value exceeds the estimated fair value of the property. We will be required to make subjective assessments as to whether there are impairments in the values of our investments in real estate. We
will evaluate the collectibility of both interest and principal related to any real estate related investments in which we may invest. If circumstances indicate that such investment is impaired, we will reduce the carrying value of the investment to
its net realizable value. Such reduction in value will be reflected as a charge to operations in the period in which the determination is made.

Investments

We evaluate our investments in accordance with Financial Accounting Standards Board, Interpretation No. 46
(revised December 2003), Consolidation of Variable Interest Entities, which we refer to as FIN 46R. If we determine that the joint venture is a variable interest entity, or a VIE, and that we are the primary
beneficiary as defined in FIN 46R, we would account for such investment as if it were a consolidated subsidiary. For a joint venture investment which is not a VIE or in which we are not the primary beneficiary, we will consider other relevant
accounting literature including Accounting Principle Board Opinion 18 The Equity Method of Accounting for Investments in Common Stock, Statement of Position 78-9 Accounting for Investments in Real Estate Ventures,
and Emerging Issues Task Force Issue 04-5 to determine the method of accounting for each of our partially-owned entities. In accordance with the above pronouncements, we will determine whether we should consolidate the entity or account for it on
the equity method or cost method. Factors that we will consider in determining whether or not we exercise control include substantive participating rights of partners on significant business decisions, including dispositions and acquisitions of
assets, financing and operating and capital budgets, board and management representatives and authority and other contractual rights of our partners. To the extent that we are deemed to control these entities, these entities would be consolidated.

As of September 30, 2006, we hold a 96.8% interest in Paladin OP and through Paladin OP hold a 70% ownership interest in Springhurst
and a 74% ownership interest in PRIP 801, LLC. We have determined that Paladin OP and its investments in Springhurst and PRIP 801, LLC are not VIEs. We consolidate Paladin OP and Springhurst, as we are the majority owner and exercise control over
all significant decisions. We account for the investment in PRIP 801, LLC under the equity method of accounting as the other member has substantive participating rights as defined in EITF 04-5 and SOP 78-9. The investment is recorded initially at
cost, and subsequently adjusted for equity in earnings or losses and cash contributions and distributions.

On a periodic basis we will
evaluate whether there are any indicators that the value of our investments in partially-owned entities are impaired. An investment is impaired if our estimate of the value of the investment is less than the carrying amount. The ultimate realization
of our investment in partially-owned entities is dependent on a number of factors including the performance of that entity and market conditions. If we determine that a decline in the value of a partially-owned entity is other than temporary, then
we would record an impairment charge.



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##### Table of Contents

Results of Operations

Prior to acquiring an interest in 801 Fiber Optic Drive on November 2, 2005, we had not commenced any operations. In addition, we did not reach our minimum offering of at least $1,000,000 in shares until
December 2, 2005, when we received $1,246,670 in subscriptions for 127,690 shares, excluding subscriptions received from Pennsylvania investors. As a result, we had limited operations in 2005, and none prior to the effective date of our
registration statement in February 2005. As of September 30, 2006, we had sold 613,215 shares in the offering for aggregate proceeds of $5,974,713, including shares sold to Paladin Realty Partners, LLC.

Three Months Ended September 30, 2006 Compared to Three Months Ended September 30, 2005

We had a net loss of $303,994 for the three months ended September 30, 2006 relating to $309,064 in interest expense, including amortization of
financing costs, $234,621 in depreciation and amortization expense, $126,141 in general and administrative expenses, $197,221 in property operating expenses and $34,548 in real property taxes offset by $20,804 of equity in earnings of PRIP 801 LLC,
$516,867 of rental income at Champion Farms Apartments, $41,405 of other income from Champion Farms Apartments and interest income of $7,904. Net income of $43 for the three months ended September 30, 2005 related solely to $1,772 of interest
income reduced by minority interest of $1,729.

Pursuant to the advisory agreement between Paladin REIT and Paladin Advisors, Paladin
Advisors is entitled to reimbursement of actual expenses incurred for administrative and other services provided to us by Paladin Advisors and its affiliates for which they do not otherwise receive a fee. We will not reimburse Paladin Advisors for
operating expenses that in the fiscal year then ended exceeded the greater of (1) 2% of our average invested assets or (2) 25% of our net income (the 2%/25% Rule), and Paladin Advisors must reimburse us quarterly for any amounts by
which our operating expenses exceed the 2%/25% Rule in the previous four consecutive fiscal quarters (the Expense Period).

Our
average invested assets for any period are equal to the average book value of our assets invested in equity interests in, and loans secured by, real estate before reserves for depreciation or bad debts or other similar non-cash reserves computed by
taking the average of such values at the end of each month during the period. Our net income for any period is equal to our total revenue less total expenses other than additions to reserves for depreciation, bad debts or other similar non-cash
reserves for such period. Operating expenses include all expenses incurred by us under GAAP (including the asset management fee), but excluding organization and offering expenses, selling commissions and dealer manager fees, interest payments,
taxes, non-cash expenditures such as depreciation, amortization and bad debt reserves, the subordinated disposition fee, acquisition and advisory fees and expenses and distributions pursuant to Paladin Advisors subordinated participation
interest in Paladin OP.

Paladin Advisors must reimburse the excess expenses to us within 60 days after the end of each fiscal quarter
unless the independent directors determine that the excess expenses were justified based on unusual and nonrecurring factors which they deem sufficient. Within 60 days after the end of any Expense Period for which total operating expenses exceed the
2%/25% Rule, we will send our stockholders a written disclosure, together with an explanation of the factors the independent directors considered in arriving at the conclusion that the excess expenses were justified. However, at Paladin
Advisors option, Paladin Advisors or its affiliate, as applicable may defer receipt of any portion of the asset management fee or reimbursement of expenses and elect to receive such payments, without interest, in any subsequent fiscal year
that Paladin Advisors designates.

During the three months ended September 30, 2006, we paid $88,496 of general and administrative
expenses. Due to the application of the 2%/25% Rule, we recognized $111,940 of general and administrative expenses in our condensed consolidated statement of operations with the balance of $23,444 being recorded as due to affiliate. The remaining
$14,201 of general and administrative expenses recorded in our condensed consolidated statement of operations relates primarily to amortization of deferred compensation related to the vesting of restricted shares granted to our independent
directors.



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##### Table of Contents

As of September 30, 2006, Paladin Advisors and its affiliates had incurred $980,400 in general and
administrative expenses on our behalf, none of which are accrued on the condensed consolidated statement of operations for the three months ended September 30, 2006. As of September 30, 2006, Paladin Advisors was also entitled to
acquisition and advisory fees of $357,456 and asset management fees of $37,959 relating to the management of 801 Fiber Optic Drive and Champion Farms Apartments. The acquisition and advisory fees were capitalized as part of these investments.
Pursuant to the terms of the advisory agreement, Paladin Advisors has elected to defer (without interest) receipt of all of these fees and expenses. During the three months ended September 30, 2005, we did not record any amounts for general and
administrative expenses as all such expenses were paid by Paladin Advisors and its affiliates.

As of September 30, 2006, the Company
had incurred organization and offering costs of $4,192,495 which includes $4,101,810 paid by Paladin Advisors on our behalf. Due to the 3% limitation, however, we only recognized $60,218 of such costs for the three months ended September 30,
2006, which were recognized as charges to stockholders equity on the condensed consolidated statement of operations. For the nine months ended September 30, 2006, we have recognized $127,957 of offering costs. In addition, we recognized
$51,134 of organization costs in our condensed consolidated statement of operations for the period ended December 31, 2005. During the three months ended September 30, 2006, we paid no offering costs. The remaining $4,013,404 in
organization and offering costs will be recorded in future periods as we receive additional proceeds of the offering.

For the three months
ended September 30, 2006, our share of the equity in earnings of 801 Fiber Optic Drive was $20,804.

The minority interest of $10,621
for the three months ended September 30, 2006 relates to Paladin Advisors interest in Paladin OP and Buckinghams interest in Springhurst. The minority interest of $1,729 for the three months ended September 30, 2005 relates to
Paladin Advisors interest in Paladin OP.

Our results of operations for the three months ended September 30, 2005 are not
indicative of future performance due to the limited operations during that quarter. During the three months ended September 30, 2005, we had not reached our minimum offering or acquired any real estate or real estate related investments. As a
result, we had no results of operations for that period.

Our management is not aware of any material trends or uncertainties, other than
national economic conditions affecting real estate generally, that may reasonably be expected to have a material impact, favorable or unfavorable, on revenues or income from the acquisition, management and operation of real estate and real estate
related investments.

Nine Months Ended September 30, 2006 Compared to Nine Months Ended September 30, 2005

We had a net loss of $414,258 for the nine months ended September 30, 2006 primarily relating to $412,385 of interest expense, including amortization
of financing costs, $228,462 of general and administrative expenses, $312,497 of depreciation and amortization expense, $252,205 of property operating expenses and $46,064 of real property taxes offset by $62,106 of equity in earnings of PRIP 801,
LLC, $690,999 of rental income for Champion Farms Apartments, $60,676 of other income from Champion Farms Apartments and interest income of $12,784. Net income of $150 for the nine months ended September 30, 2005 related solely to $6,140 of
interest income reduced by minority interest of $5,990.

During the nine months ended September 30, 2006, we incurred $239,156 of
general and administrative expenses. Due to the application of the 2%/25% Rule, we recognized $198,269 of general and administrative expenses in our condensed consolidated statement of operations with the difference recorded as to due to affiliate.
The remaining $30,194 of general and administrative expenses recorded in our condensed consolidated statement of operations relates primarily to amortization of deferred compensation related to the vesting of restricted shares granted to our
independent directors.

For the nine months ended September 30, 2006, our share of the equity in earnings of 801 Fiber Optic Drive was
$62,106.



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##### Table of Contents

The minority interest of $10,790 for the nine months ended September 30, 2006 relates to Paladin
Advisors interest in Paladin OP and Buckinghams interest in Springhurst. The minority interest share of $5,990 for the nine months ended September 30, 2005 relates to Paladin Advisors interest in Paladin OP.

Our results of operations for the nine months ended September 30, 2005 are not indicative of future performance due to the limited operations during
that period. During the nine months ended September 30, 2005, we had not reached our minimum offering or acquired any real estate or real estate related investment. As a result, we had no results of operations for that period.

Liquidity and Capital Resources

During the nine months ended
September 30, 2006, our source of funds were:



| |  |  | interest income of $12,784;
| | - |  | ---------------------------



| |  |  | gross proceeds of $4,265,244 from the sale of 427,688 common shares in our initial public offering;
| | - |  | ---------------------------------------------------------------------------------------------------



| |  |  | distributions from our investment in 801 Fiber Optic Drive of $106,731; and
| | - |  | ---------------------------------------------------------------------------



| |  |  | rental income and other income at Champion Farms Apartments of $751,675.
| | - |  | ------------------------------------------------------------------------

We are dependent upon the net proceeds to be received from the offering to conduct our proposed activities. The capital required to purchase real estate and real estate related investments will be obtained from the
offering and from any indebtedness that we may incur in connection with the acquisition of any real estate and real estate related investments thereafter. We anticipate our sources of funds will continue to primarily consist of the net proceeds of
the offering. We believe that these cash resources will be sufficient to satisfy our cash requirements for the foreseeable future, and we do not anticipate a need to raise funds from other than these sources within the next twelve months.

Net cash provided by (used in) operating activities for the nine months ended September 30, 2006 was ($75,287) and $6,140 for the
comparable period of 2005.

Net cash used in investing activities for the nine months ended was $20,810,825, which included $21,140,226
relating to the purchase of real estate and improvements, increase in due to affiliates of $263,464 relating to payments of closing costs paid by such affiliates, and $40,794 in investment in real estate joint venture offset by distributions from
real estate joint venture of $106,731. We had no investment activities during the same period of 2005.

Net cash provided by financing
activities was $21,188,430 for the nine months ended September 30, 2006 primarily related to $16,350,000 of borrowings from mortgage payable and net borrowings of $1,400,000 from note payable relating to the Champion Farms acquisition described
below and $4,265,244 in proceeds from the issuance of common shares in our offering offset primarily by $398,666 of selling commissions and dealer manager fees, $180,200 of deferred loan costs, $127,957 of offering costs, $150,327 of dividends paid
and $6,936 of distributions to minority interest. We had no financing activities during the same period of 2005.

In connection with the
closing of the Champion Farms acquisition, Springhurst put in place a mortgage loan in an amount of $16,350,000 on the property (the Springhurst Mortgage). The mortgage loan pays interest only at a fixed interest rate of 6.14% through
July 1, 2016, the maturity date, at which time all remaining principal and interest will become due and payable. In general, the mortgage loan may be voluntarily or involuntarily prepaid subject to certain prepayment penalties. The balance to
be due at the maturity date is $16,350,000. The loan agreement obligation is secured by a mortgage on the property and an assignment of rents and personal property.

The acquisition of the property interest in Champion Farms was partially funded through the assignment of proceeds from a note by and between Paladin Realty and Wachovia Bank, N.A. dated May 30, 2006 (the
Paladin Realty note) to us in the amount of $3,100,000, the proceeds of which were contributed to Paladin OP and used to make Paladin OPs investment in PRIP 3700, LLC. The Paladin Realty note was personally guaranteed by James R.
Worms, our President, John A. Gerson, our Chief Financial Officer, and Michael B. Lenard, our Executive Vice President, Secretary and Counselor. Paladin



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##### Table of Contents

Realty is our sponsor and our executive officers are also officers and principals of Paladin Realty. Assignment of the proceeds was made pursuant to a note
by and between Paladin Realty and Paladin REIT dated June 1, 2006 (the Company note) on substantially similar terms as the Paladin Realty note. The Company note provides for a loan in the amount of $3,100,000, with an interest rate
based on LIBOR plus 2.25%, which was 7.57% on September 30, 2006. Payments on the Company note are due in consecutive monthly payments of accrued interest only, commencing on July 1, 2006, and continuing on the same day of each month
thereafter until fully paid. The term of the Company note is 180 days from its execution on June 1, 2006. In the event of a default by Paladin REIT under the Company note including nonpayment, false warranty, bankruptcy or certain changes in
Paladin REITs structure or business, Paladin Realty may accelerate the maturity of the Company note, and charge additional interest at a rate of 3%. As of September 30, 2006, the outstanding balance of the Paladin Realty note is
$1,400,000.

As of September 30, 2006, the Company had $17,750,000 outstanding indebtedness relating to the Paladin Realty note and
the Springhurst Mortgage, and PRIP 801 had a $1,950,000 mortgage loan, the entire principal of which is due in 2010.

Dividends

We paid $150,327 in dividends during the nine months ended September 30, 2006. Our board of directors has declared dividends for the periods listed
below to stockholders of record as the close of business each day during the applicable period and paid on the dates listed below.



|                                        |  |                             |   |  |                    |  |                    |       
|--------------------------------------- |  | --------------------------- | - |  | ------------------ |  | ------------------ | ------
|Period                                  |  | Annualized RateDeclared (1) |   |  | Date Paid          |  | TotalDividends (2)
|December 2, 2005 to December 30, 2005   |  | 6.0                         | % |  | January 17, 2006   |  | $                  | 7,212 
|December 31, 2005 to January 31, 2006   |  | 6.0                         | % |  | February 15, 2006  |  | $                  | 10,424
|February 1, 2006 to February 28, 2006   |  | 6.0                         | % |  | March 15, 2006     |  | $                  | 10,832
|March 1, 2006 to March 31, 2006         |  | 6.0                         | % |  | April 17, 2006     |  | $                  | 15,465
|April 1, 2006 to April 30, 2006         |  | 6.0                         | % |  | May 15, 2006       |  | $                  | 17,145
|May 1, 2006 to May 31, 2006             |  | 6.0                         | % |  | June 15, 2006      |  | $                  | 19,905
|June 1, 2006 to June 30, 2006           |  | 6.0                         | % |  | July 17, 2006      |  | $                  | 20,274
|July 1, 2006 to July 31, 2006           |  | 6.0                         | % |  | August 15, 2006    |  | $                  | 21,529
|August 1, 2006 to August 31, 2006       |  | 6.0                         | % |  | September 15, 2006 |  | $                  | 27,541
|September 1, 2006 to September 30, 2006 |  | 6.0                         | % |  | October 16, 2006   |  | $                  | 29,413



|(1) | Dividends were declared in the amount of $0.0016438 per share per day, representing an annualized rate of return of 6.0% on an investment of $10.00 per share if paid each day over a
365-day period.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(2) | On September 25, 2006, our board of directors declared dividends for the month of October 2006 which will total $32,563 when paid in November 2006. On October 26, 2006,
our board of directors declared dividends for the month of November 2006 which will total approximately $35,400 when paid in December 2006.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

These dividends were set by our board of directors at a level we believe to be appropriate based upon an evaluation of our assets and liabilities, projected levels of cash flow, additional capital and debt anticipated
to be raised or incurred and invested in the future and our projected results of operations. As of the date of this Quarterly Report on Form 10-Q, we have paid $179,740 in dividends to our stockholders. However, through the nine months ended
September 30, 2006 we have had negative cash flows from operations and for the quarter ended September 30, 2006 cash flows from operations were insufficient to pay our operating expenses and to cover the dividends we have paid or declared
to our stockholders. Specifically, net cash used in operations was $8,754 for the year ended December 31, 2005 including a $87,021 in increase due to affiliates and net cash used in operations was $75,287 for the nine months ended
September 30, 2006 including a $33,690 increase in due to affiliates. Because our cash flows from operations have been insufficient to pay our operating expenses and to cover the dividends we have paid or declared to our stockholders through
the date of this Quarterly Report on Form 10-Q, we cannot assure you that we will be able to continue paying dividends to our stockholders at our historical per-share amounts, or that the dividends we pay will not decrease or be eliminated in the
future. In order to permit us to pay dividends declared to date, we have used cash distributions from our investments, Paladin Advisors has paid expenses on our behalf, and Paladin Advisors has deferred the reimbursement of these expense payments
and its receipt of asset management and acquisition and advisory fees.



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As of September 30, 2006, Paladin Advisors had paid on our behalf $4,101,810 in organization and
offering costs, none of which has been repaid. In addition, as of September 30, 2006, Paladin Advisors and its affiliates had paid on our behalf $980,400 in general and administrative expenses, none of which has been repaid. As described above,
Paladin Advisors must reimburse us quarterly for any amounts by which our operating expenses exceed the 2%/25% Rule in any Expense Period. During the Expense Period ended September 30, 2006, our operating expenses including expenses incurred on
behalf of us by Paladin Advisors and its affiliates exceeded the 2%/25% Rule by $475,388. In accordance with the advisory agreement, Paladin Advisors has deferred payment of such amount and it was recorded as a reduction in general and
administrative expenses and asset management fees, as described in Note 6 to our condensed consolidated financial statements. As of September 30, 2006, Paladin Advisors was also entitled to acquisition and advisory fees of $357,456 and asset
management fees of $37,959 relating to 801 Fiber Optic Drive and Champion Farms Apartments. The acquisition and advisory fees were capitalized as part of these investments. Pursuant to the terms of the Advisory Agreement, Paladin Advisors has
elected to defer (without interest) receipt of all of these fees and expenses including the amounts that are accrued on the condensed consolidated statement of operations for the nine months ended September 30, 2006.

We are obligated to pay these amounts to Paladin Advisors in the future, and the payment of these obligations may impact our ability to pay future
dividends. Paladin Advisors is not obligated to either pay expenses on our behalf or defer reimbursements of such expense payments or fees in future periods. At such time as Paladin Advisors requires us to reimburse such expense payments or pay
those fees, or if Paladin Advisors were to cease paying expenses on our behalf or deferring reimbursement of expense payments or fees, our ability to pay dividends to our stockholders could be adversely affected, and we may be unable to pay
dividends to our stockholders, or such dividends could decrease significantly. Additionally, if Paladin Advisors continues to pay expenses on our behalf and/or defer reimbursement of expense payments or fees, the ultimate repayment of these
obligations could adversely impact on our ability to pay dividends in future periods as well as potentially adversely impact the value of your investment.

The amount of dividends to be distributed to our stockholders in the future will be determined by our board of directors and are dependent on a number of factors, including funds available for payment of dividends
(including whether Paladin Advisors continues to pay expenses or defer and/or defer reimbursement of expense payments or fees), our financial condition, capital expenditure requirements, annual distribution requirements needed to maintain our status
as a REIT under the Internal Revenue Code and any limitations imposed by the terms of indebtedness we may incur and other factors.



|ITEM 3. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
|------- | -----------------------------------------------------------

Market risk includes risks that arise from changes in interest rates, foreign currency exchange rates, commodity prices, equity prices and other market changes that affect market sensitive instruments. In pursuing our
business plan, we expect that the primary market risk to which we will be exposed is interest rate risk.

We may be exposed to the effects
of interest rate changes primarily as a result of borrowings used to maintain liquidity and fund expansion and refinancing of our real estate investment portfolio and operations. Our interest rate risk management objectives will be to limit the
impact of interest rate changes on earnings, prepayment penalties and cash flows and to lower overall borrowing costs while taking into account variable interest rate risk. To achieve our objectives, we may borrow at fixed rates or variable rates.
We may also enter into derivative financial instruments such as interest rate swaps and caps in order to mitigate our interest rate risk on a related financial instrument. We will not enter into derivative or interest rate transactions for
speculative purposes.

In addition to changes in interest rates, the value of our real estate and real estate related investments is
subject to fluctuations based on changes in local and regional economic conditions and changes in the creditworthiness of lessees, and which may affect our ability to refinance our debt if necessary.



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|ITEM 4. | CONTROLS AND PROCEDURES.
|------- | ------------------------

As of the end of the
period covered by this report, management, including our chief executive officer and chief financial officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures. Based upon, and as of the date of, the
evaluation, our chief executive officer and chief financial officer concluded that the disclosure controls and procedures were effective, in all material respects, to ensure that information required to be disclosed in the reports we file and submit
under the Exchange Act is recorded, processed, summarized and reported as and when required.

There have been no significant changes in our
internal control over financial reporting that occurred during our last fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. There were no significant deficiencies
or material weaknesses identified in the evaluation, and therefore, no corrective actions were taken.



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PART II - OTHER INFORMATION



|ITEM 1. | LEGAL PROCEEDINGS.
|------- | ------------------

None.



|ITEM 1A. | RISK FACTORS
|-------- | ------------

To date cash flows from operations were
insufficient to pay our operating expenses and to cover the dividends we have paid and/or declared. In order to permit us to pay dividends, Paladin Advisors has paid expenses on our behalf and deferred the reimbursement of such expense payments and
its receipt of fees we owe Paladin Advisors. We cannot assure you that in the future we will be able to achieve cash flows necessary to pay both our expenses and dividends at our historical per share amounts, or to maintain dividends at any
particular level, if at all.

Because our cash flows from operations have been insufficient to pay our operating expenses and to
cover the dividends we have paid or declared to our stockholders through the date of this Quarterly Report on Form 10-Q, we cannot assure you that we will be able to continue paying dividends to our stockholders at our historical per-share amounts,
or that the dividends we pay will not decrease or be eliminated in the future. As of the date of this Quarterly Report on Form 10-Q, we have paid $179,740 in dividends to our stockholders. In order to permit us to pay dividends declared to date, we
have used cash distributions from our investments, Paladin Advisors has paid expenses on our behalf, and Paladin Advisors has deferred the reimbursement of expense payments and its receipt of asset management and acquisition and advisory fees.

Specifically, as of September 30, 2006, Paladin Advisors paid on our behalf $4,101,810 in organization and offering costs, none of
which has been repaid to Paladin Advisors. In addition, Paladin Advisors and its affiliates paid on our behalf $980,400 in general and administrative expenses, none of which has been repaid to Paladin advisors.

Pursuant to the Advisory Agreement, we will not reimburse Paladin Advisors for operating expenses that in the fiscal year then ended exceed the greater
of (1) 2% of our average invested assets or (2) 25% of our net income, which we refer to as the 2%/25% Rule, and Paladin Advisors must reimburse us quarterly for any amounts by which the operating expenses of Paladin REIT
exceed the 2%/25% Rule in the previous four consecutive fiscal quarters. During the previous four fiscal quarters, our operating expenses including expenses incurred on behalf of us by Paladin Advisors and its affiliates exceeded the 2%/25% Rule by
$475,388, which includes general and administrative expenses and asset management fees related to 801 Fiber Optic Drive and Champion Farms Apartments. In accordance with the advisory agreement, Paladin Advisors has deferred payment of such amount
and it was recorded as a reduction in general and administrative expenses and asset management fees. See Note 6 to our condensed consolidated financial statement for the nine months ended September 30, 2006. Paladin Advisors was also entitled
to acquisition and advisory fees of $357,456 and asset management fees of $37,959 relating to 801 Fiber Optic Drive and Champion Farms Apartments. The acquisition and advisory fees were capitalized as part of the investment. Pursuant to the terms of
the Advisory Agreement, Paladin Advisors has elected to defer (without interest) receipt of all of these fees and expenses.

We are
obligated to pay these amounts to Paladin Advisors in the future, and the payment of these obligations may impact our ability to pay future dividends. Paladin Advisors is not obligated to either pay expenses on our behalf or defer reimbursements of
expense payments or fees in future periods. At such time as Paladin Advisors requires us to reimburse such expense payments or pay those fees, or if Paladin Advisors were to cease paying expenses on our behalf or deferring reimbursement of expense
payments or fees, our ability to pay dividends to our stockholders could be adversely affected, and we may be unable to pay dividends to our stockholders, or such dividends could decrease significantly. Additionally, if Paladin Advisors continues to
pay expenses on our behalf and/or defer reimbursement of expense payments or fees, the ultimate repayment of these obligations could adversely impact our ability to pay dividends in future periods as well as potentially adversely impact the value of
your investment.



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Our directors will determine the amount and timing of future cash dividends to our stockholders based on
many factors, including the amount of funds available for distribution (including whether Paladin Advisors continues to pay expenses and/or defer reimbursement of expense payments or fees), our financial condition, requirements we must meet to
qualify to be taxed as a REIT, whether to reinvest or distribute such funds, capital expenditures and reserve requirements and general operational requirements. The amount of funds available for distribution will be affected by our ability to
identify and make real estate or real estate related investments as offering proceeds become available, the returns on those real estate or real estate related investments we make and our operating expense levels, as well as many other variables. We
cannot predict how long it may take to identify additional real estate or real estate related investments, to raise sufficient proceeds or to make real estate or real estate related investments. We likewise cannot predict whether we will generate
sufficient cash flow to continue to pay dividends at historical levels or at all.

In addition, differences in timing between the
recognition of income and the related cash receipts or the effect of required debt amortization payments could require us to borrow money, use proceeds from the issuance of securities or sell assets to pay out enough of our taxable income to satisfy
the requirement that we distribute at least 90% of our taxable income, other than any net capital gains, in order to qualify as a REIT.

There were no other material changes in our Risk Factors as previously disclosed in Item 1A of our Form 10-K for the year ended December 31, 2005.



|ITEM 2. | UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
|------- | ------------------------------------------------------------

On February 23, 2005, our initial public offering (SEC File No. 333-113863) was declared effective and we commenced our offering efforts. As of September 30, 2006, we had sold 613,215 shares of common
stock in the offering, raising gross offering proceeds of $5,974,713 including shares sold to Paladin Realty. From this amount, we have incurred $539,489 in selling commissions and dealer manager fees to Prospect Financial Advisors, LLC, $4,192,495
in organization and offering costs, $357,456 in acquisition and advisory fees and $37,959 in asset management fees

For information
regarding how we used the net proceeds from our initial public offering (along with how we used cash from operating activities) through September 30, 2006, see our condensed consolidated statements of cash flows included in this report and in
our Annual Report on Form 10-K for the year ended December 31, 2005.



|ITEM 3. | DEFAULTS UPON SENIOR SECURITIES.
|------- | --------------------------------

None.



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

None.



|ITEM 5. | OTHER INFORMATION.
|------- | ------------------

None.



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|ITEM 6. | EXHIBITS.
|------- | ---------



|            |  |                                                                                                                                                                                       
|----------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |  | Description                                                                                                                                                                           
|            | 
|3.1         |  | Amended and Restated Articles of Incorporation of Paladin Realty Income Properties, Inc. (incorporated by reference to the registrants Form 10-Q for the period ending June 30,
2005)
|            | 
|3.2         |  | Bylaws of Paladin Realty Income Properties, Inc. (incorporated by reference to the registrants Form 10-Q for the period ending March 31, 2005)                                       
|            | 
|4.1         |  | Form of Subscription Agreement (incorporated by reference to the registrants Registration Statement on Form S-11 (File No. 333-113863))                                              
|            | 
|31.1        |  | Section 302 Certification of Principal Executive Officer                                                                                                                              
|            | 
|31.2        |  | Section 302 Certification of Principal Financial Officer                                                                                                                              
|            | 
|32.1        |  | Section 906 Certification of Principal Executive Officer                                                                                                                              
|            | 
|32.2        |  | Section 906 Certification of Principal Financial Officer                                                                                                                              



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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.



|                        |  |  |  |                                        |  |                    |  |                                                
|----------------------- |  |  |  | -------------------------------------- |  | ------------------ |  | -----------------------------------------------
|                        |  |  |  | PALADIN REALTY INCOME PROPERTIES, INC.
|                        |  |  | 
|Date: November 13, 2006 |  |  |  | By:                                    |  | /s/ James R. Worms
|                        |  |  |  |                                        |  |                    |  | James R. Worms                                 
|                        |  |  |  |                                        |  |                    |  | President, Chief Executive Officer and Director
|                        |  |  |  |                                        |  |                    |  | (Principal Executive Officer)                  



|                        |  |  |  |     |  |                    |  |                                                                         
|----------------------- |  |  |  | --- |  | ------------------ |  | ------------------------------------------------------------------------
|                        |  |  | 
|Date: November 13, 2006 |  |  |  | By: |  | /s/ John A. Gerson
|                        |  |  |  |     |  |                    |  | John A. Gerson                                                          
|                        |  |  |  |     |  |                    |  | Executive Vice President, Chief Financial Officer and Director          
|                        |  |  |  |     |  |                    |  | (Duly Authorized Officer and Principal Financial and Accounting Officer)



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EXHIBIT INDEX



|            |  |                                                                                                                                                                                       
|----------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |  | Description                                                                                                                                                                           
|            | 
|3.1         |  | Amended and Restated Articles of Incorporation of Paladin Realty Income Properties, Inc. (incorporated by reference to the registrants Form 10-Q for the period ending June 30,
2005)
|            | 
|3.2         |  | Bylaws of Paladin Realty Income Properties, Inc. (incorporated by reference to the registrants Form 10-Q for the period ending March 31, 2005)                                       
|            | 
|4.1         |  | Form of Subscription Agreement (incorporated by reference to the registrants Registration Statement on Form S-11 (File No. 333-113863))                                              
|            | 
|31.1        |  | Section 302 Certification of Principal Executive Officer                                                                                                                              
|            | 
|31.2        |  | Section 302 Certification of Principal Financial Officer                                                                                                                              
|            | 
|32.1        |  | Section 906 Certification of Principal Executive Officer                                                                                                                              
|            | 
|32.2        |  | Section 906 Certification of Principal Financial Officer                                                                                                                              



28