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UNITED STATES
SECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended September 30, 2008

Commission File Number: 001-32330

NORTHSTAR REALTY FINANCE CORP.(Exact Name of Registrant as Specified in its Charter)

Maryland(State or Other Jurisdiction of
Incorporation or Organization)

11-3707493(IRS Employer
Identification No.)


399 Park Avenue, 18th Floor New York, NY 10022(Address of Principal Executive Offices, Including Zip Code)

(212) 547-2600(Registrant's Telephone Number, Including Area Code)

Indicate
by the 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 ý        No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting
company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer ý

Accelerated filer o

Non-accelerated filer o (Do not check if a smaller reporting company)

Smaller reporting company o


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

Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practicable date:

The
Company has one class of common stock, par value $0.01 per share, with 62,989,909 shares outstanding as of November 5, 2008.



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NORTHSTAR REALTY FINANCE CORP.  QUARTERLY REPORT  For the Three and Nine Months Ended September 30, 2008

TABLE OF CONTENTS



Index



PagePart I.

Financial InformationItem 1.

Financial StatementsCondensed Consolidated Balance Sheets as of September 30,
2008 (unaudited) and December 31, 2007

3Unaudited Condensed Consolidated Statements of Operations for the
three and nine months ended September 30, 2008 and September 30, 2007

4Unaudited Condensed Consolidated Statements of Comprehensive
Income for the three and nine months ended September 30, 2008 and September 30, 2007

5Unaudited Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2008 and
September 30, 2007

6Notes to the Condensed Consolidated Financial Statements
(unaudited)

7Item 2.

Management's Discussion and Analysis of Financial Condition and
Results of Operations

41Item 3.

Quantitative and Qualitative Disclosures about Market
Risk

66Item 4.

Controls and Procedures

70Part II.

Other Information

71Item 6.

Exhibits

71Signatures

76


2

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NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES        CONDENSED CONSOLIDATED BALANCE SHEETS        (Amounts in Thousands)

September 30,
2008

December 31,
2007(unaudited)ASSETS:Cash and cash equivalents

$
164,593

$
153,829Restricted cash


162,288


202,295Operating real estatenet


1,136,378


1,134,136Available for sale securities, at fair value


391,509


549,522Collateral held by broker





12,746Real estate debt investments, net


2,005,697


2,007,022Corporate loan investments





457,139Investments in and advances to unconsolidated ventures


106,007


33,143Receivables, net of allowance of $0 and $1 in 2008 and 2007, respectively


27,131


32,141Unbilled rents receivable


7,488


5,684Derivative instrument, at fair value


42


Deferred costs and intangible assets, net


78,014


126,677Other assets


41,718


78,448Total assets


4,120,865


4,792,782LIABILITIES AND STOCKHOLDERS' EQUITY:Liabilities:Mortgage notes and loans payable


908,601


912,365Exchangeable senior notes, measured at fair value as of September 30, 2008


196,770


172,500Bonds payable, measured at fair value as of September 30, 2008


860,771


1,654,185Credit facilities


48,216


501,432Secured term loans


410,281


416,934Liability to subsidiary trusts issuing preferred securities, measured at fair value as of September 30, 2008


95,582


286,258Repurchase obligations


1,540


1,864Securities sold, not yet purchased, at fair value





12,856Obligations under capital leases


3,561


3,541Accounts payable and accrued expenses


20,979


34,893Escrow deposits payable


49,947


65,445Derivative liability, at fair value


44,902


49,280Other liabilities


39,385


40,695Total liabilities


2,680,535


4,152,248Minority interest in operating partnership


79,347


7,534Minority interest in joint ventures


101,306


14,961Stockholders' Equity:8.75% Series A preferred stock, $0.01 par value, $25 liquidation preference per share, 2,400,000 shares issued and outstanding at September 30,
2008 and December 31, 2007, respectively


57,867


57,8678.25% Series B preferred stock, $0.01 par value, $25 liquidation preference per share, 7,600,000 shares issued and outstanding at September 30,
2008 and December 31, 2007, respectively


183,505


183,505Common stock, $0.01 par value, 500,000,000 shares authorized, 62,986,070 and 61,719,469 shares issued and outstanding at September 30, 2008 and
December 31, 2007, respectively


630


617Additional paid-in capital


607,573


595,418Retained earnings (deficit)


494,615


(40,075
)Accumulated other comprehensive loss


(84,513
)

(179,293
)Total stockholders' equity


1,259,677


618,039Total liabilities and stockholders' equity

$
4,120,865

$
4,792,782


See accompanying notes to condensed consolidated financial statements

3

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NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES        CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS        (Amounts in Thousands, Except Per Share Data)
(unaudited)

Three
Months Ended
September 30,
2008

Three
Months Ended
September 30,
2007

Nine
Months Ended
September 30,
2008

Nine
Months Ended
September 30,
2007Revenues and other income:Interest income

$
49,783

$
78,082

$
163,373

$
216,286Interest incomerelated parties


3,424


3,767


10,767


9,698Rental and escalation income


29,028


26,674


87,005


67,877Advisory and management fee incomerelated parties


1,812


2,441


10,688


5,256Other revenue


9,493


1,714


14,452


5,275Total revenues


93,540


112,678


286,285


304,392Expenses:Interest expense


45,484


65,290


146,306


177,393Real estate propertiesoperating expenses


1,938


2,158


6,023


6,406Asset management feesrelated parties


853


1,405


3,892


2,868Fundraising fees, debt issuance costs and other





6,295


4,948


6,295Provision for loss on investments


2,450





5,700


General and administrative:Salaries and equity based compensation(1)


9,429


9,525


31,084


27,175Auditing and professional fees


963


1,347


4,638


5,558Other general and administrative


3,333


3,517


10,744


10,157Total general and administrative


13,725


14,389


46,466


42,890Depreciation and amortization


13,566


9,163


33,481


23,594Total expenses


78,016


98,700


246,816


259,446Income from operations


15,524


13,978


39,469


44,946Equity in (loss)/earnings of unconsolidated ventures


772


(4,578
)

(4,846
)

(5,162
)Unrealized gain (loss) on investments and other


245,319


4,416


427,733


(3,762
)Realized gain on investments and other


6,973


997


14,057


3,524Income from continuing operations before minority interest


268,588


14,813


476,413


39,546Minority interest in operating partnership


(27,524
)

(680
)

(47,346
)

(1,835
)Minority interest in joint ventures


(2,300
)

(215
)

(2,097
)

(351
)Income from continuing operations


238,764


13,918


426,970


37,360Income (loss) from discontinued operations, net of minority interest











(56
)Net income


238,764


13,918


426,970


37,304Preferred stock dividends


(5,231
)

(5,231
)

(15,693
)

(11,302
)Net income available to common stockholders

$
233,533

$
8,687

$
411,277

$
26,002Net income per share from continuing operations (basic/diluted)

$
3.72

$
0.14

$
6.55

$
0.42Income per share from discontinued operations (basic/diluted)











Net income available to common stockholders

$
3.72

$
0.14

$
6.55

$
0.42Weighted average number of shares of common stock:Basic


62,825,383


61,629,938


62,772,013


61,448,490Diluted


70,229,958


64,659,852


69,998,215


64,400,903


See
accompanying notes to condensed consolidated financial statements

4

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NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES        CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME        (Amounts in Thousands, Except Per Share Data)
     (Unaudited)

Three
Months Ended
September 30,
2008

Three
Months Ended
September 30,
2007

Nine
Months Ended
September 30,
2008

Nine
Months Ended
September 30,
2007Net income/(loss) available to common shareholders

$
233,533

$
8,687

$
411,277

$
26,002Unrealized gain (loss) on available for sale securities


(3,719
)

(54,620
)

(17,474
)

(96,925
)Change in fair value of derivatives


(1,418
)

(24,091
)

(3,872
)

7,208Reclassification adjustment for gains/(losses) included in net income


1,397


9,502


25,160


9,712Comprehensive Income

$
229,793

$
(60,522
)
$
415,091

$
(54,003
)


See
accompanying notes to condensed consolidated financial statements

5

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NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES        CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS        (Amounts in Thousands, Except Per Share Data)
(Unaudited)

Nine Months
Ended
September 30, 2008

Nine Months
Ended
September 30, 2007Net cash provided by operating activities

$
72,592

$
78,386Cash flows from investing activities:Acquisition of operating real estate, net


(21,160
)

(606,512
)Acquisition of available for sale securities


(55,031
)

(779,821
)Proceeds from disposition of securities available for sale


6,115


104,233Available for sale securities repayments


2,987


55,702Increase in term debt transaction warehouse deposits





(18,000
)Originations/acquisitions of real estate debt investments


(276,637
)

(1,074,483
)Real estate debt investments repayments


266,200


408,755Proceeds from sale of real estate debt investments


30,400


Real estate debt investments acquisition costs


(265
)

(3,136
)Restricted cash for investment activities


(120,977
)

(121,952
)Investment deposits


(749
)

(5,308
)Corporate debt investment acquisitions


(16,362
)

(472,588
)Proceeds from sale of corporate debt investments


102,575


5,419Corporate debt investment repayments


24,985


15,181Investment in and advances to unconsolidated ventures


(40,031
)

(28,099
)Cash receipts from term debt transaction issuer





8,826Distributions from unconsolidated ventures


5,850


362Proceeds from sale of assets





62,821Other loans repayments


10,000


Net cash used in investing activities


(82,100
)

(2,448,600
)Cash flows from financing activities:Collateral held by broker


12,746


(12,346
)Securities sold, not yet purchased





28,471Settlement of short sale


(12,778
)

(16,352
)Collateral held by swap counter party


(4,394
)

Mortgage notes and loan borrowings





453,363Mortgage principal repayments


(3,764
)

(3,609
)Borrowings under credit facilities


37,648


1,524,629Repayments on credit facilities


(112,900
)

(643,744
)Repurchase obligation borrowings


2,024


23,656Repurchase obligation repayments


(2,347
)

(52,985
)Proceeds from bonds


77,000


828,300Bond repayments


(95,300
)

Bond repurchases


(35,638
)

(113,594
)Other loans payable





13,300Other loans payable repayment





(387
)Borrowing under secured loan


67,710


107,047Secured term loan repayment


(73,277
)

(900
)Borrowings from subsidiary trusts issuing preferred securities





72,500Payment of deferred financing costs


(148
)

(24,146
)Capital contributions by joint venture


94,824


2,481Distribution to joint venture


(8,746
)

Restricted cash for financing activities


87,403


(2,302
)Proceeds from exchangeable senior notes


80,000


172,500Proceeds from preferred stock offering





190,000Proceeds from common stock offering





3,740Proceeds from dividend reinvestment and stock purchase plan


1,958


Dividends (common and preferred) and distributions


(91,486
)

(80,282
)Offering costs


(263
)

(6,714
)Net cash provided by financing activities


20,272


2,462,626Net decrease in cash & cash equivalents


10,764


92,412Cash & cash equivalentsbeginning of period


153,829


44,753Cash & cash equivalentsend of period

$
164,593

$
137,165


See accompanying notes to condensed consolidated financial statements

6

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NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES        NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS        Amount in Thousands, Except per Share Data        (Unaudited)

1. Formation and Organization

NorthStar Realty Finance Corp., a Maryland corporation (the "Company"), is a self-administered and self-managed real estate investment trust ("REIT"), which was
formed in October 2003 in order to continue and expand the real estate debt, real estate securities and net lease businesses conducted by NorthStar Capital Investment Corp. ("NCIC"). Substantially all
of the Company's assets are held by, and it conducts its operations through, NorthStar Realty Finance Limited Partnership, a Delaware limited partnership and the operating partnership of the Company
(the "Operating Partnership"). On October 29, 2004, the Company closed its initial public offering (the "IPO") pursuant to which it issued 20,000,000 shares of common stock, with proceeds to
the Company of approximately $160.1 million, net of issuance costs of $19.9 million. Simultaneously with the closing of the IPO on October 29, 2004, three majority-owned
subsidiaries of NCIC (the "NCIC Contributing Subsidiaries") contributed certain controlling and non-controlling interests in entities through which NCIC conducted its subordinate real
estate debt, real estate securities and net lease businesses (collectively the "Initial Investments") to the Operating Partnership in exchange for an aggregate of 4,705,915 units of limited
partnership interest in the Operating Partnership (the "OP Units") and approximately $36.1 million in cash (the "Contribution Transactions") and an agreement to pay certain related transfer
taxes on behalf of NCIC for approximately $1.0 million. From their inception through October 29, 2004, neither the Company nor the Operating Partnership had any operations.

The
combination of the Initial Investments contributed to the Operating Partnership represents the predecessor of the Company (the "Predecessor"). The Company succeeded to the business
of the Predecessor upon the consummation of the IPO and the contribution of the initial investments on October 29, 2004. The ultimate owners of the entities which comprise the Predecessor were
NCIC and certain other persons who held minority ownership interests in such entities.

Joint Ventures



In May 2006, the Company entered into a joint venture with Chain Bridge Capital LLC to invest in senior housing and
healthcare-related net leased assets, called Wakefield. In connection with the formation of the venture, Chain Bridge contributed substantially all of its assets to Wakefield for its
$15.1 million membership interest in the joint venture.

On
July 9, 2008, Wakefield sold a $100 million convertible preferred equity interest to Inland American Real Estate Trust, Inc. ("Inland American"). The Company
received approximately $87.7 million of net proceeds from the transaction. Prior to conversion, the convertible preferred investment will yield a dividend of 10.5%. The convertible preferred
equity may be converted or redeemed, at Inland American's option, upon the sale or recapitalization of the Wakefield venture. Wakefield may, at its option, redeem the convertible preferred interests
at any time following the first anniversary of the closing, subject to payment of a call premium that declines over time. In addition, at any time after the second anniversary of the closing, Inland
American may convert its preferred equity interests into common equity in Wakefield. Based on the initial investment amount and capital accounts of the Wakefield members, the convertible preferred
equity interests represent, upon conversion, approximately a 42% common equity ownership interest in Wakefield. Inland American will have the option of contributing additional preferred equity and
participating in new Wakefield investment

7

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NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

Amount in Thousands, Except per Share Data

(Unaudited)

1. Formation and Organization(Continued)

opportunities
in proportion to its percentage ownership interest, assuming it were to convert its interests to common equity.

The
Company controls substantially all major decisions of the joint venture. Accordingly, the joint venture's financial statements are consolidated into the Company's consolidated
financial statements and Inland American's and Chain Bridge's capital are treated as minority interests.



In March 2007, the Company entered into a joint venture with Monroe Capital Holdco, LLC ("Monroe"), which served as a platform
for originating middle-market loans. The joint venture ("Monroe Capital") originated, structured and syndicated middle-market corporate loans, including middle-market loans to highly leveraged
borrowers.

On
May 7, 2008, the Company completed a recapitalization of this middle-market corporate lending venture. As part of the recapitalization, an institutional money-manager invested
approximately $87.2 million of cash equity into the business and the Company contributed $6.8 million of new equity capital and its CLO equity interests. The lender under two
consolidated revolving credit facilities totaling $800.0 million of capacity and having $378.0 million of outstanding at May 7, 2008, which we refer to as the MC Facility and the
MC VFCC Facility, extinguished a portion of the outstanding debt balance and refinanced the remaining indebtedness in the form of a private CLO which match funded the underlying assets. The venture
was also permitted to sell a portion of the loan collateral and to use the cash to make new corporate loan investments.

In
connection with the recapitalization, the Company recognized a $46.0 million realized gain upon the extinguishment of a portion of the debt, a simultaneous $27.1 million
cost basis reduction to its investment in the recapitalized venture and a realized loss of $18.9 million related to the sale of certain corporate loans within the portfolio, which were recorded
in realized gain (loss) on investments and other in the condensed consolidated statement of operations. The new investor became the controlling manager of the entity and the Company deconsolidated the
venture. Additionally, as part of this recapitalization, the Company terminated its joint venture with Monroe Management.

2. Summary of Significant Accounting Policies

Basis of Quarterly Presentation

The accompanying condensed consolidated financial statements and related notes of the Company have been prepared in accordance with
accounting principles generally accepted in the United States for interim financial reporting and the instructions to Form 10-Q and Rule 10-01 of
Regulation S-X. Accordingly, certain information and footnote disclosures normally included in financial statements prepared under accounting principles generally accepted in the
United States have been condensed or omitted. In the opinion of management, all adjustments considered necessary for a fair presentation of the Company's financial position, results of operations and
cash flows have been included and are of a normal and recurring nature. The operating results presented for interim periods are not necessarily indicative of the results that may be expected for any
other interim period or for the entire year. These financial statements should be read in conjunction with the Company's consolidated financial

8

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NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

Amount in Thousands, Except per Share Data

(Unaudited)

2. Summary of Significant Accounting Policies(Continued)

statements
and notes thereto included in the Company's annual report on Form 10-K for the year ended December 31, 2007, which was filed with the Securities and Exchange
Commission. Capitalized terms used herein, and not otherwise defined, are defined in the Company's December 31, 2007 consolidated financial statements included in its annual report on
Form 10-K.

Principles of Consolidation

The condensed consolidated financial statements include the accounts of the Company and its subsidiaries which are either
majority-owned or controlled by the Company or variable interest entities ("VIE") where the Company is the primary beneficiary in accordance with the provisions of FIN 46(R)-6. All
significant intercompany balances have been eliminated in consolidation.

Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires
management to make estimates and assumptions that could affect the amounts reported in the condensed consolidated financial statements. Actual results could differ from these estimates.

Reclassifications

Certain prior period amounts have been reclassified to conform to the current period presentation.

Financial Instruments



Fair value is used to measure many of the Company's financial instruments. In accordance with provisions of SFAS No. 157 "Fair
Value Measurements" ("SFAS 157") the fair value of these financial instrument is the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction
between market participants at the measurement date (i.e., the exit price).



In accordance with SFAS No. 159 "The Fair Value Option for Financial Assets and Financial Liabilities" ("SFAS 159"), the
Company had the one-time option to elect fair value on January 1, 2008 for its existing financial assets and liabilities. For all new financial instruments, the Company has the
one-time option to elect fair value for these financial assets or liabilities on the election date, as defined in SFAS 159. The changes in the fair value of these instruments are
recorded in unrealized gain (loss) on investments and other in the condensed consolidated statements of operations.

Available for Sale Securities

The Company carries its available for sale securities at fair market value with the net unrealized gains or losses reported as a
component of other comprehensive income; however, available for sale securities for which the Company has elected the fair value option under SFAS 159 are carried at fair

9

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NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

Amount in Thousands, Except per Share Data

(Unaudited)

2. Summary of Significant Accounting Policies(Continued)

value
with the net unrealized gains or losses reported in the condensed consolidated statements of operations.

Recent Accounting Pronouncements

In December 2007, the FASB issued SFAS 141(R), "Business Combinations" (SFAS 141(R)). This Statement replaces
SFAS 141, "Business Combinations", and requires an acquirer to recognize the assets acquired, the liabilities assumed, including those arising from contractual contingencies, any contingent
consideration, and any noncontrolling interest in the acquiree at the acquisition date, measured at their fair values as of that date, with limited exceptions specified in the statement.
SFAS 141(R) also requires the acquirer in a business combination achieved in stages (sometimes referred to as a step acquisition) to recognize the identifiable assets and liabilities, as well
as the noncontrolling interest in the acquiree, at the full amounts of their fair values (or other amounts determined in accordance with SFAS 141(R)). In addition, SFAS 141(R)'s
requirement to measure the noncontrolling interest in the acquiree at fair value will result in recognizing the goodwill attributable to the noncontrolling interest in addition to that attributable to
the acquirer. SFAS 141(R) amends SFAS No. 109, "Accounting for Income Taxes", to require the acquirer to recognize changes in the amount of its deferred tax benefits that are
recognizable because of a business combination either in income from continuing operations in the period of the combination or directly in contributed capital, depending on the circumstances. It also
amends SFAS 142, "Goodwill and Other Intangible Assets", to, among other things, provide guidance on the impairment testing of acquired research and development intangible assets and assets
that the acquirer intends not to use. SFAS 141(R) applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period
beginning on or after December 15, 2008. The Company is currently evaluating the potential impact that the adoption of SFAS 141(R) could have on its financial statements.

In
December 2007, the FASB issued SFAS 160, "Noncontrolling Interests in Consolidated Financial Statements" ("SFAS 160"). SFAS 160 amends Accounting Research
Bulletin 51, "Consolidated Financial Statements", to establish accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. It also
clarifies that a noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the
consolidated financial statements. SFAS 160 also changes the way the consolidated income statement is presented by requiring consolidated net income to be reported at amounts that include the
amounts attributable to both the parent and the noncontrolling interest. It also requires disclosure, on the face of the consolidated statement of income, of the amounts of consolidated net income
attributable to the parent and to the noncontrolling interest. SFAS 160 requires that a parent recognize a gain or loss in net income when a subsidiary is deconsolidated and requires expanded
disclosures in the consolidated financial statements that clearly identify and distinguish between the interests of the parent owners and the interests of the noncontrolling owners of a subsidiary.
SFAS 160 is effective for fiscal periods, and interim periods within those fiscal years, beginning on or after December 15, 2008. The Company is currently evaluating the potential impact
that the adoption of SFAS 160 could have on its financial statements.

In
March 2008, the FASB issued SFAS No. 161, "Disclosures about Derivative Instruments and Hedging ActivitiesAn Amendment of FASB Statement No. 133"
("SFAS 161"). SFAS 161 expands

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NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

Amount in Thousands, Except per Share Data

(Unaudited)

2. Summary of Significant Accounting Policies(Continued)

the
disclosure requirements for derivative instruments and hedging activities. SFAS 161 specifically requires entities to provide enhanced disclosures addressing the following: (a) how
and why an entity uses derivative instruments; (b) how derivative instruments and related hedged items are accounted for under SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities" ("SFAS 133") and its related interpretations; and (c) how derivative instruments and related hedged items affect an entity's financial position, financial
performance, and cash flows. SFAS 161 is effective for fiscal years and interim periods beginning after November 15, 2008. SFAS 161 will be effective for the Company on
January 1, 2009. The Company is currently evaluating the potential impact that the adoption of SFAS 161 could have on its financial statements.

In
May 2008, the FASB issued SFAS No. 162, "The Hierarchy of Generally Accepted Accounting Principles" ("SFAS 162"). SFAS 162 is intended to improve financial
reporting by identifying a consistent framework, or hierarchy, for selecting accounting principles to be used in preparing financial statements that are presented in conformity with generally accepted
accounting principles in the United States for non-governmental entities. SFAS 162 is effective 60 days following approval by the U.S. Securities and Exchange Commission
("SEC") of the Public Company Accounting Oversight Board's amendments to AU Section 411, "The Meaning of Present Fairly in Conformity with Generally Accepted Accounting Principles". The Company
is currently evaluating the potential impact that the adoption of SFAS 162 could have on its financial statements.

In
May 2008, the FASB issued FASB Staff Position APB 14-1, "Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial
Cash Settlement)" ("FSP APB 14-1"). FSP APB 14-1 applies to convertible debt instruments that, by their stated terms, may be settled in cash (or other assets)
upon conversion, including partial cash settlement of the conversion option. FSP APB 14-1 requires bifurcation of the instrument into a debt component that is initially recorded at
fair value and an equity component. The difference between the fair value of the debt component and the initial proceeds from issuance of the instrument is recorded as a component of equity. The
liability component of the debt instrument is accreted to par using the effective yield method; accretion is reported as a component of interest expense. The equity component is not subsequently
re-valued as long as it continues to qualify for equity treatment. This practice marks a significant change from the current accounting practice for convertible debt instruments in the
scope of FSP APB 14-1. Current practice does not require separation of the liability and equity components of such instruments. Separately accounting for these instruments'
liability and equity components will results in the recording of more non-cash interest cost over the life of the convertible debt instrument, because of an initial debt discount.
Additionally, FSP APB 14-1 precludes the use of the fair value option pursuant to SFAS No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities." FSP
APB 14-1 is effective for fiscal years beginning after December 15, 2008 and interim periods within those fiscal years. The Company intends to adopt FSP
APB 14-1 effective January 1, 2009 and apply its provisions retrospectively to all periods presented in its financial statements. The Company is currently evaluating the
impact of the adoption of FSP APB 14-1 on the balance sheet, but has determined that FSP APB 14-1 will result in the Company recognizing additional non-cash
interest expense of approximately $0.8 million, $2.1 million and $3.6 million in its 2007, 2008 and 2009 statements of operations, respectively. The 2008 increase in
non-cash interest expense will be offset by

11

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Table of Contents

NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

Amount in Thousands, Except per Share Data

(Unaudited)

2. Summary of Significant Accounting Policies(Continued)

a
$5.0 million capitalization of financing fees which were expensed upon the election of the fair value option on the convertible debt instruments.

In
October 2008, the FASB issued Staff Position No. FAS 157-3, "Determining the Fair Value of a Financial Asset When the Market for That Asset is Not Active ("FSP
157-3"). FSP 157-3 clarifies the application of SFAS 157, which the Company adopted as of January 1, 2008, in cases where a market is not active. The Company has
considered the guidance provided by FSP 157-3 in its determination of estimated fair values as of September 30, 2008, and the impact was not material.

3. Fair Value of Financial Instruments

The Company adopted the provisions of SFAS 157 and 159 effective as of January 1, 2008 and elected to apply the fair value option to the following financial assets and
liabilities existing at the time of adoption:



During
the second quarter 2008, the Company elected the fair value option for its 11.50% exchangeable senior notes issued in May 2008 and its equity investment in its corporate lending
business.

The
Company has elected the fair value option for the above financial instruments for the purpose of enhancing the transparency of its financial condition.

Fair Value Measurements

SFAS 157 defines fair value, establishes a framework for measuring fair value, establishes a fair value hierarchy based on the
quality of inputs used to measure fair value and enhances disclosure requirements for fair value measurements. In addition, SFAS 157 requires an issuer to incorporate changes in its own credit
spreads when determining the fair value of its liabilities.



In accordance with SFAS 157, the Company has categorized its financial instruments, based on the priority of the inputs to the
valuation technique, into a three-level fair value hierarchy. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities
(Level 1) and the lowest priority to unobservable inputs (Level 3). If the inputs used to measure the financial instruments fall within different levels of the hierarchy, the
categorization is based on the lowest level input that is significant to the fair value measurement of the instrument.

12

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Table of Contents

NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

Amount in Thousands, Except per Share Data

(Unaudited)

3. Fair Value of Financial Instruments(Continued)

Financial
assets and liabilities recorded on the condensed consolidated balance sheets are categorized based on the inputs to the valuation techniques as follows:

Level 1.

Financial assets and liabilities whose values are based on unadjusted quoted prices for identical assets or liabilities in an active market (examples include active exchange-traded equity securities, listed derivatives,
most U.S. government and agency securities, and certain other sovereign government obligations).Level 2.

Financial assets and liabilities whose values are based on the following:a)

Quoted prices for similar assets or liabilities in active markets (for example, restricted stock);b)

Quoted prices for identical or similar assets or liabilities in non-active markets (examples include corporate and municipal bonds, which trade infrequently);c)

Pricing models whose inputs are observable for substantially the full term of the asset or liability (examples include most over-the-counter derivatives, including interest rate and currency swaps); andd)

Pricing models whose inputs are derived principally from or corroborated by observable market data through correlation or other means for substantially the full term of the asset or liability (for example, certain
mortgage loans).Level 3.

Financial assets and liabilities whose values are based on prices or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement. These inputs reflect
management's own assumptions about the assumptions a market participant would use in pricing the asset or liability (examples include private equity investments, beneficial interest in securitizations and long-dated or complex derivatives, including
certain foreign exchange options and long-dated options on gas and power).


As
required by SFAS 157, financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.
The following table sets forth the

13

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Table of Contents

NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

Amount in Thousands, Except per Share Data

(Unaudited)

3. Fair Value of Financial Instruments(Continued)

Company's
financial assets and liabilities that were accounted for at fair value on a recurring basis as of September 30, 2008 by level within the fair value hierarchy (in thousands):

Assets and Liabilities at Fair ValueLevel 1

Level 2

Level 3

TotalAssets:Available for sale securities:CMBS

$


$
172,588

$
87,986

$
260,574Real estate term debtN-Star(1)








13,023


13,023Real estate term debtThird party








2,150


2,150REIT debt





66,293


900


67,193Term debt equityN-Star








40,736


40,736Trust preferred securities








7,833


7,833Derivative asset





42





42Corporate lending investment








47,275


47,275Total assets

$


$
238,923

$
199,903

$
438,826Liabilities:Exchangeable senior notes

$


$
196,770

$


$
196,770N-Star IV,VI, VII and VIII bonds payable(1)








860,771

$
860,771Liability to subsidiary trusts issuing preferred securities








95,582


95,582Derivative liability





44,902





44,902Total liabilities

$


$
241,672

$
956,353

$
1,198,025


---

As
of September 30, 2008, the Company did not have any assets or liabilities measured at fair value on a non-recurring basis.

The
following table presents additional information about the Company's available for sale securities, liabilities to subsidiary trusts issuing preferred securities and corporate lending
investment

14

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Table of Contents

NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

Amount in Thousands, Except per Share Data

(Unaudited)

3. Fair Value of Financial Instruments(Continued)

which
are measured at fair value on a recurring basis for which the Company has utilized Level 3 inputs to determine fair value (in thousands):

Fair Value Measurements Using Significant Unobservable Inputs (Level 3):

Available
for sale
securities

Corporate
lending
investment

N-Star
Bonds Payable

Liability to
subsidiary trusts
issuing preferred
securitiesBeginning balance:

$
80,851

$


$


$
168,454Total transfers into Level 3


125,208


79,583


1,138,919Total losses (realized or unrealized):








Included in earnings


46,030


32,308





Included in other comprehensive loss


7,401








Total gains (realized or unrealized):











Included in earnings








278,148


72,872Included in other comprehensive loss











Ending balance

$
152,628

$
47,275

$
860,771

$
95,582The amount of total gains or losses for the period included in earnings attributable to the change in unrealized gains or losses relating to assets or
liabilities still held at the reporting date

$
46,030

$
32,308

$
278,148

$
72,872




SFAS 159 provides a fair value option election that allows companies to irrevocably elect fair value as the initial and
subsequent measurement attribute for certain financial assets and liabilities. Changes in fair value for assets and liabilities for which the election is made will be recognized in earnings as they
occur. SFAS 159 permits the fair value option election on an instrument by instrument basis at initial recognition of an asset or liability or upon an event that gives rise to a new basis of
accounting for that instrument.

15

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Table of Contents

NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

Amount in Thousands, Except per Share Data

(Unaudited)

3. Fair Value of Financial Instruments(Continued)

The
following table sets forth the Company's financial instruments for which the fair value option was elected:

Financial Instruments, at Fair Value

September 30,
2008

December 31,
2007Assets:Available for sale securities:CMBS

$
260,574

$
342,353Real estate term debtN-Star


11,079


18,507Real estate term debtThird party


2,150


12,159REIT debt


67,193


80,292Trust preferred securities


7,833


12,264Corporate lending investment


47,275


Total assets

$
396,104

$
465,575Liabilities:(1)Exchangeable senior notes


196,770


172,500N-Star IV,VI, VII and VIII bonds payable


860,771


1,654,185Liability to subsidiary trusts issuing preferred securities


95,582


286,258Total liabilities

$
1,153,123

$
2,112,943






The
following table presents a summary of existing eligible financial assets and financial liabilities for which the fair value option was elected on January 1, 2008 and the
cumulative-effect adjustment to retained earnings recorded in connection with the initial adoption of SFAS 159.

Carrying Value at
January 1, 2008

Transition
Adjustment to
Retained Earnings
(Gain)/Loss

Carrying Value at
January 1, 2008
(After adoption
of SFAS 159)Assets:Available for sale securities(1)

$
465,575

$
90,966

$
465,575Liabilities:Exchangeable senior notes


172,500


(26,824
)

145,676N-Star IV, VI, VII and VIII bonds payable


1,654,185


(196,209
)

1,457,976Liability to subsidiary trusts issuing preferred securities


286,258


(117,804
)

168,454Cumulative gain upon the adoption of SFAS 159(2)




$
(249,871
)


---

16

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Table of Contents

NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

Amount in Thousands, Except per Share Data

(Unaudited)

3. Fair Value of Financial Instruments(Continued)



The
following table presents the difference between fair values and the aggregate contractual amounts of available for sale securities and liabilities, for which the fair value option
has been elected:

Fair Value at
September 30,
2008

Amount
Due Upon
Maturity

DifferenceAssets:Available for sale securities:CMBS

$
260,574

$
490,032

$
(229,458
)Real estate term debtN-Star


11,079


38,448


(27,369
)Real estate term debtThird party


2,150


16,576


(14,426
)REIT debt


67,193


84,183


(16,990
)Trust preferred securities


7,833


15,000


(7,167
)Total assets

$
348,829

$
644,239

$
(295,410
)Liabilities:Exchangeable Senior Notes


196,770


252,500


(55,730
)N-Star IV,VI, VII and VIII bonds payable


860,771


1,573,285


(712,514
)Liability to subsidiary trusts issuing preferred securities


95,582


286,258


(190,676
)Total Liabilities

$
1,153,123

$
2,112,043

$
(958,920
)


At
September 30, 2008, the basis in our corporate lending investment was $79.6 million. We have elected the fair market value option pursuant to SFAS 159 for this
investment which is accounted for under the equity method of accounting. The fair market value of our investment at September 30, 2008 was $47.3 million.

For
the three and nine months ended September 30, 2008, the Company recognized a net gain of $252.4 million and a net gain of $434.3 million, respectively, as the
result of the change in fair value of financial assets and liabilities for which the fair value option was elected, which is recorded as unrealized gain (loss) on investments and other in the
Company's condensed consolidated statement of operations.

4. Operating Real Estate

The Company made the following acquisitions from January 1, 2008 through September 30, 2008:

A
$4.0 million acquisition of four skilled nursing facilities totaling 40,369 square feet located in Ohio and Wisconsin, in January 2008. The properties are net leased to a single
tenant under a lease that expires in December 2017. The acquisition was purchased with cash.

17

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Table of Contents

NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

Amount in Thousands, Except per Share Data

(Unaudited)

4. Operating Real Estate(Continued)

On
September 25, 2008, JPMorgan Chase & Co. ("JPMorgan") announced that it had acquired substantially all of the assets and liabilities of Washington Mutual Bank, FA
("WaMu") from the Federal Deposit Insurance Corp. JPMorgan is entitled to a 90-day period from the WaMu acquisition date to decide whether they will accept or reject the terms of the
lease. During the third quarter 2008, the Company added its net leased asset comprised of three office buildings totaling 257,000 square feet located in Chatsworth, CA and 100% leased to WaMu to its
watch list. As of September 30, 2008 the buildings had a combined $54.6 million net book value and were financed with a non-recourse $43.0 million first mortgage loan.
The assets are also financed with a $9.7 million mezzanine loan which is collateral for one of the Company's securities term financings. The Company's potential loss if the lease is rejected
would be the value of the Company's mezzanine loan and residual equity interest, which totals $15.2 million at September 30, 2008.

Discontinued Operations

The condensed consolidated statement of operations for the nine months ended September 30, 2007, includes results of operations
of real estate assets sold or held for sale. These assets include two assisted care living facilities which were sold in April 2007. There were no discontinued operations for the three and nine months
ended September 30, 2008 and for the three months ended September 30, 2007.

The
following table summarizes income from discontinued operations and related gain on sale of discontinued operations, each net of minority interest, for the nine months ended
September 30, 2007 (in thousands):

Nine months
Ended
September 30, 2007Revenue:Rental and escalation income

$
38Total revenue


38Expenses:General and administrative expenses


1Interest expense


20Depreciation and amortization


31Total expenses


52Loss from discontinued operations


(14
)Loss on disposition of discontinued operations


(45
)Loss from discontinued operations, before minority interest


(59
)Minority interest


3Loss from discontinued operations, net of minority interest

$
(56
)


18

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Table of Contents

NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

Amount in Thousands, Except per Share Data

(Unaudited)

5. Available for Sale Securities

The following is a summary of the Company's available for sale securities at September 30, 2008 and December 31, 2007 (in thousands):

September 30, 2008

Carrying
Value

SFAS 159
Transition Adjustment

Losses in
Accumulated
OCI

Unrealized
Loss on
Investments

Estimated
Fair Value(1)CMBS

$
453,850

$
(64,442
)
$


$
(128,834
)
$
260,574Real estate term debtN-Star


50,527


(17,616
)

(12,369
)

(7,519
)

13,023Real estate term debtThird party


16,130


(3,896
)




(10,084
)

2,150REIT debt


82,691


(2,276
)




(13,222
)

67,193Term debt equity


69,357





(28,621
)




40,736Trust preferred securities


15,000


(2,736
)




(4,431
)

7,833Total

$
687,555

$
(90,966
)
$
(40,990
)
$
(164,090
)
$
391,509


---



December 31, 2007

Carrying
Value

Gains in
Accumulated
OCI

Losses in
Accumulated
OCI

Estimated
Fair Value(1)CMBS

$
419,835

$
987

$
(73,253
)
$
347,569Real estate term debtN-Star


36,123





(17,616
)

18,507Real estate term debtThird party


16,055





(3,896
)

12,159REIT debt


82,568





(2,276
)

80,292Term debt equity


67,825





(22,960
)

44,865Corporate CLO


50,697





(16,831
)

33,866Trust preferred securities


15,000





(2,736
)

12,264Total

$
688,103

$
987

$
(139,568
)
$
549,522


---

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Table of Contents

NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

Amount in Thousands, Except per Share Data

(Unaudited)

6. Real Estate Debt Investments

At September 30, 2008 and December 31, 2007, the Company held the following real estate debt investments (in thousands):

September 30, 2008

Carrying
Value(1)

Allocation by
Investment Type

Average
Fixed Rate

Average Spread
Over LIBOR

Number of
InvestmentsWhole loans, floating rate

$
1,039,124


51.8
%


%

3.26
%

53Whole loans, fixed rate


55,732


2.8


9.39





7Subordinate mortgage interests, floating rate


224,260


11.2





6.25


15Mezzanine loans, floating rate


500,676


25.0





4.50


16Mezzanine loan, fixed rate


162,903


8.1


11.26





15Other loansfloating


16,609


0.8





1.60


2Other loansfixed


6,393


0.3


5.53





1Total/Weighted average


2,005,697


100.0
%

10.64
%

3.97
%

109


---

December 31, 2007

Carrying
Value(1)

Allocation by
Investment Type

Average
Fixed Rate

Average Spread
Over LIBOR

Number of
InvestmentsWhole loans, floating rate

$
1,082,399


53.9
%


%

3.09
%

59Whole loans, fixed rate


80,371


4.0


10.17





10Subordinate mortgage interests, floating rate


158,347


7.9





3.72


13Mezzanine loans, floating rate


505,227


25.3





4.59


16Mezzanine loan, fixed rate


157,092


7.8


11.16





16Other loansfloating


16,653


0.8





1.60


2Other loansfixed


6,933


0.3


5.53





1Total/Weighted average

$
2,007,022


100.0
%

10.67
%

3.56
%

117


---

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Table of Contents

NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

Amount in Thousands, Except per Share Data

(Unaudited)

6. Real Estate Debt Investments(Continued)

The
Company has identified one real estate debt investment as a variable interest in a VIE and has determined that the Company is not the primary beneficiary of this VIE and as such the
VIE should not be consolidated in the Company's consolidated financial statements. The Company's maximum exposure to loss would not exceed the carrying amount of its investment of
$26.2 million. For all other investments, the Company has determined that these investments are not VIEs and, as such, the Company has continued to account for all real estate debt investments
as loans.

As
of September 30, 2008 and December 31, 2007, all loans were current on principal and interest payments in accordance with the terms of the loan agreement. However, for
the three and nine months ended September 30, 2008, the Company recorded a credit loss provision of $3.3 million, partially offset
by the reversal a $0.8 million reserve taken during the first quarter of 2008, and $5.7 million, respectively, related to loans on its watch list. Contractual maturities of real estate
debt investments at September 30, 2008 are as follows:

Years Ending December 31:

Initial
Maturity

Maturity
Including
Extensions2008 (remainder)

$
123,861

$
18,6112009


755,252


61,3852010


550,132


288,7862011


215,703


628,8242012


192,201


682,178Thereafter


191,166


348,531Total

$
2,028,315

$
2,028,315


Actual
maturities may differ from contractual maturities because certain borrowers have the right to prepay with or without prepayment penalties. The contractual amounts differ from the
carrying amounts due to unamortized origination fees and costs and unamortized premiums and discounts being reported as part of the carrying amount of the investment. Maturity Including Extensions
assumes that all loans with extension options will qualify for extension at initial maturity according to the conditions stipulated in the related loan agreements.

7. Corporate Loan Investments

At September 30, 2008, the Company held no corporate debt investments as a result of the recapitalization and deconsolidation of the Monroe joint venture. See Note 1 for
additional information.

21

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Table of Contents

NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

Amount in Thousands, Except per Share Data

(Unaudited)

7. Corporate Loan Investments(Continued)

At
December 31, 2007, the Company held the following corporate debt investments (dollars in thousands):

December 31, 2007

Carrying
Value(1)

Allocation by
Investment
Type

Average
Spread Over
LIBOR/Prime

Number of
InvestmentsFirst lien note

$
421,973


92.3
%

2.96
%

100Second lien note


35,166


7.7


6.02


8Total/Weighted average

$
457,139


100.0
%

3.19
%

108


---

8. Investment in and Advances to Unconsolidated Ventures

The Company has non-controlling, unconsolidated/uncombined ownership interests in entities that are accounted for using the equity method. Capital contributions,
distributions, and profits and losses of the real estate entities are allocated in accordance with the terms of the applicable partnership and limited liability company agreements. Such allocations
may differ from the stated percentage interests, if any, in such entities as a result of preferred returns and allocation formulas as described in such agreements.

CS/Federal Venture

In February 2006, the Company, through a joint venture with an institutional investor, acquired a portfolio of three adjacent
class A office/flex buildings located in Colorado Springs, Colorado for $54.3 million. The joint venture financed the transaction with two non-recourse, first mortgage loans
totaling $38.0 million and the balance in cash. The loans mature on February 11, 2016 and bear fixed interest rates of 5.51% and 5.46%. The Company contributed $8.4 million for a
50% interest in the joint venture and incurred $0.3 million in costs related to its acquisition, which are capitalized to the investment account. These costs will be amortized over the useful
lives of the assets held by the joint venture. The Company accounts for its investment under the equity method of accounting. At September 30, 2008 and December 31, 2007, the Company had
an investment in CS/Federal of approximately $7.4 million and $7.8 million, respectively. The Company recognized equity in earnings of $0.1 million for each of the three months
ended September 30, 2007 and 2008. The Company recognized equity in earnings $0.3 million for each of the nine months ended September 30, 2007 and 2008.

Monroe Capital Management Advisors, LLC

In March 2007, the Company entered into a joint venture with Monroe Management, a Chicago-based firm, and acquired a 49.9%
non-controlling interest in Monroe Management. Monroe Management originated, structured and syndicated middle-market corporate loans for Monroe Capital

22

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NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

Amount in Thousands, Except per Share Data

(Unaudited)

8. Investment in and Advances to Unconsolidated Ventures(Continued)

and
provided asset management services. On May 7, 2008, the Company terminated its joint venture with Monroe Management upon the completion of the recapitalization of Monroe Capital. See
Note 1 for additional information.

G-NRF, LTD

On May 7, 2008, the Company completed a recapitalization of Monroe Capital, its middle-market corporate lending platform. Upon
completion of the recapitalization transaction, the new investor became the controlling manager of the assets and the Company deconsolidated the joint venture. The Company currently uses the equity
method of accounting to account for the recapitalized joint venture and has elected the fair value option under SFAS 159 for its equity investment. As of September 30, 2008, the fair
market value of the Company's investment in the corporate lending venture was $47.3 million. For the three months ended September 30, 2008, the Company recognized equity in earnings of
$0.9 million and an unrealized gain of $0.2 million related to the fair value adjustment on its equity investment. For the period from May 8, 2008 to September 30, 2008,
the Company recognized equity in earnings of $1.3 million and an unrealized loss of $32.3 million related to the fair value adjustment on its equity investment. See Note 1 for
additional information.

NorthStar Realty Finance Trusts

The Company owns all of the common stock of NorthStar Realty Finance Trusts I through VIII (collectively, the "Trusts"). The Trusts
were formed to issue preferred securities. Under the provisions of FIN 46(R)-6, the Company determined that the holders of the trust preferred securities were the primary
beneficiaries of the Trusts. As a result, the Company did not consolidate the Trusts and has accounted for the investment in the common stock of the Trusts under the equity method of accounting. At
September 30, 2008 and December 31, 2007, the Company had an investment in the Trusts of approximately $3.8 million.

NorthStar Real Estate Securities Opportunity Fund

In July 2007, the Company closed on $109.0 million of equity capital for its Securities Fund, an investment vehicle in which the
Company conducts most of its real estate securities investment business.

The
Company is the manager and general partner of the Securities Fund. The Company receives base management fees ranging from 1.0% to 2.0% per annum on third-party capital and is
entitled to annual incentive management fees ranging from 20% to 25% of the increase in the Securities Fund's net asset value in excess of an 8.0% per annum return. Base and incentive fees vary
depending on the investor capital lockup periods.

During
the second quarter 2008, the Company invested an additional $16.0 million in the Securities Fund. Additionally, during the second quarter 2008, the Company sold 67% of its
N-Star IX advisory fee income stream to the Securities Fund for $8.8 million. The Securities Fund owns all of the equity in the N-Star IX term financing but the Company
retained the advisory fees when N-Star IX was sold to the Securities Fund at its inception. The Company recognized $4.8 million of advisory fee

23

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Table of Contents

NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

Amount in Thousands, Except per Share Data

(Unaudited)

8. Investment in and Advances to Unconsolidated Ventures(Continued)

income
from the sale and deferred the remaining $4.0 million, which represented the Company's ownership interest in the Securities Fund. The deferred advisory fee income will be recognized into
income as the fees are earned. For the three and nine months ended September 30, 2008, the Company recognized $0.1 million in additional income from the amortization of deferred advisory
fee income. At September 30, 2008, the Company had invested a total of $47.9 million in the Securities Fund and the carrying value of its investment was $33.8 million,
representing a 46.0% interest.

In
the third quarter 2008, the Securities Fund filed a claim against Lehman Brothers for $6.8 million (plus damages) to recover cash collateral held by Lehman Brothers. On
September 30, 2008, the Securities Fund decided to record a reserve of $3.4 million against the $6.8 million cash collateral receivable.

For
the three months ended September 30, 2008, the Company recognized equity in earnings of $0.5 million. The Company also earned $0.1 million of management fees
from the Securities Fund for the three months ended September 30, 2008. For the nine months ended September 30, 2008, the Company recognized equity in loss of $5.1 million. The
Company also earned $0.4 million of management fees from the Securities Fund for the nine months ended September 30, 2008.

LandCap Investment

On October 5, 2007, the Company entered into a joint venture with Whitehall Street Global Real Estate Limited Partnership 2007,
to form LandCap Partners, which is referred to as LandCap. LandCap seeks to opportunistically invest in single family residential land through land loans, lot option agreements and select land
purchases. The venture is managed by professionals who have extensive experience in the single family housing sector. The Company has sole discretion with respect to funding its portion of any
investment decisions relating to LandCap and accounts for its investment under the equity method of accounting. At September 30, 2008 the Company's investment in LandCap is carried at
$13.7 million, which includes the Company's contributions to LandCap of $5.6 million and $11.3 million made during the second and third quarters of 2008, respectively, less the
Company's $3.2 million share of LandCap's losses from the cumulative general and administrative expenses since inception. For the three and nine months ended September 30, 2008, the
Company recognized equity in loss of $0.8 million and $2.5 million, respectively. At September 30, 2008, LandCap has made investments totaling $39.1 million. In addition,
the Company advanced approximately $2.6 million under a $2.8 million loan agreement to LandCap, which bears interest at a fixed rate of 12% and was included in other assets in the
condensed consolidated balance sheets.

24

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Table of Contents

NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

Amount in Thousands, Except per Share Data

(Unaudited)

9. Borrowings

The following is a table of the Company's outstanding borrowings as of September 30, 2008 and December 31, 2007 (in thousands):

Initial
Stated
Maturity

Maximum
Maturity
Including
Extensions

Interest
Rate

Maximum
Amount
Available

Contractual
Balance at
September 30,
2008

Balance at
December 31,
2007Credit FacilitiesMC Facility(1)


3/31/2008


3/31/2008

LIBOR + 0.75%

$


$


$
374,459MC Facility VFCC(1)


7/29/2008


7/29/2010

Commercial Paper Rate + 0.75%








71,037JP Facility


8/8/2009


8/8/2010

LIBOR + 1.25% to 1.80%


350,000


48,216


55,936Total Credit Facilities










350,000


48,216


501,432Term LoansWA Term Loan(2)


11/6/2009


11/6/2010

LIBOR + 2.00%


471,744


279,655


308,588Euronote


11/6/2009


11/6/2010

3 month Euribor + 2.0%


106,387


106,387


108,346LB Term Loan


2/9/2009


2/9/2012

LIBOR + 1.50%


24,238


24,239


Total Credit Facilities & Term Loans










952,369


458,497


918,366Mortgage notes payable (non-recourse)Chatsworth


5/1/2015




5.65%





43,001


43,219Salt Lake City


9/1/2012




5.16%





15,958


16,231EDS


10/8/2015




5.37%





47,872


48,371Executive Center


1/1/2016




5.85%





51,480


51,480Green Pond


4/11/2016




5.68%





17,395


17,480Indianapolis


2/1/2017




6.06%





28,553


28,600Wakefield GE


8/30/2010




6.93%





67,501


67,586WakefieldPark National


1/11/2014




5.94%





33,300


33,300WakefieldGEWLK


1/11/2017




6.49%





160,000


160,000WakefieldGETusc & Harmony


1/11/2017




6.59%





7,875


7,875WakefieldHarmony FNMA


2/1/2017




6.39%





75,000


75,000WakefieldGrove City


2/1/2038




5.45%





1,868


1,887WakefieldLancaster


6/1/2037




6.40%





2,612


2,636WakefieldMarysville


6/1/2037




6.40%





1,677


1,693WakefieldWashington


10/1/2038




6.65%





1,980


1,995WakefieldMiller Merril


6/30/2012




7.07%





116,000


116,000WakefieldARL Mob Wachovia


5/11/2017




5.89%





3,412


3,412WakefieldAscend Colonial


5/31/2012




7.52%





6,500


6,500WakefieldColonial Dova


8/31/2012




7.32%





6,500


6,500WakefieldColonial 6 Alfs


11/1/2012




6.98%





19,653


19,653WakefieldSt Francis


9/31/2010




LIBOR + 2.00%





11,400


11,400Aurora


7/11/2016




6.22%





33,415


33,500DSG


10/11/2016




6.17%





34,346


34,648Keene


2/1/2016




5.85%





6,815


6,882Fort Wayne


1/1/2015




6.41%





3,499


3,555Portland


6/17/2014




7.34%





4,866


4,984Milpitas


3/6/2017




5.95%





22,655


22,959Fort Mill


4/6/2017




5.63%





27,700


27,700Reading


1/1/2015




5.58%





14,212


14,387Reading


1/1/2015




6.00%





5,000


5,000Alliance


12/6/2017




6.48%





23,848


24,032Mezzanine loan payable (non-recourse)Chatsworth


5/1/2014




6.64%





9,664


10,692Fort Mill


4/6/2017




6.21%





3,044


3,208Exchangeable Senior Notes(3)


6/15/2027




7.25%





172,500


172,500Exchangeable Senior Notes ("NNN Notes")(3)


6/15/2013




11.50%





80,000


Repurchase obligations


Varies




LIBOR varies





1,540


1,864Bonds payable(3)N-Star IV


7/1/2040




LIBOR + 0.62% (average spread)





292,500


300,000N-Star VI


6/1/2041




3 month LIBOR + 0.56% (average spread)





269,700


310,500N-Star VII


6/22/2051




LIBOR + 0.36% (average spread)





504,300


510,800N-Star VIII


2/1/2041




LIBOR + 0.57% (average spread)





506,785


532,885Liability to subsidiary trusts issuing preferred securities(3)(4)Trust I


3/30/2035




8.15%





41,240


41,240Trust II


6/30/2035




7.74%





25,780


25,780Trust III


1/30/2036




7.81%





41,238


41,238Trust IV


6/30/2036




7.95%





50,100


50,100Trust V


9/30/2036




3 month LIBOR





30,100


30,1002.70%Trust VI


12/30/2036




3 month LIBOR





25,100


25,1002.90%Trust VII


4/30/2037




3 month LIBOR





37,600


37,6002.50%Trust VIII


7/30/2037




3 month LIBOR





35,100


35,1002.70%$
3,480,681

$
3,945,538


---

25

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Table of Contents

NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

Amount in Thousands, Except per Share Data

(Unaudited)

9. Borrowings(Continued)

Scheduled principal payment requirements on the Company's borrowings based on initial maturity dates are as follows as of September 30,
2008 (in thousands):

Total

Mortgage and
Mezzanine
Loans

Credit
Facilities

Secured Term
Loan(1)

Liability to
Subsidiary
Trusts Issuing
Preferred
Securities(2)

Exchangeable
Senior Notes(2)

Repurchase
Obligations

Bonds
Payable(1)2008

$
1,522

$
1,522

$


$


$


$


$


$
2009


470,842


10,805


48,216


410,281








1,540


2010


96,765


96,765

















2011


14,330


14,330

















2012


164,036


164,036

















Thereafter


2,733,186


621,143








286,258


252,500





1,573,285Total

$
3,480,681

$
908,601

$
48,216

$
410,281

$
286,258

$
252,500

$
1,540

$
1,573,285


---

At September 30, 2008, the Company was in compliance with all covenants under its borrowings.

Bonds Payable Repurchases

During the second quarter 2008, the Company repurchased $7.1 million of Class B, AA rated notes and $8.0 million
of Class J, BBB rated notes of N-Star VIII, $5.0 million of Class B, AA rated notes and $4.5 million of Class C, single A rated notes of
N-Star VI, $6.5 million of Class C, single A rated notes of N-Star VII and $3.5 million of Class C, single A rated notes of N-Star IV
for approximately $20.6 million. The Company recorded a realized gain of $7.1 million in connection with the repurchase of notes.

During
the third quarter 2008, the Company repurchased approximately $33.0 million of its bonds, which consisted of $7.0 million of Class H, BBB rated notes,
$7.0 million of Class J, BBB rated notes, $5.0 million of Class B, AA rated notes, $5.0 million of Class A2, AAA rated notes of N-Star VIII,
$4.0 million of Class D, BBB rated notes of N-Star IV and 5.0 million of Class J, BB rated notes of N-Star IX for approximately
$16.2 million. The Company recorded a realized gain of $7.1 million in connection with the repurchase of notes.

26

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Table of Contents

NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

Amount in Thousands, Except per Share Data

(Unaudited)

9. Borrowings(Continued)

Exchangeable Senior Notes

In May 2008, NRFC NNN Holdings, LLC ("Triple Net Holdings"), a wholly-owned subsidiary of the Company issued
$80.0 million of 11.50% exchangeable senior notes (the "NNN Notes") due in 2013. The NNN Notes were offered in accordance with Rule 144A under the Securities Act of 1933, as amended. The
NNN Notes pay interest semi-annually on June 15 and December 15, at a rate of 11.50% per annum, and mature on June 15, 2013. The NNN Notes have an initial exchange
rate representing an exchange price of approximately $12.00 per share of the Company's common stock, subject to adjustment under certain circumstances. The NNN Notes
are senior unsecured obligations of Triple Net Holdings and may be exchangeable upon the occurrence of specified events, and at any time on or after March 15, 2013, and prior to the close of
business on the second business day immediately preceding the maturity date, into cash, shares of the Company's common stock or a combination of cash and shares of the Company's common stock, if any,
at the Company's option. The NNN Notes are redeemable, at the Company's option, on and after June 15, 2011. The Company may be required to repurchase the NNN Notes upon the occurrence of
certain events. The net proceeds from the offering were approximately $71.4 million, after deducting a $4.6 million security deposit representing one semi-annual interest
payment, and fees and expenses. The proceeds of the offering will be used for general corporate purposes.

The
Company has elected the SFAS 159 fair value option for the NNN Notes. Changes in fair value of the NNN Notes will be recognized in earnings as they occur.

Term Loan

In June 2008, a wholly owned subsidiary of the Company entered into a $24.2 million term loan agreement with an investment bank
(the "LB Term Loan"). The collateral for the LB Term Loan is a $44.0 million mezzanine loan position and the Company has guaranteed 50% of such amount. The LB Term Loan matures in February 2009
and bears interest at a spread of 1.50% over one-month LIBOR. Both the LB Term Loan and the mezzanine loan collateral have three one-year extension options. The LB Term Loan
contains certain covenants including, among others, financial covenants of a minimum tangible net worth and a minimum debt-to-equity ratio.

Unsecured Revolving Line of Credit

On May 28, 2008, the Company voluntarily terminated the Revolving Credit Agreement, dated November 3, 2006 with KeyBanc
Capital Markets and Bank of America, N.A. (the "Credit Agreement") in order to permit the issuance of the NNN Notes, given certain restrictive covenants set forth in the Credit Agreement. The Credit
Agreement had a November 2009 expiration and no amounts were outstanding under the Credit Agreement at the time of termination.

10. Related Party Transactions

Advisory Fees

The Company has agreements with each of N-Star I, N-Star II, N-Star III, N-Star V and
N-Star IX to perform certain advisory services. During the second quarter 2008, the Company sold 67% of its

27

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Table of Contents

NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

Amount in Thousands, Except per Share Data

(Unaudited)

10. Related Party Transactions(Continued)

advisory
fee income stream, pursuant to its agreement with N-Star IX, to the Securities Fund for $8.8 million. Advisory and management fee incomerelated parties for the
nine months ended September 30, 2008 includes $4.8 million of additional income as a result of the sale. The Company deferred the remaining $4.0 million, which represents the
Company's ownership interest in the Securities Fund. The deferred advisory fee income will be recognized into income as the fees are earned. The Company earned total fees on these agreements of
approximately $1.7 million and $2.2 million for the three months ended September 30, 2008 and 2007, respectively and $10.3 million and $5.0 million for the nine
months ended September 30, 2008 and 2007, respectively.

The
Company has an agreement with the Securities Fund to receive base management fees ranging from 1.0% to 2.0% per year on third-party capital. For the three and nine months ended
September 30, 2008, the Company earned $0.1 million and $0.4 million, respectively, in management fees. For each of the three and nine months ended September 30, 2007, the
Company earned $0.2 million in management fees.

Asset Management Fees

The Company entered into a management agreement in April 2006 with Wakefield Capital Management Inc. to perform certain
management services. Wakefield Capital Management Inc. is owned by the partners who own Chain Bridge. The Company incurred $0.9 million and $0.8 million in management fees for the
three months ended September 30, 2008 and 2007, respectively, and $2.6 million and $2.2 million in management fees for the nine months ended September 30, 2008 and 2007,
respectively, which are recorded in asset management fees-related parties in the condensed consolidated statement of operations.

The
Company entered into a management agreement in March 2007 with Monroe Management to perform certain management services, as described in Note 1. On May 7, 2008, the
Company terminated its management agreement with Monroe Management. The Company incurred $0.5 million in management fees for the three months ended September 30, 2007, and
$1.3 million and $0.7 million in management fees for the nine months ended September 30, 2008 and 2007, respectively, which are recorded in asset management
fees-related parties in the condensed consolidated statement of operations.

Legacy Fund

In September 2008, the Company and a major financial institution, as co-lenders, amended an existing loan agreement with a
subsidiary of Legacy Partners Realty Fund I, LLC (the "Legacy Fund"), as borrower, to extend the loan maturity in exchange for an extension fee, a partial principal repayment of the loan
and a guaranty by the borrower of certain additional obligations. One of the Company's directors, Preston Butcher, is the chairman of the Board of Directors and chief executive officer and owns a
significant interest in Legacy Partners Commercial, LLC, which indirectly owns an equity interest in, and owns the manager of, the Legacy Fund. The loan is included in real estate debt
investments in the consolidated balance sheets.

28

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Table of Contents

NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

Amount in Thousands, Except per Share Data

(Unaudited)

10. Related Party Transactions(Continued)

Hard Rock Hotel Loan

In August 2008, the Company purchased from Credit Suisse ("CS"), a $30.0 million junior participation in the financing provided
by CS in connection with the acquisition of 11.05 acres of land immediately adjacent to the Hard Rock Hotel and Casino in Las Vegas by a joint venture between DLJ Merchant Banking Partners and the
Morgans Hotel Group, or Morgans, which is the minority interest in the joint venture. David Hamamoto, the Company's president and chief executive officer, is the chairman of the board of Morgans. The
loan is included in real estate debt investments in the consolidated balance sheets.

11. Equity Based Compensation

Omnibus Stock Incentive Plan

On September 14, 2004, the Board of Directors of the Company adopted the NorthStar Realty Finance Corp. 2004 Omnibus Stock
Incentive Plan (the "Stock Incentive Plan"). The Stock Incentive Plan provides for the issuance of stock-based incentive awards, including incentive stock options, non-qualified stock
options, stock appreciation rights, shares of common stock of the Company, including restricted shares, and other equity-based awards, including OP Units which are structured as profits interests
("LTIP Units") or any combination of the foregoing. The eligible participants in the Stock Incentive Plan include directors, officers and employees of the Company and, prior to October 29,
2005, employees pursuant to the shared facilities and services agreement. An aggregate of 8,933,038 shares of common stock of the Company are currently reserved and authorized for issuance under the
Stock Incentive Plan, subject to equitable adjustment upon the occurrence of certain corporate events. As of September 30, 2008, the Company has issued an aggregate of 7,308,642 LTIP Units, net
of forfeitures of 60,198 LTIP Units. An aggregate of 544,785 LTIP Units
were converted to commons stock and 374,020 shares of common stock were issued pursuant to the Stock Incentive Plan. Of the 7,308,642 LTIP Units, 4,790,391 vest to the individual recipient at a rate
of one-twelfth of the total amount granted as of the end of each quarter, beginning with the first quarter after the date of grant ended either January 29, April 29,
July 29, or October 29 for the three-year vesting period so long as the recipient continues to be an eligible recipient, 2,347,450 vest over 16 consecutive quarters with the
first quarter being January 29, 2008 and 170,801 are subject to no vesting requirements. In addition, the LTIP Unit holders are entitled to dividends on the entire grant beginning on the date
of the grant.

The
Company has recognized compensation expense of $5.2 million and $3.9 million for the three months ended September 30, 2008 and 2007, respectively and
$15.3 million and $11.8 million for the nine months ended September 30, 2008 and 2007, respectively, related to the amortization of awards granted under this plan. As of
September 30, 2008, there were approximately 4,717,926 unvested LTIP Units and 55,520 LTIP Units were forfeited during the period. The related compensation expense to be recognized over the
remaining vesting period of all of the Company's LTIP grants is $42.1 million, provided there are no forfeitures.

Long-Term Incentive Bonus Plan

On September 14, 2004, the Board of Directors of the Company adopted the NorthStar Realty Finance Corp. 2004
Long-Term Incentive Bonus Plan (the "Incentive Bonus Plan"), in order to retain

29

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Table of Contents

NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

Amount in Thousands, Except per Share Data

(Unaudited)

11. Equity Based Compensation(Continued)

and
provide incentive to officers and certain key employees of the Company, among others. Up to 2.5% of the Company's total capitalization as of consummation of the IPO is available to be paid under
the Incentive Bonus Plan in cash, shares of common stock of the Company or other share-based form at the discretion of the compensation committee of the Company's Board of Directors, if certain return
hurdles are met.

An
aggregate of 698,142 shares of common stock of the Company were reserved and authorized for issuance under the Incentive Bonus Plan, subject to equitable adjustment upon the
occurrence of certain corporate events. All units under the plan were allocated to employees of the Company. The Company's compensation committee established the return hurdle for these performance
periods as an annual return on paid in capital as defined in the plan, equal to or greater than 12.5%.

The
Company achieved the performance hurdles for both performance periods in 2006 and 2007 and all units reserved under this plan were granted to each of the participants that was an
employee at the conclusion of the last performance period in November 2007. The Company has recognized, in the
condensed consolidated financial statements, $1.0 million and $2.2 million in compensation expense for the three and nine months ended September 30, 2007, respectively.

Employee Outperformance Plan

In connection with the employment agreement of the Company's head of its real estate securities business, he was eligible to receive
incentive compensation equal to 15% of the annual net profits from the Company's real estate securities business in excess of a 12% return on invested capital (the annual bonus participation amount).

In
April 2008, the Company's head of its real estate securities business left the Company. As a result, his employment agreement with the Company was terminated effective
April 11, 2008. He was not entitled to any severance, bonus or other payments or awards as a result of his departure. However, pursuant to his Outperformance Bonus Plan, he is deemed to have a
vested interest in, and may continue to receive the following: (i) 20% of the bonus participation amount relating to fee streams and securities investments that were made in the
12 months prior to April 11, 2008; (ii) 40% of the bonus participation amount relating to fee streams and securities investments that were made more than 12 months and less
than 24 months prior to April 11, 2008; (iii) 60% of the bonus participation amount relating to fee streams and securities investments that were made more than 24 months
and less than 36 months prior to April 11, 2008; (iv) 80% of the bonus participation amount relating to fee streams and securities investments that were made more than
36 months and less than 48 months prior to April 11, 2008; and (v) 100% of the bonus participation amount relating to fee streams and securities investments that were made
more than 48 months prior to April 11, 2008.

The
Company has recorded compensation expense under this plan of zero and $0.2 million for the three months ended September 30, 2008 and 2007, respectively, and zero and
$1.2 million for the nine months ended September 30, 2008 and 2007, respectively.

2006 Outperformance Plan

In January 2006, the Compensation Committee of the Board of Directors approved the NorthStar Realty Finance Corp. 2006 Outperformance
Plan (the "2006 Outperformance Plan"), a long-term

30

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Table of Contents

NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

Amount in Thousands, Except per Share Data

(Unaudited)

11. Equity Based Compensation(Continued)

compensation
program to further align the interests of the Company's stockholders and management. Under the 2006 Outperformance Plan, award recipients will share in a "performance pool" if the
Company's total return to stockholders for the period from January 1, 2006 (measured based on the average closing price of the Company's common stock for the 20 trading days prior to
January 1, 2006) to December 31, 2008 exceeds a cumulative total return to stockholders of 30%, including both share price appreciation and dividends paid. The size of the pool will be
10% of the outperformance amount in excess of the 30% benchmark, subject to a maximum dilution cap equal to $40 million, exclusive of accrued dividends. Each employee's award under the 2006
Outperformance Plan will be designated as a specified percentage of the aggregate performance pool. Assuming the 30% benchmark is achieved, the performance pool that is established under the 2006
Outperformance Plan will be allocated among the Company's employees in accordance with the percentage specified in each employee's award agreement. Although the amount of the awards earned under the
2006 Outperformance Plan will be determined when the performance pool is established, not all of the awards vest at that time. Instead, 50% of the awards vest on December 31, 2008 and 25% of
the awards vest on each of the first two anniversaries thereafter based on continued employment. The Company recorded the compensation expense for the 2006 Outperformance Plan in accordance with
SFAS 123 (R) "Stock Based Compensation." The fair value of the 2006 Outperformance Plan on the date of adoption was determined by the Company to be $4.1 million. In connection
with its determination, the Company retained a firm that had experience in appraising similar plans and considered such appraisal in its determination of the fair value of the 2006 Outperformance
Plan. The Company will amortize 50% of the value into compensation expense over the first three years of the plan, 25% will be amortized over four years and the remaining 25% over five years. The
Company recorded compensation expense of $0.3 million for each of the three months and $0.9 million for each of the nine months ended September 30, 2008 and 2007, respectively.

The
status of all of the Company's LTIP grants as of September 30, 2008 and December 31, 2007 are as follows (units in thousands):

September 30, 2008

December 31, 2007LTIP
Grants

Weighted Average
Grant Price

LTIP
Grants

Weighted Average
Grant PriceBalance at beginning of year(1)


5,484

$
11.47


1,683

$
9.44Granted


2,558


8.59


3,826


12.25Converted to common stock


(582
)

9.51


(20
)

9.0Forfeited


(55
)

9.42


(5
)

16.48Ending balance(2)


7,405

$
10.64


5,484

$
11.47


---

31

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Table of Contents

NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

Amount in Thousands, Except per Share Data

(Unaudited)

12. Stockholders' Equity

In April 2007, the Company implemented a Dividend Reinvestment and Stock Purchase Plan, or the Plan, pursuant to which it registered with the Securities and Exchange Commission and
reserved for issuance 15,000,000 shares of its common stock. Under the terms of the Plan, stockholders who participate in the Plan may purchase shares of the Company's common stock directly from it,
in cash investments up to $10,000. At the Company's sole discretion, it may accept optional cash investments in excess of $10,000 per month, which may qualify for a discount from the market price of
0% to 5%. Plan participants may also automatically reinvest all or a portion of their dividends for additional shares of the Company's stock. The Company expects to use the proceeds from any dividend
reinvestments or stock purchases for general corporate purposes.

In
May 2008, the Company entered into an equity distribution agreement with Wachovia Capital Markets, LLC ("Wachovia"). In accordance with the terms of the agreement, the Company
may offer and sell up to 10,000,000 shares of its common stock from time to time through Wachovia. Wachovia will receive a commission from the Company of up to 2.5% of the gross sales price of all
shares sold through it under the equity distribution agreement.

Common Stock

In May 2008, the Company issued 37,812 shares of common stock with a fair value at the date of grant of $0.4 million to its
Board of Directors as part of their annual grants.

For
the three and nine months ended September 30, 2008, the Company issued a total of zero and 224,434 shares of common stock, respectively, related to employee compensation
arrangements and employee separation agreements.

For
the three and nine months ended September 30, 2008, the Company sold a total of 12,100 shares and 114,100 shares, respectively, of common stock related to its equity
distribution agreement with Wachovia raising net proceeds of approximately $0.1 million and $0.6 million, net of $2,497 and $28,199, respectively, in commissions.

For
the three and nine months ended September 30, 2008, the Company sold a total of 34,301 and 98,151 shares of common stock, respectively, pursuant to the Plan, raising net
proceeds of approximately $0.2 million and $0.8 million, respectively.

Dividends

On January 22, 2008, the Company declared a cash dividend of $0.36 per share of common stock, $0.54688 per share of
Series A preferred stock and $0.51563 per share of Series B preferred stock. The dividends were paid on February 15, 2008 to stockholders of record as of the close of business on
February 5, 2008.

On
April 22, 2008, the Company declared a cash dividend of $0.36 per share of common stock, $0.54688 per share of Series A preferred stock and $0.51563 per share of
Series B preferred stock. The dividends were paid on May 15, 2008 to the stockholders of record as of the close of business on May 5, 2008.

On
July 22, 2008, the Company declared a cash dividend of $0.36 per share of common stock, $0.54688 per share of Series A preferred stock and $0.51563 per share of
Series B preferred stock. The

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NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

Amount in Thousands, Except per Share Data

(Unaudited)

12. Stockholders' Equity(Continued)

dividends
were paid on August 15, 2008 to the stockholders of record as of the close of business on August 5, 2008.

Earnings Per Share

Earnings per share for the three and nine months ended September 30, 2008 and 2007 is computed as follows (in thousands):

For the Three Months Ended September 30,

For the Nine Months Ended September 30,2008

2007

2008

2007Numerator (Income)Basic EarningsNet income available to common stockholders

$
233,533

$
8,687

$
411,277

$
26,002Effect of dilutive securitiesIncome allocated to minority interest


27,524


680


47,346


1,835Dilutive net income available to stockholders

$
261,057

$
9,367

$
458,623

$
27,837Denominator (Weighted Average Shares)Basic Earnings:Shares available to common stockholders


62,825


61,630


62,772


61,449Effect of dilutive securities:OP/LTIP units


7,405


3,030


7,226


2,952Dilutive Shares


70,230


64,660


69,998


64,401


13. Minority Interest

Operating Partnership

Minority interest represents the aggregate limited partnership interests or OP Units in the Operating Partnership held by limited
partners (the "Unit Holders"). Income allocated to the minority interest is based on the Unit Holders ownership percentage of the Operating Partnership. The ownership percentage is determined by
dividing the numbers of OP Units held by the Unit Holders by the total OP Units outstanding. The issuance of additional shares of beneficial interest (the "Common Shares" or "Share") or OP Units
changes the percentage ownership of both the Unit Holders and the Company. Since a unit is generally redeemable for cash or Shares at the option of the Company, it is deemed to be equivalent to a
Share. Therefore, such transactions are treated as capital transactions and result in an allocation between shareholders' equity and minority interest in the accompanying condensed consolidated
balance sheet to account for the change in the ownership of the underlying equity in the Operating Partnership. As of September 30, 2008 and December 31, 2007, minority interest related
to the aggregate limited partnership units of 7,404,575 and 5,683,118, represented a 10.52% and 8.43% interest in the Operating Partnership, respectively.

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NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

Amount in Thousands, Except per Share Data

(Unaudited)

13. Minority Interest(Continued)

Joint Ventures

In May 2006, the Company formed the Wakefield joint venture with Chain Bridge. On July 9, 2008, Wakefield sold a
$100 million convertible preferred equity interest to Inland American Real Estate Trust, Inc. The joint venture is consolidated in the condensed consolidated financial statements and
Inland American's and Chain Bridge's capital are treated as minority interests. Income allocated to minority interest for the three and nine months ended September 30, 2008 was
$2.3 million and $2.1 million, respectively. Income allocated to minority interest for the three and nine months ended September 30, 2007 was $0.2 million and
$0.4 million, respectively.

In
March 2007, the Company formed a joint venture with Monroe. On May 7, 2008, the Company completed a recapitalization of Monroe Capital, its middle-market corporate lending
venture. Upon completion of the recapitalization transaction, the Company deconsolidated the venture. Monroe Capital's equity is no longer a component of minority interest. Loss allocated to minority
interest prior to the recapitalization of Monroe Capital was $0.3 million.

14. Risk Management and Derivative Activities

Derivatives

The Company uses derivatives primarily to manage interest rate risk exposure. These derivatives are typically in the form of interest
rate swap agreements and the primary objective is to minimize interest rate risks associated with the Company's investment and financing activities. The counterparties of these arrangements are major
financial institutions with which the Company may also have other financial relationships. The Company is exposed to credit risk in the event of non-performance by these counterparties and
it monitors their financial condition; however, the Company currently does not anticipate that any of the counterparties will fail to meet their obligations because of their high credit ratings and
financial support from the U.S. Government. The objective in using interest rate derivatives is to add stability to interest expense and to manage exposure to interest rate movements.

In
January 2008, the Company adopted SFAS 159 and elected the fair value option for its bonds payable and its liability to subsidiary trusts issuing preferred securities. Under
SFAS 159, the changes in fair value of these financial instruments are now recorded in earnings. As a result of this election, the interest rate swap agreements associated with these debt
instruments no longer qualify for hedge accounting, in accordance with SFAS 133 "Derivatives and Hedging Activity", since the underlying debt is remeasured with changes in the fair value
recorded in earnings. The unrealized gains or losses accumulated in other comprehensive income, related to these interest rate swaps, will be reclassified into earning over the shorter of either the
life of the swap or the associated debt with current mark-to-market unrealized gains or losses recorded in earnings. For the three months ended September 30, 2008, the
Company recorded, in earnings, a mark-to-market unrealized loss of $1.8 million and a $1.4 million reclassification from accumulated other comprehensive income
for the non-qualifying interest rate swaps. For the nine months ended September 30, 2008, the Company recorded, in earnings, a mark-to-market unrealized gain
of $8.3 million and a $4.1 million reclassification from accumulated other comprehensive income for the non-qualifying interest rate swaps.

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NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

Amount in Thousands, Except per Share Data

(Unaudited)

14. Risk Management and Derivative Activities(Continued)

The
following tables summarize the Company's derivative financial instruments as of September 30, 2008 and December 31, 2007 (in thousands):

Notional
Amount

Fair Value
Net Asset/
(Liability)

Range of
Fixed LIBOR

Range of MaturityInterest rate swaps and basis swapsAs of September 30, 2008


1,495,212


(44,860
)
3.02% - 5.96%

October 2009 - August 2018As of December 31, 2007


856,306


(49,280
)
4.18% - 6.61%

February 2008 - August 2018


Credit Risk Concentrations

Concentrations of credit risk arise when a number of borrowers, tenants or issuers related to the Company's investments are engaged in
similar business activities or located in the same geographic location to be similarly affected by changes in economic conditions. The Company monitors its portfolio to identify potential
concentrations of credit risks. The Company has no one borrower or one tenant that generates 10% or more of its total revenue. However, approximately 17.7% and 11.2% of the Company's rental and
escalation revenue for the nine months ended September 30, 2008 is generated from two tenants in the Company's healthcare net lease portfolio. The Company believes the remainder of its net
lease portfolio is reasonably well diversified and does not contain any unusual concentration of credit risks.

15. Off Balance Sheet Arrangements

Term Debt Transactions

The Company has interests in four term debt transactions, N-Star I, N-Star II, N-Star III and
N-Star V, which are structured as collateralized debt obligations and whose term notes are primarily collateralized by investment grade real estate securities. The Company generally
purchases the preferred equity or the income notes of each term debt transaction, which are the equity securities of the term debt issuances, and, with the exception of N-Star I, all of
the below investment grade term debt notes of each term debt transaction. In addition, the Company earns a fee of 0.35% of the outstanding principal balance of the assets backing each of these term
debt issuances as an annual collateral management fee. The Company's interest in each of the four term debt transactions is accounted for as a single debt security available for sale pursuant to
EITF 99-20.

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NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

Amount in Thousands, Except per Share Data

(Unaudited)

15. Off Balance Sheet Arrangements(Continued)

The
following tables describe certain terms of the collateral for and the notes issued by N-Star I, N-Star II, N-Star III and N-Star V at
September 30, 2008 and December 31, 2007 (in thousands):

CollateralSeptember 30, 2008

Term NotesSeptember 30, 2008Issuance

Date
Closed

Par Value
of Collateral

Weighted
Average
Interest
Rate

Weighted
Average
Expected
Life (years)

Outstanding
Term
Notes(1)

Weighted
Average
Interest
Rate

Stated
MaturityN-Star I(2)


8/21/03

$
301,735


6.64
%

4.14

$
282,732


6.21
%

8/01/2038N-Star II


7/01/04


331,878


6.22


4.77


295,931


5.60


6/01/2039N-Star III


3/10/05


404,771


5.90


4.25


358,676


5.14


6/01/2040N-Star V


9/22/05


509,722


5.49


6.22


456,319


4.74


9/05/2045Total




$
1,548,106


5.98
%

4.99

$
1,393,658


5.32
%


---

CollateralDecember 31, 2007

Term NotesDecember 31, 2007Issuance

Date
Closed

Par Value
of Collateral

Weighted
Average
Interest
Rate

Weighted
Average
Expected
Life (years)

Outstanding
Term
Notes(1)

Weighted
Average
Interest
Rate

Stated
MaturityN-Star I(2)


8/21/03

$
320,583


6.58
%

4.64

$
301,406


6.24
%

8/01/2038N-Star II


7/01/04


335,301


6.24


4.73


306,110


5.75


6/01/2039N-Star III


3/10/05


404,772


6.30


5.20


358,892


5.84


6/01/2040N-Star V


9/22/05


495,971


5.87


7.09


456,319


5.07


9/05/2045Total




$
1,556,627


6.21
%

5.59

$
1,422,727


5.66
%


---

Equity Notes of Collateralized Loan Obligations

In December 2006, the Company acquired 40% of the residual equity interests in a Collateralized Loan Obligation ("CLO") originated by
Monroe Capital, LLC, a specialty finance company, for $16.7 million. The CLO includes collateral of approximately $400 million backed primarily by first lien senior secured loans.
The Company also acquired a 12.5% and 33.5% residual equity interest in two third party CLOs. The Company determined the CLOs to be variable interest entities under FIN 46(R)-6 and that it
was not the primary beneficiary; therefore, the financial statements of the CLOs were not consolidated into the condensed consolidated financial statements of the Company. On May 7, 2008, the
Company completed a recapitalization of Monroe Capital, its middle-market

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NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

Amount in Thousands, Except per Share Data

(Unaudited)

15. Off Balance Sheet Arrangements(Continued)

corporate
lending venture and contributed its CLO equity interests into the recapitalized entity. See Note 1 for additional information.

The
Company's potential loss in its off balance sheet investments is limited to the carrying value of its investment, which is $53.8 million and $78.1 million at
September 30, 2008 and December 31, 2007, respectively.

16. Segment Reporting

The Company's real estate debt segment is focused on originating, structuring and acquiring senior and subordinate debt investments secured primarily by commercial real estate
properties. The Company generates revenues from this segment by earning interest income from its debt investments and its operating expenses consist primarily of interest costs from financing the
assets. This segment generates
income from operations by earning a positive spread between the yield on its assets and the interest cost of its debt. The Company evaluates performance and allocates resources to this segment based
upon its contribution to income from continuing operations.

The
Company's operating real estate segment is focused on acquiring commercial real estate facilities located throughout the U.S. that are primarily leased under long-term
triple-net leases to corporate tenants. Triple-net leases generally require the lessee to pay all costs of operating the facility, including taxes and insurance and maintenance
of the facility. The Company's net-leased facilities are currently located in New York, Ohio, California, Utah, Pennsylvania, New Jersey, Indiana, Illinois, New Hampshire, Massachusetts,
Kansas, Maine, South Carolina, Michigan, Colorado, North Carolina, Florida, Washington, Oregon, Wisconsin, Georgia, Oklahoma, Nebraska, Tennessee, Texas and Kentucky. Revenues from these assets are
generated from rental income received from lessees of the facilities, and operating expenses, which include interest costs related to financing the assets, operating expenses, real estate taxes,
insurance, ground rent and repairs and maintenance. The segment generates income from operations by leasing these facilities at a higher rate than the costs of owning and financing the assets.

The
Company's real estate securities segment is focused on investing in a wide range of commercial real estate debt securities, including commercial mortgage-backed securities ("CMBS"),
REIT unsecured debt, credit tenant loans and unsecured subordinate securities of commercial real estate companies. The Company generates revenues from this segment by earning interest income and
advisory fees from owning and managing these investments. Its operating expenses consist primarily of interest costs from financing its securities. The segment generates income from operations by
earning advisory fees and a positive spread between the yield on its assets and the interest cost of its debt.

On
May 7, 2008, the Company completed a recapitalization of its middle-market corporate lending venture. Upon completion of the recapitalization transaction, the Company
deconsolidated the venture and now uses the equity method of accounting for the investment. As a result, and as of May 7, 2008, the corporate loan segment is no longer a reportable segment of
the Company. Its current investment is included in corporate.

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NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

Amount in Thousands, Except per Share Data

(Unaudited)

16. Segment Reporting(Continued)

The
following table summarizes segment reporting for the three and nine months ended September 30, 2008 and 2007 (in thousands):

Real
Estate
Debt

Operating
Real
Estate

Real
Estate
Securities

Corporate(1)

Consolidated
TotalTotal revenues for the three months endedSeptember 30, 2008

$
42,001

$
38,108

$
13,083

$
348

$
93,540September 30, 2007


56,356


27,529


16,095


12,698


112,678Income (loss) from continuing operations before minority for the three months endedSeptember 30, 2008


186,356


4,273


38,604


39,355


268,588September 30, 2007


17,119


(2,741
)

4,862


(4,427
)

14,813Net income (loss) for the three months endedSeptember 30, 2008


166,977


3,819


34,536


33,432


238,764September 30, 2007


17,119


(2,822
)

4,862


(5,241
)

13,918Total revenue for the nine months endedSeptember 30, 2008


130,202


96,313


47,096


12,674


286,285September 30, 2007


150,907


70,752


64,080


18,653


304,392Income (loss) from continuing operations before minority interest for the nine months endedSeptember 30, 2008


412,730


1,903


40,573


21,207


476,413September 30, 2007


56,927


(2,273
)

13,789


(28,897
)

39,546Net income (loss) for the nine months endedSeptember 30, 2008


369,215


2,712


36,295


18,748


426,970September 30, 2007


56,927


(2,495
)

13,789


(30,917
)

37,304Total assets as ofSeptember 30, 2008

$
2,304,804

$
1,258,527

$
405,118

$
152,416

$
4,120,865


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NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

Amount in Thousands, Except per Share Data

(Unaudited)

17. Supplemental Disclosure of Non-Cash Investing and Financing Activities

A summary of non-cash investing and financing activities for the nine months ended September 30, 2008 and 2007 is presented below (in thousands):

September 30,2008

2007The acquisition of available for sale securities with warehouse deposit

$


$
(21,898
)Real estate debt investment pay-down due from servicer


18,000


25,587Write-off of deferred financing cost in connection with FAS 159 implementation


34,605


Initial mark-to-market adjustment in connection with FAS 159 implementation


(340,835
)

Elimination of available for sale securities due to acquisition of consolidated liabilities





(5,398
)Reduction of mortgage notes and loans payable due to acquisition of consolidated asset and release of mortgage escrow





1,485Elimination of bonds payable due to acquisition of consolidated assets





(7,250
)Allocation of purchase price of operating real estate to deferred cost


(272
)

(30,287
)Minority interest buy-out


(1,566
)

Assumption of loan in connection with acquisition of operating real estate





19,480Deed in lieu of foreclosure of operating real estate





7,525Contribution of book value of assets to unconsolidated joint venture


112,097


Reclassification of prior-year construction in progress


(4,409
)

Write-off of deferred lease cost, tenant improvements and below market lease adjustments related to lease termination


(3,456
)




18. Subsequent Events

Dividends

On October 8, 2008, the Company declared a dividend of $0.36 per share of common stock. On October 21, 2008, the Company
declared a dividend of $0.54688 per share of Series A preferred stock and $0.51563 per share of Series B preferred stock. The dividends will be paid on November 15, 2008 to the
stockholders of record as of the close of business on November 4, 2008.

JP Facility

On October 7, 2008, the Company and a subsidiary entered into Amendment No. 1 (the "Amendment") to the Master Repurchase
Agreement (as amended, the "Facility") with JPMorgan

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NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

Amount in Thousands, Except per Share Data

(Unaudited)

18. Subsequent Events(Continued)

Chase
Bank, N.A. ("JPMorgan"). The Facility had approximately $50.4 million outstanding on the amendment date and such amounts bear interest at spreads of 1.25% to 1.80% over
one-month LIBOR. Advance rates for the assets currently financed under the Facility range from 55% to 80% of the value of the collateral for which the advance is made. Interest rates and
advance rates on future borrowings under the Facility will be determined by JPMorgan. Pursuant to the Amendment, the maximum amount outstanding under the Facility shall not exceed $150 million
and the Company has agreed to guaranty the outstanding amount under the Facility. The term of the Facility will expire on August 8, 2010, subject to renewal by JPMorgan on August 8,
2009.

Stock Repurchase Program

On October 8, 2008, the Company's Board of Directors authorized a stock repurchase program of up to 10,000,000 shares of the
Company's outstanding common stock, or approximately 16% of the Company's outstanding common stock. Stock repurchases under this program will be made from time to time through the open market or in
privately negotiated transactions. The timing and actual number of shares repurchased will depend on a variety of factors including price, corporate and regulatory requirements, market conditions, and
other corporate liquidity requirements and priorities. As of November 6, 2008, the Company had not repurchased any shares under the authorization.

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

The following discussion should be read in conjunction with our financial statements and notes thereto included in this report.

Forward-Looking Statements

This report contains information that may constitute "forward-looking statements." Such forward-looking
statements relate to, among other things, the operating performance of our investments and financing needs. Forward-looking statements are generally identifiable by use of forward-looking terminology
such as "may," "will," "should," "potential," "intend," "expect," "seek," "anticipate," "estimate," "believe," "could," "project," "predict," "continue" or other similar words or
expressions. Forward-looking statements are not guarantees of performance and are based on certain assumptions, discuss future expectations, describe plans and strategies, contain projections of
results of operations or of financial condition or state other forward-looking information. Our ability to predict results or the actual effect of plans or strategies is inherently uncertain. Although
we believe that the expectations reflected in such forward-looking statements are based on reasonable assumptions, our actual results and performance could differ materially from those set forth in
the forward-looking statements. These forward-looking statements involve risks, uncertainties and other factors that may cause our actual results in future periods to differ materially from those
forward looking statements. We are under no duty to update any of the forward-looking statements after the date of this report to conform these statements to actual results.

Factors that could have a material adverse effect on our operations and future prospects are set forth in "Risk Factors" in our Annual Report on
Form 10-K for the year ended December 31, 2007, and those described from time to time in our future reports filed with the Securities and Exchange Commission. The factors set
forth in the Risk Factors section could cause our actual results to differ significantly from those contained in any forward-looking statement contained in this report.

Introduction

We primarily derive revenues from interest income on the real estate debt investments that we originate with borrowers or acquire from
third parties and our real estate securities in which we invest. We generate rental income from our net lease investments. We also generate interest revenues from our ownership interest in
non-consolidated securities term debt transaction issuances and advisory fee income and income from our unconsolidated ventures. Other income comprises a much smaller and more variable
source of revenues and is generated principally from fees associated with early loan repayments and gains/losses from sales of securities.

We
primarily derive income through the difference between the interest and rental income we are able to generate from our investments and the cost at which we are able to obtain
financing for our investments. In order to protect this difference, or "spread", we seek to match-fund our investments using secured sources of long-term financing such as term
debt transaction financings, mortgage financings and long-term unsecured subordinate debt. Match-funding means that we try to obtain debt with maturities equal to our asset maturities and
borrow funds at interest rate benchmarks similar to our assets. Match-funding results in minimal impact to spread when interest rates are rising and falling and minimizes refinancing risk since our
asset maturities match those of our debt.

Profitability and Performance Metrics

We calculate several metrics to evaluate the profitability and performance of our business.



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Credit
risk management is our ability to manage our assets in a manner that preserves principal and income and minimizes credit losses that would decrease income.

Corporate
expense management influences the profitability of our business. We must balance making appropriate investments in our infrastructure and employees with a recognition that our
accounting, finance, legal and risk management infrastructure does not directly generate quantifiable revenues for us. We frequently refer to general and administrative expenses, excluding stock-based
compensation expense, divided by total revenues as a measure of our efficiency in managing expenses.

Availability
and cost of capital will impact our profitability and earnings since we must raise new capital to fund a majority of our AUM growth.

Outlook and Recent Trends

In early 2007, the subprime residential lending and single family housing markets began to experience significant default rates,
declining real estate values and increasing backlog of housing supply. Other lending markets also experienced higher volatility and decreased liquidity resulting from the poor credit performance in
the residential lending markets. The residential sector capital markets issues quickly spread more broadly into the asset-backed commercial real estate, corporate and other credit and equity markets.
Although we do not have any direct subprime exposure or direct exposure to the single family mortgage market, the factors described above have resulted in substantially reduced mortgage loan
originations, virtually no availability of debt capital in the securitization market, and a severe contraction in available credit.

During
the third quarter 2008, financial institutions became increasingly loath to lend cash to peer institutions, even on a very short-term basis, as lack of transparency
regarding asset quality reduced confidence in counterparty creditworthiness. Despite liquidity infusions from government-sponsored central banks worldwide, the cost of capital increased dramatically,
and even the most liquid markets such as the commercial paper market experienced enormous outflows of capital. Those institutions deemed by the market to be most at risk for credit issues, principally
those with large real estate and mortgage portfolios, experienced massive withdrawals from customer brokerage and deposit accounts. These institutions also became unable to transact in the capital
markets because few participants were willing to take their counterparty risk, thereby resulting in their insolvency (most notably Lehman Brothers Holding, Inc). The U.S. Government reacted to the
rapid deterioration in the financial system by passing the Emergency Economic Stabilization Act of 2008 (the "Act") in early October. The Act authorized and provided funds to the U.S. Treasury
Department to acquire financial assets from institutions as a buyer of last resort in order to enable these institutions to reduce their exposure to troubled assets and to regain market confidence.
Since that time, the U.S. has committed to make up to $250 billion of direct equity investments into banking institutions and announced a program to purchase commercial paper from corporations.
At this time it is unclear whether these actions will have a positive impact on the credit markets. Most experts forecast poor economic conditions through 2009 caused by higher unemployment, reduced
consumer and business spending, scarcity of credit and a need for banks and consumers to deleverage after years of plentiful and cheap debt capital.

As
a result of the enormous credit market disruptions and negative economic outlook, most financial industry participants, including commercial real estate lenders and investors,
continue to find it difficult to obtain cost-effective debt and equity capital to fund new investment activity or to refinance maturing debt. In addition, most economic measures indicate
the U.S. and other major

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economic
regions worldwide are entering a recession. Weaker macroeconomic conditions combined with the continued lack of liquidity in the U.S. commercial real estate market continue to pressure
underlying real estate values and cash flows.

Property
types most directly and immediately impacted by these weaker conditions include residential condominium projects in markets which experienced a high level of development during
the residential market boom, such as in South Florida, Las Vegas and areas of California. Multi-family properties located in nearby areas have generally been impacted by the oversupply of condominiums
because many of these projects are being converted into competing rental properties. We have $91.7 million of loans backed by residential condominium properties of which 83.1% are located in
New York City, a market that has not experienced severe oversupply. We own six first mortgage assets totaling $151.5 million having multi-family rental collateral properties located in South
Florida that are experiencing weak operating performance due to overbuilding and weak economic conditions in these markets. Also, hotels are generally most immediately impacted by changing economic
conditions because revenues are generated on a nightly basis, based on room rates and occupancy. The next most sensitive real estate class to changing economic conditions is retail, followed by office
and industrial properties. Office, industrial and retail property types have longer-term, multi-year leases and therefore reset to market on a lagging basis. The degree to
which commercial real estate values are impacted by weaker economic conditions and the level of credit losses in our asset base will be determined primarily by the length that such conditions exist
and the severity of the contraction.

Due
to the liquidity crisis, our primary short-term lending and borrowing benchmark rates, one-month and three-month LIBOR, rose during the quarter and exceeded
4.0%, even though the Fed Funds target rate is currently at a low 1.0%. These LIBOR indices have recently decreased but the spread between LIBOR and the Fed Funds target remains very high by
historical standards. Rising LIBOR increases earnings from our loans and securities whose interest payments are based on a floating rate index, but adversely impacts commercial real estate values and
credit. Higher interest rates result in a greater discount rate applied to underlying real estate cash flows and therefore generate lower implied values. Higher interest rates also result in greater
debt service costs, lower debt service coverage and more quickly depleted interest reserves for loans that rely on interest reserves to service debt while the collateral properties are being
repositioned by our borrowers.

For
existing loans, when credit spreads widen, the fair value of these existing loans decreases. If a lender were to originate a similar loan today, such loan would carry a greater
credit spread than the existing loan. Even though a loan may be performing in accordance with its loan agreement and the underlying collateral has not changed, the fair value of the loan may be
negatively impacted by the incremental interest foregone from the widened credit spread. Accordingly, when a lender wishes to sell
or finance the loan, the reduced value of the loan will impact the total proceeds that the lender will receive.

Our
real estate securities investments could also be negatively impacted by weaker rental market conditions. Within the underlying loan pools, any slowdown in economic conditions would
likely reduce tenants' ability to make rent payments in accordance with the terms of their leases. Additionally, to the extent that market rental rates are reduced, property-level cash flows would
likely be negatively affected as existing leases renew at lower rates. Finally, declining occupancy rates could also impact cash flow and reduce borrowers' ability to service their outstanding loans.

Our
net leased assets could be adversely impacted by a weaker economy as well. Corporate space needs may contract resulting in lower lease renewal rates and longer releasing periods when
leases are not renewed. Poor economic conditions may negatively impact the creditworthiness of our tenants which could result in their inability to meet the contractual terms of their leases.

We
responded to these difficult conditions by decreasing investment activity when we observed deteriorating market conditions. We expect credit to continue to be challenging throughout
the

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remainder
of 2008 and into 2009 and believe we have the resources to quickly identify potential issues and to act aggressively to protect our invested capital.

Approximately
$4.0 billion of our term debt transaction liabilities (including the off-balance sheet and on-balance sheet financings) currently permit
reinvestment of capital proceeds which means when the underlying assets repay we are able to reinvest the proceeds in new assets without having to repay the liabilities. We expect very few loan
repayments in the fourth quarter due to the scarcity of debt capital. Approximately $756 million of our funded loan commitments have their initial maturity date in 2009; however, most of the
loans contain extension options of at least nine months (many subject to performance criteria) so it is difficult to estimate how much capital, if any, from initial maturities or prepayments may be
recycled into higher earning investments for 2009.

Our
near-term business plan assumes that we manage our current asset base to maximize earnings, minimize credit losses and maintain liquidity levels that provide us the
flexibility to potentially make selective new investments when we believe the opportunity is exceptional. Our plan also assumes that we can successfully continue to generate other income levels
consistent with or greater than in the past, given our larger asset base, and can manage credit so that future credit losses, while higher than prior periods, will not be significantly greater than in
the past. Furthermore, we may allocate a portion of our available investment capital to our LandCap joint venture, and have a $175 million discretionary commitment along with an equal amount
committed by Goldman, Sachs' Whitehall funds. The venture's investment strategy to take advantage of distress in the residential
markets will likely involve making investments in non-performing loans backed by residential land and equity interests in residential lots. These investments potentially are not expected
to generate meaningful current returns for several years and a majority of our returns will likely be realized upon disposition or resolution of the assets. Because the capital we raise has a current
pay requirement, including our equity, there will likely be a timing difference between payments we must make to our creditors and shareholders and the ultimate receipt of a return on our invested
capital. Our future level of earnings and dividends in this changing interest rate and liquidity environment is dependent upon market conditions and our ability to successfully execute these plans.

We
believe that in the longer term, liquidity could return to the commercial real estate finance markets but that in the near term, new financing sources must be developed in order to
attractively finance new investment activity. We believe these sources will include term loans from financial institutions and life companies, more restrictive commercial real estate finance
structures, which may not permit reinvestment from asset repayments, and financing provided by motivated sellers of assets.

Investors
are encouraged to read the Risk Factors section of our Annual Report on Form 10-K for the year ended December 31, 2007 and in our Quarterly Report on
Form 10-Q for the period ended September 30, 2008.

Risk Management

As of September 30, 2008, no assets were delinquent on contractual principal or interest payments according to the underlying
loan terms and no assets were considered non-performing. A loan is classified as non-performing at such time as the loan becomes 90 days delinquent or the loan has a
maturity default.

We
use many methods to actively manage our asset base to preserve our income and capital. Generally, for loans and net lease assets, frequent dialogue with borrowers/tenants and
inspections of our collateral and owned properties have proven to be an effective process for identifying issues early and prior to missed debt service and lease payments. Many of our loans also
require borrowers to replenish cash reserves for items such as taxes, insurance and future debt service costs. Late replenishments also may be an early indicator there could be a problem with the
borrower or collateral property. We also may negotiate modifications to loan terms if we believe such modification improves our ability to maximize principal recovery. Modifications may include
changes to contractual interest

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rates,
maturity dates and other borrower obligations. Generally, when we make a concession such as reducing an interest rate or extending a maturity date, we seek to get additional collateral and/or
fees in return for the modification. In some cases we may issue default notices and begin foreclosure
proceedings when the borrower is not complying with the loan terms and we believe taking control of the collateral is the best course of action to protect our capital. For net leases, we may seek to
obtain up-front or accelerated payment in return for an early cancelation of the lease if we believe the tenant's creditworthiness has significantly deteriorated and that taking control of
the property and re-leasing it maximizes value.

Securities
investments generally have a more liquid market than loans and net lease assets, but we typically have very little control over restructuring decisions when there is a problem
with the asset. Generally, we manage risk in the securities portfolio by selling the asset when we can obtain a price that is attractive relative to its riskiness. In certain situations, we may sell
an asset because there is an opportunity to reinvest the capital into a new asset with a more attractive risk/return profile.

We
conduct a quarterly comprehensive credit review which is designed to enable management to evaluate and proactively manage asset-specific credit issues and identify credit trends on a
portfolio-wide basis as an "early warning system." Nevertheless, we cannot be certain that our review will identify all issues within our portfolio due to, among other things, adverse
economic conditions or events adversely affecting specific assets; therefore, potential future losses may also stem from assets that are not identified by our credit reviews. Based on the quarterly
reviews, loans and net lease assets are put on an internal "Watch List" if we believe there is greater near-term risk that we could lose invested capital and/or there is a situation at the
underlying collateral which requires intensive risk management and portfolio management resources. Securities investments are generally added to the watch list if there is a default, although
management may use its discretion to include or exclude any asset from the watch list based on qualitative factors such as likelihood of actual loss realization, level of resources required to work
out the issue, and probability of default if there has not yet been an actual default. A Watch List asset does not necessarily mean it is non-performing or that there is an impaired loan
basis, but indicates our view that the risk of the asset becoming non-performing or impaired is much greater than in the overall portfolio.

In
the first quarter 2008, we recorded a $0.8 million credit loss provision on a $19.5 million first mortgage loan secured by two multi-family properties located in San
Antonio, Texas. The loans were paying current. During the second quarter 2008 we recorded a $2.5 million credit loss provision relating to two loans which are on the Watch List. We recorded a
$2.0 million credit loss provision relating to an $11.0 million mezzanine loan backed by a portfolio of seven limited service hotel properties and unentitled land. The properties
securing the loan were recently completed and continue to experience improving operating performance as they reach expected stabilized occupancy levels. In addition, the borrower plans to market the
land for sale. During the second quarter 2008, we also recorded a $0.5 million credit loss provision relating to an $18.0 million first mortgage loan backed by a multi-family property
located in South Florida. The sponsor of this asset has experienced financial distress and cannot currently meet its reserve replenishment funding obligations. We believe the reserve is prudent until
such time as the collateral's performance indicates that its value fully covers our loan basis.

In
the third quarter of 2008, we recorded a $2.2 million reserve against a $13.1 million mezzanine loan backed by a multi-family property located in Georgia, a
$0.5 million reserve against a $16.9 million first mortgage loan backed by a multi-family property located in South Florida and an additional $0.5 million reserve
($1.0 million total to date) against the $18.0 million first mortgage loan backed by a multi-family
property located in South Florida referred to earlier. We also reversed the $0.8 million reserve taken during the first quarter 2008 against the $19.5 million first mortgage backed by
two multi-family properties located in San Antonio, Texas upon a third party acquisition of the property for $2.5 million cash and assumption of our loan. Credit loss reserves for real estate
loans total $5.7 million as of September 30, 2008.

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During
the third quarter we added four loan assets totaling $99.7 million and our equity investment in one net lease asset totaling $15.2 million to the Watch List. We
removed the $19.5 million San Antonio first mortgage from the Watch List. We do not currently believe that any credit loss reserves are required for the loan assets added to the Watch List this
quarter. As of September 30, 2008, we had 11 assets on our Watch List totaling $205.4 million.

The
loan assets added this quarter include a $46.0 million first mortgage on a multi-family property in Naples, FL, a $21.4 million first mortgage on a residential condo
development site in Manhattan (New York City), a $20.8 million mezzanine loan on a multi-family property in Ventura, CA and an $11.3 million first mortgage on an independent living
facility in Arlington, TX. Each of these assets is significantly underperforming our underwritten expectations and/or the sponsors are under financial stress and may not be able to provide additional
support to the assets.

This
quarter we also added a net leased asset comprised of three office buildings totaling 257,000 square feet located in Chatsworth, CA and 100% leased to Washington Mutual
Bank, FA ("WaMu"). As of September 30, 2008 the buildings had a combined $54.6 million net book value and were financed with a non-recourse $43.0 million first
mortgage loan. The assets are also financed with a $9.7 million mezzanine loan which is collateral for one of our securities term financings. On September 25, 2008, JPMorgan
Chase & Co. ("JPMorgan") announced that it had acquired substantially all of the assets and liabilities of WaMu from the Federal Deposit Insurance Corp. JPMorgan is entitled to a
90-day period from the WaMu acquisition date to decide whether they will accept or reject the terms of the lease. JPMorgan has preliminarily indicated they would like to decrease the
rented space and shorten the remaining term of the existing lease. We have not yet agreed to any lease modification, the terms of which would also have to be satisfactory to the first mortgage lender.
In a worst case scenario, we could transfer our ownership of the facilities to the first mortgage lender, in which case the value of our mezzanine loan and residual equity interest totaling
$15.2 million at September 30, 2008 would be reduced to zero.

Critical Accounting Policies

The following is a summary of our critical accounting policies. Refer to the section of our Annual Report on
Form 10-K for the year ended December 31, 2007 entitled "Management's Discussion and Analysis of Financial Condition and Results of OperationsCritical Accounting
policies" for a full discussion of our critical accounting policies.

Valuation of Financial Instruments

Proper valuation of financial instruments is a critical component of our financial statement preparation. We adopted the provisions of
SFAS No. 157 "Fair Value Measurements" ("SFAS 157") effective January 1, 2008. SFAS 157 defines fair value, establishes a framework for measuring fair value, establishes a
fair value hierarchy based on the quality of inputs used to measure fair value and enhances disclosure requirements for fair value measurements. Fair value is defined as the price that would be
received to sell an asset or paid to transfer a liability in an orderly transaction between marketplace participants at the measurement date (i.e., the exit price).

We
have categorized our financial instruments, based on the priority of the inputs to the valuation technique, into a three level fair value hierarchy. The fair value hierarchy gives the
highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). If the inputs used to measure
the financial instruments fall within different levels of the hierarchy, the categorization is based on the lowest level input that is significant to the fair value measurement of the instrument.

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Financial
assets and liabilities recorded on the Condensed Consolidated Balance Sheets are categorized based on the inputs to the valuation techniques as follows:

Level 1.

Financial assets and liabilities whose values are based on unadjusted quoted prices for identical assets or liabilities in an active market (examples include active exchange-traded equity securities, listed derivatives,
most U.S. Government and agency securities, and certain other sovereign government obligations).Level 2.

Financial assets and liabilities whose values are based on the following:a)

Quoted prices for similar assets or liabilities in active markets (for example, restricted stock);b)

Quoted prices for identical or similar assets or liabilities in non-active markets (examples include corporate and municipal bonds, which trade infrequently);c)

Pricing models whose inputs are observable for substantially the full term of the asset or liability (examples include most over-the-counter derivatives, including interest rate and currency swaps); andd)

Pricing models whose inputs are derived principally from or corroborated by observable market data through correlation or other means for substantially the full term of the asset or liability (for example, certain
mortgage loans).Level 3.

Financial assets and liabilities whose values are based on prices or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement. These inputs reflect
management's own assumptions about the assumptions a market participant would use in pricing the asset or liability (examples include private equity investments, commercial mortgage backed securities, and long-dated or complex derivatives including
certain foreign exchange options and long dated options on gas and power).


The
fair values of our financial instruments are based on observable market prices when available. Such prices are based on the last sales price on the date of determination, or, if no
sales occurred on such day, at the "bid" price at the close of business on such day and if sold short at the "asked" price at the close of business on such day. Interest rate swap contracts are valued
based on market rates or prices obtained from recognized financial data service providers. Generally these prices are provided by a recognized financial data service provider.

We
have valued our financial instruments, in the absence of observable market prices, using the valuation methodologies described below applied on a consistent basis. For some financial
instruments little market activity may exist; management's determination of fair value is then based on the best information available in the circumstances, and may incorporate management's own
assumptions and involves a significant degree of management's judgment.

Investments
for which market prices are not observable are generally investments in equity or income notes of term debt transactions, equity interests in collateralized loan obligations
and trust preferred securities. Fair values of these investments are determined by reference to market rates or prices provided by the underwriters of the structured securities or cash flow models
utilizing an internal rate of return provided by the underwriters of the term debt or CLO transaction. An analysis is applied to the estimated future cash flows using various factors depending on the
investments, including various reinvestment parameters.

Liabilities
for which market prices are not generally observable include our liability to subsidiary trusts issuing preferred securities. The fair value of these debt instruments are
based upon an analysis of other instruments issued by us that are currently actively traded including our preferred stock and exchangeable senior notes. An analysis is performed on the implied credit
spreads that could be observed for these instruments. We believe that the credit spreads for our preferred stock and

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exchangeable
senior notes are valid proxies for those of the liability to subsidiary trusts issuing preferred securities because they share many of the same structural and credit features. However, in
deriving appropriate credit spreads for the liability to subsidiary trusts issuing preferred securities on
the basis of observed credit spreads for preferred stock and exchangeable senior notes, several adjustments are made to reflect the differences between these instruments and the liability to
subsidiary trusts issuing preferred securities.

We
also adopted SFAS No. 159 "The Fair Value Option for Financial Assets and Financial Liabilities" ("SFAS 159") effective January 1, 2008 and we have elected to
fair value certain financial instruments. The change in fair value of these instruments is recorded in unrealized gain (loss) on investments and other in the condensed consolidated statement of
operations. See Note 3 to the condensed consolidated financial statements for further information.

Recent Accounting Pronouncements

In December 2007, the FASB issued SFAS 141(R), "Business Combinations" ("SFAS 141(R)"). This Statement replaces
SFAS 141, "Business Combinations", and requires an acquirer to recognize the assets acquired, the liabilities assumed, including those arising from contractual contingencies, any contingent
consideration, and any noncontrolling interest in the acquiree at the acquisition date, measured at their fair values as of that date, with limited exceptions specified in the statement.
SFAS 141(R) also requires the acquirer in a business combination achieved in stages (sometimes referred to as a step acquisition) to recognize the identifiable assets and liabilities, as well
as the noncontrolling interest in the acquiree, at the full amounts of their fair values (or other amounts determined in accordance with SFAS 141(R)). In addition, SFAS 141(R)'s
requirement to measure the noncontrolling interest in the acquiree at fair value will result in recognizing the goodwill attributable to the noncontrolling interest in addition to that attributable to
the acquirer. SFAS 141(R) amends SFAS No. 109, "Accounting for Income Taxes", to require the acquirer to recognize changes in the amount of its deferred tax benefits that are
recognizable because of a business combination either in income from continuing operations in the period of the combination or directly in contributed capital, depending on the circumstances. It also
amends SFAS 142, "Goodwill and Other Intangible Assets", to, among other things, provide guidance on the impairment testing of acquired research and development intangible assets and assets
that the acquirer intends not to use. SFAS 141(R) applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period
beginning on or after December 15, 2008. We are currently assessing the potential impact that the adoption of SFAS 141(R) could have on our financial statements.

In
December 2007, the FASB issued SFAS 160, "Noncontrolling Interests in Consolidated Financial Statements" ("SFAS 160"). SFAS 160 amends Accounting Research
Bulletin 51, "Consolidated Financial Statements", to establish accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. It also
clarifies that a noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements. SFAS 160
also changes the way the consolidated income statement is presented by requiring consolidated net income to be reported at amounts that include the amounts attributable to both the parent and the
noncontrolling interest. It also requires disclosure, on the face of the consolidated statement of income, of the amounts of consolidated net income attributable to the parent and to the
noncontrolling interest. SFAS 160 requires that a parent recognize a gain or loss in net income when a subsidiary is deconsolidated and requires expanded disclosures in the consolidated
financial statements that clearly identify and distinguish between the interests of the parent owners and the interests of the noncontrolling owners of a subsidiary. SFAS 160 is effective for
fiscal periods, and interim periods within those fiscal years, beginning on or after December 15, 2008. We are currently assessing the potential impact that the adoption of SFAS 160
could have on our financial statements.

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In
March 2008, the FASB issued SFAS No. 161, "Disclosures about Derivative Instruments and Hedging ActivitiesAn Amendment of FASB Statement No. 133"
("SFAS 161"). SFAS 161 expands the disclosure requirements for derivative instruments and hedging activities. SFAS 161 specifically requires entities to provide enhanced
disclosures addressing the following: (a) how and why an entity uses derivative instruments; (b) how derivative instruments and related hedged items are accounted for under SFAS
No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133") and its related interpretations; and (c) how derivative instruments and related hedged items
affect an entity's financial position, financial performance, and cash flows. SFAS 161 is effective for fiscal years and interim periods beginning after November 15, 2008.
SFAS 161 is effective for us on January 1, 2009. We are currently assessing the potential impact that the adoption of SFAS 161 could have on our financial statements.

In
May 2008, the FASB issued SFAS No. 162, "The Hierarchy of Generally Accepted Accounting Principles" ("SFAS 162"). SFAS 162 is intended to improve financial
reporting by identifying a consistent framework, or hierarchy, for selecting accounting principles to be used in preparing financial statements that are presented in conformity with generally accepted
accounting principles in the United States for non-governmental entities. SFAS 162 is effective 60 days following approval by the U.S. Securities and Exchange Commission
("SEC") of the Public Company Accounting Oversight Board's amendments to AU Section 411, "The Meaning of Present Fairly in Conformity with Generally Accepted Accounting Principles". We are
currently assessing the potential impact that the adoption of SFAS 162 could have on our financial statements.

In
May 2008, the FASB issued FASB Staff Position APB 14-1, "Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial
Cash Settlement)" ("FSP APB 14-1"). FSP APB 14-1 applies to convertible debt instruments that, by their stated terms, may be settled in cash (or other assets)
upon conversion, including partial cash settlement of the conversion option. FSP APB 14-1 requires bifurcation of the instrument into a debt component that is initially recorded at
fair value and an equity component. The difference between the fair value of the debt component and the initial proceeds from issuance of the instrument is recorded as a component of equity. The
liability component of the debt instrument is accreted to par using the effective yield method; accretion is reported as a component of interest expense. The equity component is not subsequently
re-valued as long as it continues to qualify for equity treatment. This practice marks a significant change from the current accounting practice for convertible debt instruments in the
scope of the FSP. Current practice does not require separation of the liability and equity components of such instruments. Separately accounting for these instruments' liability and equity components
will results in
the recording of more non-cash interest cost over the life of the convertible debt instrument, because of an initial debt discount. Additionally, FSP APB 14-1 precludes
the use of the fair value option pursuant to SFAS No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities." FSP APB 14-1 is effective for fiscal years
beginning after December 15, 2008 and interim periods within those fiscal years. We intend to adopt FSP APB 14-1 effective January 1, 2009 and apply its provisions
retrospectively to all periods presented in our financial statements. We are currently evaluating the impact of the adoption of FSP APB 14-1 on our balance sheet, but has determined that
FSP APB 14-1will result in the recognition of additional non-cash interest expense of approximately $0.8 million, $2.1 million and $3.6 million in
our 2007, 2008 and 2009 statements of operations, respectively. The 2008 increase in non-cash interest expense will be offset by a $5.0 million capitalization of financing fees
which were expensed upon the election of the fair value option on the convertible debt instruments.

In
October 2008, the FASB issued Staff Position No. FAS 157-3, "Determining the Fair Value of a Financial Asset When the Market for That Asset is Not Active ("FSP
157-3"). FSP 157-3 clarifies the application of SFAS 157, which we adopted as of January 1, 2008, in cases where a market is not active. We have considered the
guidance provided by FSP 157-3 in our determination of estimated fair values as of September 30, 2008, and the impact was not material.

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RESULTS OF OPERATIONS

Comparison of the Three Months Ended September 30, 2008 to the Three Months Ended September 30, 2007

Revenues



Interest income for the three months ended September 30, 2008 totaled $49.8 million, representing a decrease of
$28.3 million, or 36%, compared to $78.1 million for the three months ended September 30, 2007. The decrease consisted of a $16.5 million decrease attributable to a lower
average LIBOR rate of approximately 310 basis points, a decrease of $10.8 million in interest income, attributable to the sale of certain assets to the Securities Fund and the deconsolidation
of Monroe Capital as a result of the recapitalization, and a decrease of $5.9 million attributable to lower investment volume.



Interest income from related parties for the three months ended September 30, 2008 totaled $3.4 million, representing a
decrease of $0.4 million, or 11%, compared to $3.8 million for the three months ended September 30, 2007. The decrease is attributable to decreased interest income earned on
certain of our unconsolidated term debt investments due to decreased LIBOR. All of our real estate securities term debt transactions completed since 2006 in which we retain the equity notes have been
accounted for as on-balance sheet financings.



Rental and escalation income for the three months ended September 30, 2008 totaled $29.0 million, representing an
increase of $2.3 million, or 9%, compared to $26.7 million for the three months ended September 30, 2007. The increase was primarily attributable to net lease property
acquisitions by our Wakefield joint venture. These acquisitions collectively contributed $2.0 million of additional rental income. Other net lease properties acquired during the three months
ended, or subsequent to, September 30, 2007, contributed additional rental and escalation income of $0.7 million. These increases were partially offset by a decrease of
$0.4 million in reimbursement and miscellaneous income in our core net lease properties.



Advisory fees from related parties for the three months ended September 30, 2008 totaled $1.8 million, representing a
decrease of approximately $0.6 million, or 25%, compared to $2.4 million for the three months ended September 30, 2007. The decrease was primarily attributable to the sale of 67%
of our advisory fee income stream, pursuant to our agreement with N-Star IX, to the Securities Fund, during the second quarter 2008.



Other revenue for the three months ended September 30, 2008 totaled $9.5 million, representing an increase of
$7.8 million, or 459%, compared to $1.7 million the three months ended September 30, 2007. Other revenue for three months ended September 30, 2008 consisted primarily of
$9.0 million in a lease termination fee, $0.3 million in exit fees, $0.1 million in unused credit line fees and $0.1 million in miscellaneous other revenue. Other revenue
for the three months ended September 30, 2007

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consisted
primarily of $1.0 million in early prepayment fees, $0.5 million of exit fees and loan draw fees and $0.2 million in other fees across our portfolio.

Expenses



Interest expense for the three months ended September 30, 2008 totaled $45.5 million, representing a decrease of
$19.8 million, or 30%, compared to $65.3 million for the three months ended September 30, 2007. The decrease in interest expense for the three months ended September 30,
2008 includes the sale of N-Star IX and other assets to the Securities Fund, decreasing interest expense by $0.5 million, a decrease of $13.9 million on N-Star
IV, VI, VII and VIII bonds payable due to decreases in LIBOR, debt pay downs, the effect of net settlements on interest rate swaps being recorded in unrealized gain (loss) on investments and other and
reduced amortization of deferred financing as the result of the SFAS 159 election on the underlying debt, reduced interest as a result of the recapitalization of our corporate lending venture
of $6.4 million, lower credit facility balances resulting in lower expense of $2.5 million, and the pay down of repurchase obligations decreasing interest expense by $0.9 million.
These decreases were partially offset by additional mortgage loans payable due to acquisitions in our net lease portfolio resulting in $3.3 million in additional interest expense, higher
balances on credit facilities increasing interest expense by $0.7 million and the foreign exchange impact of the Euro-note resulting in $0.4 million additional interest
expense.



Real estate property operating expenses for three months ended September 30, 2008 totaled $1.9 million, representing a
decrease of $0.3 million, or 14%, compared to $2.2 million for three months ended September 30, 2007. The decrease was primarily attributable to reduced insurance expense at
various net lease properties.



Advisory fees for related parties for the three months ended September 30, 2008 totaled $0.9 million, representing a
decrease of $0.5 million, or 36%, compared to $1.4 million for the three months ended September 30, 2007. The decrease was primarily attributable to the termination of the Monroe
Management joint venture agreement. We incurred $0.9 million of advisory fees to Wakefield Capital Management and no advisory fees to Monroe Management for the three months ended
September 30, 2008, respectively. We incurred $0.8 million of advisory fees to Wakefield Capital Management and $0.6 million of advisory fees to Monroe Management for the three
months ended September 30, 2007, respectively.



Fundraising fees, debt issuance costs and other for the three months ended September 30, 2007 consisted of $3.2 million
of placement fee expenses for raising private capital for our Securities Fund and a $3.1 million write-off of due diligence costs relating to the termination of a purchase agreement
to acquire a portfolio of tax credit multi-family properties by one of our joint ventures. We incurred no such fundraising fees, debt issuance costs and other for the three months ended
September 30, 2008.



Provision for loss on investments for the three months ended September 30, 2008 totaled $2.5 million. The provision
includes a $2.2 million reserve against a $13.1 million mezzanine loan backed by a multi-family complex located in Georgia, a $0.5 million reserve against a $16.9 million
first

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mortgage
loan backed by multi-family property located in South Florida and a $0.5 million reserve against a $18.0 million first mortgage loan backed by a multi-family property located in
South Florida. We also reversed a $0.8 million reserve taken during the first quarter 2008 against a $19.5 million first mortgage backed by two multi-family properties upon
recapitalization and assumption of the loan by a third party. There was no provision for loss on investments for the three months ended September 30, 2007.



General and administrative expenses for the three months ended September 30, 2008 totaled $13.7 million, representing a
decrease of $0.7 million, or 5%, compared to $14.4 million for the three months ended September 30, 2007. The primary components of our general and administrative expenses were
the following:

Salaries
and equity-based compensation for the three months ended September 30, 2008 totaled $9.4 million, representing a decrease of approximately $0.1 million, or
1%, compared to $9.5 million, for
the three months ended September 30, 2007. The decrease was attributable to a $1.6 million decrease related to salaries due to lower staffing levels resulting from decreased investment
activity offset partially by a $1.5 million increase related to equity-based compensation. The $1.5 million increase in equity-based compensation expense was attributable to an increase
of approximately $2.7 million of vesting of equity-based awards issued under our 2004 Omnibus Stock Incentive Plan relating to grants issued in the fourth quarter 2007 and first quarter 2008.
The increase was offset by a decrease of $1.0 million relating to the Long Term Incentive Bonus Plan, which was fully vested as of September 30, 2007, and a decrease in equity-based
compensation expense of $0.2 million related to our Employee Outperformance Plan.

Auditing
and professional fees for the three months ended September 30, 2008 totaled $1.0 million, representing a decrease of $0.3 million, or 23%, compared to
$1.3 million for the three months ended September 30, 2007. The decrease was primarily attributable to lower legal fees for general corporate work and investment activities, recruiting
fees, and fees related to agreed upon procedures in connection with term debt transactions.

Other
general and administrative expenses for the three months ended September 30, 2008 totaled $3.3 million, representing a decrease of approximately $0.2 million,
or 12%, compared to $3.5 million for the three months ended September 30, 2007. The decrease was primarily attributable to decreases costs related to decreased investment initiatives and
a decrease in overhead resulting from lower staffing levels during the three months ended September 30, 2008.



Depreciation and amortization expense for the three months ended September 30, 2008 totaled $13.6 million, representing
an increase of $4.4 million, or 48%, compared to $9.2 million for the three months ended September 30, 2007. This increase was primarily attributable to $82.8 million of
net lease acquisitions made subsequent to September 30, 2007.



Equity in (loss) earnings for the three months ended September 30, 2008 totaled earnings of $0.8 million, representing an
increase of $5.4 million, compared to a loss of $4.6 million for the three months ended September 30, 2007. In July 2007, we closed our Securities Fund, retaining a 25.7% interest
that is accounted for under the equity method of accounting. During the second quarter 2008, we increased our interest in the Securities Fund to 46.0%. For the three months ended September 30,
2008, we recognized equity in earnings of $0.5 million from the Securities Fund, $0.9 million equity in

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earnings
from our investment in the corporate lending joint venture, which was recapitalized in May 2008 resulting in deconsolidation of the venture and equity in earnings of $0.1 million in
connection with our net lease joint venture. The earnings were partially offset by equity in loss of $0.8 million on the LandCap joint venture. Equity in losses for the three months ended
September 30, 2007 consisted primarily of a loss of $3.8 million from the Securities Fund, the operations of Monroe Management which generated a loss of $1.0 million, partially
offset by a net lease joint venture, which generated equity in earnings of $0.1 million.



Unrealized gain (loss) on investments and other increased by approximately $240.9 million for the three months ended
September 30, 2008 to a gain of $245.3 million, compared to a gain of $4.4 million for the three months ended September 30, 2007. The unrealized gain on investments for the
three months ended September 30, 2008 consisted primarily of unrealized gains related to SFAS 159 mark-to-market adjustments of $251.0 million on various
N-Star bonds payable, $42.9 million on liability to subsidiary trusts issuing preferred securities and $16.2 million on exchangeable senior notes, offset partially by
unrealized losses related to SFAS 159 mark-to-market adjustments of $57.9 million on various N-Star available for sale securities and
$7.1 million on interest rate swaps as a result of these swaps no longer qualifying for hedge accounting under SFAS 133. The unrealized gain on investment for the three months ended
September 30, 2007 consisted of a reversal of a prior period negative $4.9 million mark-to-market adjustment on the assets sold to the Securities Fund prior to
the date of sale. We also had a $0.1 million unrealized loss related to the ineffective portion on our interest rate swaps and a $0.4 million unrealized loss on a U.S. treasury note
short sale hedge.



The realized gain of $7.0 million for the three months ended September 30, 2008 was attributable to the repurchase of
various N-Star bonds. Realized gain on investments and other for the three months ended September 30, 2007, consisted of a realized gain on the settlement of US treasury note short
sale entered into as a hedge offset by a gain on assets sold.



There were no discontinued operations for either the three months ended September 30, 2008 or September 30, 2007.

Comparison of the Nine months Ended September 30, 2008 to the Nine months Ended September 30, 2007

Revenues



Interest income for the nine months ended September 30, 2008 totaled $163.4 million, representing a decrease of
$52.9 million, or 24%, compared to $216.3 million for the nine months ended September 30, 2007. The decrease consisted of a $37.8 million decrease attributable to a lower
average LIBOR rate of approximately 242 basis points, a decrease of $33.4 million in interest income attributable to the sale of certain assets to the Securities Fund and the deconsolidation of
Monroe Capital as a result of the recapitalization. The decrease was partially offset by a net increase to interest income of approximately $18.3 million resulting from the $2.9 billion
of investments acquired subsequent to September 30, 2007, the origination and acquisition of commercial real estate debt, commercial real estate securities and corporate debt subsequent to
September 30, 2007 with a net book

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value
of $0.6 million and approximately $0.7 million of investment dispositions and repayments subsequent to September 30, 2007.



Interest income from related parties for the nine months ended September 30, 2008 totaled $10.8 million, representing an
increase of $1.1 million, or 11%, compared to $9.7 million for the nine months ended September 30, 2007. The increase is attributable to increases in our investments in the
non-investment grade note classes of our unconsolidated term debt transactions. All of our real estate securities term debt transactions completed since 2006 in which we retain the equity
notes have been accounted for as on-balance sheet financings.



Rental and escalation income for the nine months ended September 30, 2008 totaled $87.0 million, representing an increase
of $19.1 million, or 28%, compared to $67.9 million for the nine months ended September 30, 2007. The increase was primarily attributable to net lease property acquisitions by our
Wakefield joint venture. These acquisitions collectively contributed $15.3 million of additional rental income. Other net lease properties acquired during the nine months ended, or subsequent
to, September 30, 2007, contributed additional rental and escalation income of $3.8 million.



Advisory fees from related parties for the nine months ended September 30, 2008 totaled $10.7 million, representing an
increase of approximately $5.4 million, or 102%, compared to $5.2 million for the nine months ended September 30, 2007. In July 2007, we sold our equity interest in
N-Star IX to the Securities Fund. As a result of the sale, N-Star IX is no longer consolidated into our financial statements, but we continue to earn advisory fees from the
financing. During the second quarter 2008, we sold 67% of our advisory fee income stream, pursuant to our agreement with N-Star IX, to the Securities Fund. The increase was primarily
attributable to the recognition of an additional $4.8 million in fee income related to the sale, the advisory fees earned on N-Star IX prior to the sale of $1.0 million,
partially offset by reduced advisory fees earned on N-Star IX after the sale of $0.5 million, all of which were formerly eliminated in consolidation, and increased fees earned on
the Securities Fund of $0.1 million.



Other revenue for the nine months ended September 30, 2008 totaled $14.5 million, representing an increase of
$9.2 million, or 174%, compared to $5.3 million the nine months ended September 30, 2007. Other revenue for nine months ended September 30, 2008 consisted primarily of
$9.0 million in a lease termination fee, $3.7 million in profit participation proceeds from the modification of a real estate debt investment and $0.3 million in prepayment
penalties, $0.6 million of exit fees, $0.4 million in unused credit line fees, $0.2 million in draw fees and $0.3 million miscellaneous other revenue. Other revenue for the
nine months ended September 30, 2007 included $1.8 million in early prepayment fees, $0.5 million of exit fees and loan draw fees, $0.2 million in assumption fees,
$0.2 million in unused credit line fees and $0.2 million in other fees on loans in our real estate debt portfolio, $1.9 million of recurring income from premiums received on
credit default swaps related to Abacus NS2, and $0.3 million related to a one-time consent fee on the early repayment of one of our real estate securities investment.

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Expenses



Interest expense for the nine months ended September 30, 2008 totaled $146.3 million, representing a decrease of
$31.1 million, or 18%, compared to $177.4 million for the nine months ended September 30, 2007. The decrease in interest was primarily the result of the sale of N-Star
IX and other assets to the Securities Fund, decreasing interest expense by $16.1 million, decreased interest expense of $32.3 million on N-Star IV, VI, VII and VIII bonds
payable due to decreases in LIBOR, debt paydowns, the effect of net settlements on interest rate swaps being recorded in unrealized gain (loss) on investments and other and reduced amortization of
deferred financing as the result of the SFAS 159 election on the underlying debt, decreased interest expense of $3.1 million due to the paydown of repurchase obligations, lower balances
on credit facilities resulting in decreased interest expense of $2.4 million and reduced interest as a result of the recapitalization of our corporate lending venture of $0.9 million
and. The decrease in interest expense was partially offset by additional mortgage loans payable due to acquisitions in our net lease portfolio resulting in $13.1 million additional interest
expense, the impact of the June 2007 closing of our $172.5 million exchangeable senior notes offering and the March 2007 and June 2007 private placement of $72.7 million of trust
preferred debt resulting in additional interest expense of approximately $5.4 million, the full period impact of the Euro-note resulting in $3.0 million additional interest
expense and increased term loan balance resulting in $2.1 million additional interest expense.



Real estate property operating expenses for nine months ended September 30, 2008 totaled $6.0 million, representing a
decrease of $0.4 million, or 6%, compared to $6.4 million for nine months ended September 30, 2007. The decrease was primarily attributable to reduced insurance expense at various
net lease properties.



Advisory fees for related parties for the nine months ended September 30, 2008 totaled $3.9 million, representing an
increase of $1.0 million, or 34%, compared to $2.9 million for the nine months ended September 30, 2007. The increase was primarily attributable to our Monroe Management joint
venture, which was formed in March 2007 and increased fees in our Wakefield joint venture resulting from healthcare property acquisitions. We incurred $2.6 million of advisory fees to Wakefield
Capital Management and $1.3 million of advisory fees to Monroe Management for the nine months ended September 30, 2008, respectively. We incurred $2.2 million of advisory fees to
Wakefield Capital Management and $0.7 million of advisory fees to Monroe Management for the nine months ended September 30, 2007, respectively.



Fundraising fees, debt issuance costs and other for the nine months ended September 30, 2008 totaled $4.9 million,
representing a decrease of $1.4 million, or 22%, compared to $6.3 million for the nine months ended September 30, 2007. Fundraising Fees, Debt Issuance Costs and Other for the
nine months ended September 30, 2008 included $4.9 million of debt issuance cost related to the May 2008 issuance of our 11.50% exchangeable senior notes (the "NNN Notes"). Fundraising
Fees, Debt Issuance Costs and Other for the nine months ended September 30, 2007 included $3.2 million of placement fee expenses for raising private capital for our Securities Fund and a
$3.1 million write-off of due diligence costs relating to the termination of a purchase agreement to acquire a portfolio of tax credit multi-family properties by one of our joint
ventures.

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Provision for loss on investments for the nine months ended September 30, 2008 totaled $5.7 million. The provision
includes a $2.2 million reserve against a $13.1 million mezzanine loan backed by a multi-family complex located in Georgia, a $2.0 million reserve against a $11.0 million
mezzanine loan backed by a portfolio of seven limited service hotel properties and unentitled land, a $1.0 million reserve against a $18.0 million first mortgage loan backed by a
multi-family property located
in South Florida, and a $0.5 million reserve against a $16.9 million first mortgage loan backed by multi-family property located in South Florida. There was no provision for loss on
investments for the nine months ended September 30, 2007.



General and administrative expenses for the nine months ended September 30, 2008 totaled $46.5 million, representing an
increase of $3.6 million, or 8%, compared to $42.9 million for the nine months ended September 30, 2007. The primary components of our general and administrative expenses were the
following:

Salaries
and equity-based compensation for the nine months ended September 30, 2008 totaled 31.1 million, representing an increase of approximately $4.0 million, or
15%, compared to $27.1 million, for the nine months ended September 30, 2007. The increase was attributable to a $6.6 million increase related to equity-based compensation, which
was partially offset by a $2.6 million decrease related to salaries due to lower staffing levels resulting from decreased investment activity. The $6.6 million increase in equity-based
compensation expense was attributable to an increase of approximately $8.2 million of vesting of equity-based awards issued under our 2004 Omnibus Stock Incentive Plan relating to grants issued
in the fourth quarter 2007 and first quarter 2008, an increase of $0.8 million in additional equity-based compensation granted in connection with employee compensation arrangements and an
increase of $1.1 million in connection with employee separation agreements. The increase was offset by a decrease of $2.3 million relating to the Long Term Incentive Bonus Plan, which
was fully vested as of September 30, 2007, and a decrease in equity-based compensation expense of $1.2 million related to our Employee Outperformance Plan.

Auditing
and professional fees for the nine months ended September 30, 2008 totaled $4.6 million, representing a decrease of $1.0 million, or 18%, compared to
$5.6 million for the nine months ended September 30, 2007. The decrease was primarily attributable to lower legal fees for general corporate work and investment activities, recruiting
fees, and fees related to agreed upon procedures in connection with term debt transactions.

Other
general and administrative expenses for the nine months ended September 30, 2008 totaled $10.7 million, representing a decrease of approximately $0.5 million,
or 4%, compared to $10.2 million for the three months ended September 30, 2007. The decrease was primarily attributable to decreases costs related to decreased investment initiatives and
a decrease in overhead resulting from lower staffing levels during the nine months ended September 30, 2008.



Depreciation and amortization expense for the nine months ended September 30, 2008 totaled $33.5 million, representing an
increase of $9.9 million, or 42%, compared to $23.6 million for the nine months ended September 30, 2007. This increase was primarily attributable to $82.8 million of net
lease acquisitions made subsequent to September 30, 2007.

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Equity in (loss) earnings for the nine months ended September 30, 2008 totaled a loss of $4.8 million, representing an
increase of $0.4 million, compared to a loss of $5.2 million for the nine months ended September 30, 2007. In July 2007, we closed our Securities Fund, retaining a 25.7% interest
that is accounted for under the equity method of accounting. During the second quarter 2008, we increased our interest in the Securities Fund to 45.9%. For the nine months ended September 30,
2008, we recognized equity in loss of $5.1 million from the Securities Fund and equity in loss of $2.5 million on the LandCap joint venture. The losses were partially offset by our
investment in Monroe Management prior to terminating the joint venture in May 2008 and our investment in the corporate lending joint venture which was recapitalized in May 2008 resulting in
deconsolidation of the venture. We are currently accounting for the venture under the equity method of accounting. We recognized $2.3 million of equity in earnings in connection with these
joint ventures and $0.3 million in connection with our net lease joint venture. Equity in losses for the nine months ended September 30, 2007 consisted primarily of a loss of
$3.8 million on the Securities Fund and to the operations of Monroe Management, which generated a loss of $1.7 million. The losses were partially offset by a net lease joint venture we
entered into in February 2006, which generated equity in earnings of $0.3 million.



Unrealized gain (loss) on investments and other increased by approximately $431.5 million for the nine months ended
September 30, 2008 to a gain of $427.7 million, compared to a loss of $3.8 million for the nine months ended September 30, 2007. The unrealized gain on investments for the
nine months ended September 30, 2008 consisted primarily of unrealized gains
related to SFAS 159 mark-to-market adjustments of $529.0 million on various N-Star bonds payable, $72.8 million on liability to subsidiary
trusts issuing preferred securities and $28.9 million on exchangeable senior notes, offset partially by unrealized losses related to SFAS 159 mark-to-market
adjustments of $164.1 million on various N-Star available for sale securities, $32.3 million on our corporate lending joint venture and $6.6 million on interest rate
swaps as a result of these swaps no longer qualifying for hedge accounting under SFAS 133. The unrealized loss on investment for the nine months ended September 30, 2007 consisted of a
$3.4 million mark-to-market loss on the securities in N-Star IX warehouse prior to the closing of the term debt transaction in February 2007 and a
$0.3 million unrealized loss related to the ineffective portion of our interest rate swaps.



The realized gain of $14.1 million for the nine months ended September 30, 2008 was attributable to the recapitalization
of our corporate loan venture in which we recognized a $46.0 million realized gain upon the extinguishment of a portion of the debt, a simultaneous $27.1 million cost basis reduction of
our investment in the recapitalized venture and a realized loss of $18.9 million related to the sale of certain corporate loans within the portfolio. In addition we recognized a
$14.1 million gain on the repurchase of various N-Star bonds. The realized gain of $3.5 million for the nine months ended September 30, 2007 is related to the increase
in fair value related to the net Carry of securities during the warehouse period of $1.3 million, which was realized at the close of N-Star IX, a gain of $1.4 million on the
early redemption of REIT debt securities in N-Star VII, a foreign currency translation gain of $0.1 million related to our Euro-denominated investment and a net realized
gain of $1.0 million on the sale of certain assets to the Securities Fund, partially offset by a realized loss of $0.3 million on the closing of a short securities position.

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Income from discontinued operations represents the operations of properties sold or held for sale during the period. In April 2007, our
Wakefield venture sold two assisted care living facilities. Accordingly, these operations were reclassified to income from discontinued operations. We had no discontinued operations for the nine
months ended September 30, 2008.

Liquidity and Capital Resources

We require significant capital to fund our investment activities and operating expenses. Our capital sources may include cash flow from
operations, borrowings under revolving credit facilities, financings secured by our assets such as first mortgage and term debt transaction financings, long-term senior and subordinate
corporate capital such as senior notes, trust preferred securities and perpetual preferred and common stock. As we indicated earlier, availability of such capital is extremely scarce (if available at
all) for financial institutions including commercial mortgage REITs.

Our
total available liquidity at September 30, 2008 was approximately $280.0 million, including $164.6 million of unrestricted cash and cash equivalents and
$107.4 million of cash in our on balance sheet term debt transactions and $8.0 million in our off balance sheet term debt transactions, which is available for reinvestment within the
term debt transaction.

We
expect to meet our long term liquidity requirements, including the repayment of debt and our investment funding needs, through existing cash resources, our existing secured term debt
and potentially additional borrowings, the issuance of debt and/or equity securities and the liquidation or refinancing of assets at maturity. We believe that the value of the net lease portfolio is,
and will continue to be, sufficient to allow us to refinance the mortgage debt on this portfolio at maturity.

As
a REIT, we are required to distribute at least 90% of our annual REIT taxable income to our stockholders, including taxable income where we do not receive corresponding cash, and we
intend to distribute all or substantially all of our REIT taxable income in order to comply with the REIT distribution requirements of the Internal Revenue Code and to avoid federal income tax and the
non deductible excise tax. In the future, our dividend will be evaluated based upon consideration of several factors including our view of taxable income, company liquidity, availability of capital in
the markets and investment opportunities.

These
distribution requirements limit our ability to retain earnings and thereby replenish or increase capital committed to our operations; however, we believe that our existing capital
resources and financing will enable us to meet current non-discretionary capital requirements. We believe that our existing sources of funds will be adequate for purposes of meeting our
short-term liquidity needs; however, our secured term debt financing structures generally require that the underlying collateral and cash flow generated by the collateral to be in excess
of ratios stipulated in the related indentures. These ratios are called overcollateralization ("OC") and interest coverage ("IC") tests. In the event these tests are not met, cash that would normally
be distributed to us would be used to amortize the senior notes until the financing is back in compliance with the tests. In the event cash flow is diverted to repay the notes, this could decrease
cash available to pay our dividend and to comply with REIT requirements. As of September 30, 2008 we are in compliance with all of the OC and IC tests in our secured term debt transactions.

Our
ability to meet a long-term (beyond one year) liquidity requirement may be subject to obtaining additional debt and equity financing. Any decision by our lenders and
investors to provide us with financing will depend upon a number of factors, such as our compliance with the terms of its existing credit arrangements, our financial performance, industry or market
trends, the general availability of and rates applicable to financing transactions, such lenders' and investors' resources and

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policies
concerning the terms under which they make capital commitments and the relative attractiveness of alternative investment or lending opportunities.

Exchangeable Senior Notes

In May 2008, NRFC NNN Holdings, LLC ("Triple Net Holdings"), a wholly-owned subsidiary of ours issued $80.0 million of
11.50% exchangeable senior notes (the "Notes") which are due in 2013. The net proceeds from the offering were approximately $71.4 million, after deducting fees and expenses. The proceeds of the
offering were used to make additional investments.

We
have elected the SFAS 159 fair value option for the Notes. Changes in fair value of the Notes will be recognized in earnings as they occur.

Unsecured Revolving Line of Credit

On May 28, 2008, we voluntarily terminated the Revolving Credit Agreement, dated November 3, 2006 by us and KeyBanc
Capital Markets and Bank of America, N.A. (the "Credit Agreement") in order to permit the issuance of the NNN Notes, given certain restrictive covenants set forth in the Credit Agreement. The Credit
Agreement had a November 2009 expiration and no amounts were outstanding under the Credit Agreement at the time of termination.

Term Loan

In June 2008, a wholly owned subsidiary of ours entered into a $24.2 million term loan agreement with an investment bank (the
"LB Term Loan"). The collateral for the LB Term Loan is a $44.0 million mezzanine loan position and we have guaranteed 50% of such amount. The LB Term Loan matures in February 2009 and bears
interest at a spread of 1.50% over one-month LIBOR. Both the LB Term Loan and the mezzanine loan collateral have three one-year extension options. The LB Term Loan contains certain
covenants including, among others, financial covenants of a minimum tangible net worth and a minimum debt-to-equity ratio.

Equity Distribution Agreement

In May, 2008, we entered into an equity distribution agreement with Wachovia Capital Markets, LLC ("Wachovia"). In accordance
with the terms of the agreement, we may offer and sell up to 10,000,000 shares of our common stock from time to time through Wachovia. Wachovia will receive a commission from us of up to 2.5% of the
gross sales price of all shares sold through it under the equity distribution agreement.

For
the three and nine months ended September 30, 2008, we issued a total of 12,100 and 114,100 shares of common stock, respectively, related to our equity distribution agreement
with Wachovia raising net proceeds of approximately $0.1 million and $0.6 million, net of $2,497 and $28,199 in commissions, respectively.

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Dividend Reinvestment and Stock Purchase Plan

Effective as of April 27, 2007, we implemented a Dividend Reinvestment and Stock Purchase Plan, or the Plan, pursuant to which
we registered and reserved for issuance 15,000,000 shares of our common stock. Under the terms of the Plan, stockholders who participate in the Plan may purchase shares of our common stock directly
from us, in cash investments up to $10,000. At our sole discretion, we may accept optional cash investments in excess of $10,000 per month, which may qualify for a discount from the market price of 0%
to 5%. Plan participants may also automatically reinvest all or a portion of their dividends for additional shares of our stock. We expect to use the proceeds from any dividend reinvestments or stock
purchases for general corporate purposes.

During
the three and nine months ended September 30, 2008, we issued a total of approximately 34,301 and 98,151 common shares, respectively, pursuant to the Plan for a gross sales
price of approximately $0.2 million and $0.8 million, respectively.

Wakefield Preferred Equity

On July 9, 2008, Wakefield sold a $100 million convertible preferred equity interest to Inland American Real Estate
Trust, Inc. ("Inland American"). We received approximately $87.7 million of net proceeds from the transaction. Prior to conversion, the convertible preferred investment will yield a
dividend of 10.5%. The convertible preferred equity may be converted or redeemed, at Inland American's option, upon the sale or recapitalization of the Wakefield venture. Wakefield may, at its option,
redeem the convertible preferred interests at any time following the first anniversary of the closing, subject to payment of a call premium that declines over time. In addition, at any time after the
second anniversary of the closing, Inland American may convert its preferred equity interests into common equity in Wakefield. Based on the current investment amount and capital accounts of the
Wakefield members, the convertible preferred equity interests would represent, upon conversion, approximately a 42% common equity ownership interest in Wakefield. Inland American will have the option
of contributing additional preferred equity and participating in new Wakefield investment opportunities in proportion to its percentage ownership interest, assuming it were to convert its interests to
common equity.

Cash Flows

The net cash flow provided by operating activities of $72.6 million, decreased by $5.8 million for the nine months ended
September 30, 2008 from $78.4 million for the nine months ended September 30, 2007. This was primarily due to the lower LIBOR rates which decreased interest income generated from
our asset base.

The
net cash flow used by investing activities was $82.1 million for the nine months ended September 30, 2008 compared to the net cash used by investing activities of
$2.4 billion for the nine months ended September 30, 2007. This decrease from 2007 was primarily a result of decreased investment activity. Net cash flow used in investing activities in
2007 consisted primarily of the acquisitions of operating real estate, real estate securities, corporate loan investments, and the origination or acquisition of real estate debt investments.

The
net cash flow provided by financing activities was $20.3 million for the nine months ended September 30, 2008 compared to $2.5 billion of cash provided by
financing activities for the nine months ended September 30, 2007. The primary source of cash flow provided by financing activities was the sale of $100 million convertible preferred
equity interest to Inland American, the sale of the issuance of $80.0 million of exchangeable senior notes and additional borrowings under our term loans and credit facilities. Net cash flow in
provided by financing activity in 2007 was primarily from the issuance of preferred equity issuance of our 7.25% exchangeable senior notes, issuance of term and borrowing under our credit facilities
to finance our investing activities.

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Contractual Obligations and Commitments

As of September 30, 2008, we had the following contractual commitments and commercial obligations (in thousands):

Payments Due by PeriodContractual Obligations

Total

Less than 1 year

1-3 years

3-5 years

After 5 YearsMortgage notes

$
895,894

$
1,109

$
104,012

$
174,222

$
616,551Mezzanine loan payable


12,708


413


3,558


4,144


4,593Exchangeable senior notes


252,500











252,500Bonds payable


1,573,285











1,573,285Credit facilities


48,216





48,216





Secured term loan


410,281





410,281





Liability to subsidiary trusts issuing preferred securities


286,258











286,258Repurchase agreements


1,540





1,540





Capital leases(1)


16,792


174


974


982


14,662Operating leases


77,821


1,392


11,260


10,983


54,186Placement fees


1,216


608


608





Outstanding unfunded commitments(2)


363,536


295,782


67,754





Total contractual obligations

$
3,940,047

$
299,478

$
648,203

$
190,331

$
2,802,035


---

Our
debt obligations contain covenants that are both financial and non-financial in nature. Significant financial covenants include a requirement that we maintain a minimum
tangible net worth, a minimum level of liquidity and a minimum fixed charge coverage ratio. As of September 30, 2008, we were in compliance with all financial and non-financial
covenants in our debt agreements.

Off-Balance Sheet Arrangements

Term Debt Issuances

The terms of the portfolio of real estate securities held by the term debt transactions are structured to be matched with the terms of
the non-recourse term debt liabilities. These term debt liabilities are repaid with the proceeds of the principal payments on the real estate securities collateralizing the term debt
liabilities when these payments are actually received. There is no refinancing risk associated with the term debt liabilities, as principal is only due to the extent that it has been collected on the
underlying real securities and the stated maturities are noted above. Term debt transactions produce a relatively predictable income stream based on the spread between the interest earned on the
underlying securities and the interest paid on the term debt transaction liabilities. This spread may be reduced by credit losses on the underlying securities or by hedging mismatches. Our term debt
transactions have not incurred any losses on any of their securities investments from the date of purchase through September 30, 2008. We receive quarterly cash distributions from
N-Star I and monthly cash distributions from N-Star II, N-Star III and N-Star V, each representing our proportionate

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share
of the residual cash flow from the term debt transactions, as well as collateral advisory fees and interest income on the unrated income notes of the term debt transactions.

The
following tables describe certain terms of the collateral for and the notes issued by term debt transactions at September 30, 2008 (dollars in thousands):

CollateralSeptember 30, 2008

Term NotesSeptember 30, 2008Issuance

Date
Closed

Par Value
of Collateral

Weighted
Average
Interest
Rate

Weighted
Average
Expected
Life (years)

Outstanding
Term
Notes(1)

Weighted
Average
Interest
Rate

Stated
MaturityN-Star I(2)


8/21/03

$
301,735


6.64
%

4.14

$
282,732


6.21
%

8/01/2038N-Star II


7/01/04


331,878


6.22


4.77


295,931


5.60


6/01/2039N-Star III


3/10/05


404,771


5.90


4.25


358,676


5.14


6/01/2040N-Star V


9/22/05


509,722


5.49


6.22


456,319


4.74


9/05/2045Total




$
1,548,106


5.98
%

4.99

$
1,393,658


5.32
%


---

Any
potential losses in our off balance sheet term debt transactions is limited to the carrying value of our investment of $53.8 million at September 30, 2008.

CLO Equity Notes

In December 2006, we acquired 40% of the residual equity interests in a Collateralized Loan Obligation ("CLO") originated by Monroe
Capital, LLC, a specialty finance company, for $16.7 million. The CLO includes collateral of approximately $400 million backed primarily by first lien senior secured loans. We
also acquired a 12.5% and 33.5% residual equity interest in two
third party CLO's. The CLOs were determined to be variable interest entities under Fin 46(R)-6 and we were determined not to be the primary beneficiary; therefore, the financial statements
of the CLOs were not consolidated into our condensed consolidated financial statements. On May 7, 2008, we completed a recapitalization of our middle-market corporate lending venture. We
contributed our CLO equity interests into the recapitalized entity. Prior to May 7, 2008, our residual combined equity interests were accounted for as debt securities available for sale
pursuant to EITF 99-20. Upon completion of the recapitalization transaction, the new investor became the controlling manager of the assets and we deconsolidated the venture and now
use the equity method of accounting for the investment, which includes our residual combined equity interests in the CLO's contributed in the recapitalization.

NorthStar Real Estate Securities Opportunity Fund

In July 2007, we closed on $109.0 million of equity capital for our Securities Fund, an investment vehicle in which we conduct
most of our real estate securities investment business.

We
are the manager and general partner of the Securities Fund. We receive base management fees ranging from 1.0% to 2.0% per annum on third-party capital and are entitled to annual
incentive management fees ranging from 20% to 25% of the increase in the Securities Fund's net asset value in excess of an 8.0% per annum return. Base and incentive fees vary depending on the investor
capital lockup periods.

During
the second quarter 2008, we invested an additional $16.0 million in the Securities Fund. Additionally, during the second quarter 2008, we sold 67% of our N-Star
IX advisory fee income stream to the Securities Fund for $8.8 million. The Securities Fund owns all of the equity in the N-Star

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IX
term financing but we retained the advisory fees when N-Star IX was sold to the Securities Fund at its inception. We recognized $4.8 million of advisory fee income from the sale
and deferred the remaining $4.0 million, which represented our ownership interest in the Securities Fund. The deferred advisory fee income will be recognized into income as the fees are earned.
For the three and nine months ended September 30, 2008, we recognized $0.1 million in additional income from the amortization of deferred advisory fee income. At September 30,
2008, we had invested a total of $47.9 million in the Securities Fund and the carrying value of our investment was $33.8 million, representing a 46.0% interest.

In
the third quarter 2008, the Securities Fund filed a claim against Lehman Brothers for $6.8 million (plus damages) to recover cash collateral held by Lehman Brothers. On
September 30, 2008, the Securities Fund decided to record a reserve of $3.4 million against the $6.8 million cash collateral receivable.

For
the three months ended September 30, 2008, we recognized equity in earnings of $0.5 million. We also earned $0.1 million of management fees from the Securities
Fund for the three months ended September 30, 2008. For the nine months ended September 30, 2008, we recognized equity in loss of $4.5 million. We also earned $0.4 million
of management fees from the Securities Fund for the three months ended September 30, 2008.

Recent Developments

Dividends

On October 8, 2008, we declared a dividend of $0.36 per share of common stock. On October 21, 2008, we declared a
dividend of $0.54688 per share of Series A preferred stock and $0.51563 per share of Series B preferred stock. The dividends will be paid on November 14, 2008 to the stockholders
of record as of the close of business on November 4, 2008.

JP Facility

On October 7, 2008, we and a subsidiary of ours entered into Amendment No. 1 (the "Amendment") to the Master Repurchase
Agreement (as amended, the "Facility") with JPMorgan Chase Bank, N.A. ("JPMorgan"). The Facility had approximately $50.4 million outstanding on the amendment date and such amounts bear interest
at spreads of 1.25% to 1.80% over one-month LIBOR. Advance rates for the assets currently financed under the Facility range from 55% to 80% of the value of the collateral for which the
advance is made. Interest rates and advance rates on future borrowings under the Facility will be determined by JPMorgan. Pursuant to the Amendment, the maximum amount outstanding under the Facility
shall not exceed $150 million and we have agreed to guaranty the outstanding amount under the Facility. The term of the Facility will expire on August 8, 2010, subject to renewal by
JPMorgan on August 8, 2009.

Stock Repurchase Program

On October 8, 2008, our Board of Directors authorized a stock repurchase program of up to 10,000,000 shares of our outstanding
common stock, or approximately 16% of our outstanding common stock. Stock repurchases under this program will be made from time to time through the open market or in privately negotiated transactions.
The timing and actual number of shares repurchased will depend on a variety of factors including price, corporate and regulatory requirements, market conditions, and other corporate liquidity
requirements and priorities. As of November 6, 2008, we have not repurchased any shares under the authorization.

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Inflation

Our leases for tenants of operating real estate are generally either:



We
believe that most inflationary increases in expenses will be offset by the expense reimbursements and contractual rent increases described above to the extent of occupancy.

We
believe that the risk associated with an increase in market interest rates on the floating rate debt used to finance our investments in our term debt transactions and our direct
investments in real estate debt, will be largely offset by our strategy of matching the terms of our assets with the terms of our liabilities and through our use of hedging instruments.

Non-GAAP Financial Measures

Funds from Operations and Adjusted Funds from Operations

Management believes that funds from operations, or FFO, and adjusted funds from operations, or AFFO, each of which are
non-GAAP measures, are additional appropriate measures of the operating performance of a REIT and NorthStar in particular. We compute FFO in accordance with the standards established by
the National Association of Real Estate Investment Trusts (NAREIT), as net income or loss (computed in accordance with GAAP), excluding gains or losses from sales of depreciable properties, the
cumulative effect of changes in accounting principles, real estate-related depreciation and amortization, and after adjustments for unconsolidated/uncombined partnerships and joint ventures. AFFO, as
defined by NAREIT, is a computation made by analysts and investors to measure a real estate company's cash flow generated by operations.

We
calculate AFFO by subtracting from (or adding) to FFO:



Our
calculation of AFFO differs from the methodology used for calculating AFFO by certain other REITs and, accordingly, our AFFO may not be comparable to AFFO reported by other REITs.
Our management utilizes FFO and AFFO as measures of our operating performance, and believes they are also useful to investors, because they facilitate an understanding of our operating performance
after adjustment for certain non-cash expenses, such as real estate depreciation, which assumes that the value of real estate assets diminishes predictably over time and, in the case of
AFFO, equity based compensation. Additionally, FFO and AFFO serve as measures of our operating performance because they facilitate evaluation of our company without the effects of selected items
required in accordance with GAAP that may not necessarily be indicative of current operating performance and that may not accurately compare our operating performance between periods. Furthermore,
although FFO, AFFO and other supplemental performance measures are defined in various ways throughout the REIT

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industry,
we also believe that FFO and AFFO may provide us and our investors with an additional useful measure to compare our financial performance to certain other REITs.

Neither
FFO nor AFFO is equivalent to net income or cash generated from operating activities determined in accordance with U.S. GAAP. Furthermore, FFO and AFFO do not represent
amounts available for management's discretionary use because of needed capital replacement or expansion, debt service obligations or other commitments or uncertainties. Neither FFO nor AFFO should be
considered as an alternative to net income as an indicator of our operating performance or as an alternative to cash flow from operating activities as a measure of our liquidity.

Set
forth below is a reconciliation of FFO and AFFO to net income from continuing operations before minority interest for the three and nine months ended September 30, 2008 and
2007 (in thousands):

Three Months
Ended
September 30, 2008

Three Months
Ended
September 30, 2007

Nine Months
Ended
September 30, 2008

Nine Months
Ended
September 30, 2007Funds from Operations:Income from continuing operations before minority interest

$
268,588

$
14,813

$
476,413

$
39,546Minority interest in joint ventures


(2,300
)

(215
)

(2,097
)

(351
)Income from continuing operations before minority interest in operating partnership


266,288


14,598


474,316


39,195Adjustments:Preferred dividend


(5,231
)

(5,231
)

(15,693
)

(11,302
)Depreciation and amortization


13,566


9,163


33,481


23,594Funds from discontinued operations











17Real estate depreciation and amortizationunconsolidated ventures


247


247


742


743Funds from Operations

$
274,870

$
18,777

$
492,846

$
52,247Adjusted Funds from Operations:Funds from Operations

$
274,870

$
18,777

$
492,846

$
52,247Straight-line rental income, net


(344
)

(866
)

(1,817
)

(1,853
)Straight-line rental income, discontinued operations











10Straight-line rental income and fair value lease revenue (SFAS 141 adjustment), unconsolidated ventures


(39
)

(54
)

(125
)

(167
)Amortization of equity-based compensation


5,439


3,948


18,396


11,837Fair value lease revenue (SFAS 141 adjustment)


(809
)

(271
)

(1,420
)

(611
)Unrealized(gains)/losses from mark-to-market adjustments


(249,244
)

(6,365
)

(438,565
)

3,473Unrealized losses from mark-to-market adjustments, unconsolidated ventures


(3,291
)

4,393


6,356


4,393Adjusted Funds from Operations

$
26,582

$
19,562

$
75,671

$
69,329


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Return on Average Common Book Equity

We calculate return on average common book equity ("ROE") on a consolidated basis and for each of our major business lines. We believe
that ROE provides a good indication of the performance of the Company and our business lines because we believe it provides the best approximation of cash returns on common equity invested. Management
also uses ROE, among other factors, to evaluate profitability and efficiency of equity capital employed, and as a guide in determining where to allocate capital within its business. ROEs may fluctuate
from quarter to quarter based upon a variety of factors, including the timing and amount of investment fundings, repayments and asset sales, capital raised and leverage used, and the yield on
investments funded.

Return on Average Common Book Equity (including and excluding G&A and one-time items)  (dollars in thousands)

Three Months
Ended
September 30,
2008

Annualized
September 30,
2008(2)

Year Ended
December 31,
2007Adjusted Funds from Operations (AFFO)

[A]

$
26,582

$
106,328

$
95,683Plus: Fundraising Fees, Debt Issuance Costs and Other










6,295AFFO, excluding Fundraising Fees, Debt Issuance Costs and Other

[B]


26,582


106,328


101,978Plus: General & Administrative Expenses




13,725





56,561Plus: General & Administrative Expenses from Unconsolidated Ventures




1,070





4,810Less: Equity-Based Compensation included in G&A




5,439





16,214AFFO, excluding G&A

[C]


35,938


143,752


147,135Average Common Book Equity & Operating Partnership Minority Interest(1)

[D]

$
979,020




$
442,018Return on Average Common Book Equity (including G&A)

[A]/[D]


10.9
%




21.6
%Return on Average Common Book Equity (excluding Fundraising Fees, Debt Issuance Costs and Other)

[B]/[D]


10.9
%




23.1
%Return on Average Common Book Equity (excluding G&A)

[C]/[D]


14.7
%




33.3
%


---

Item 3.    Quantitative and Qualitative Disclosures about Market Risk

Market risk is the exposure to loss resulting from changes in interest rates and asset prices. We are subject to credit risk and
interest rate risk with respect to our investments in real estate debt, real estate securities and net leased real estate. The primary market risk that we are exposed to is interest rate risk.
Interest rates are highly sensitive to many factors, including governmental monetary and tax policies, domestic and international economic and political considerations and other factors beyond our
control. Our interest rate risk sensitive assets, liabilities and related derivative positions are generally held for non-trading purposes. At September 30, 2008, a hypothetical 100
basis point increase in

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interest
rates applied to our variable rate assets would increase our annual interest income by approximately $27.2 million, offset by an increase in our interest expense of approximately $21.6
million on our variable rate liabilities.

Real Estate Debt

We invest in real estate debt which are generally instruments secured by commercial and multifamily properties, including first lien
mortgage loans, junior participations in first lien mortgage loans, second lien mortgage loans, mezzanine loans, and preferred equity interests in borrowers who own such properties. We generally hold
these instruments for investment rather than trading purposes. These investments are either floating or fixed rate. The interest rates on our floating rate investments typically float at a fixed
spread over an index such as LIBOR. These instruments typically reprice every 30 days based upon LIBOR in effect at that time. Given the frequent and periodic repricing of our floating rate
investments, changes in interest rates are unlikely to materially affect the value of our floating rate portfolio. Changes in short-term rates will, however, affect earnings from our
investments. Increases in LIBOR will increase the interest income received by us on our investments and therefore increase our earnings. Decreases in LIBOR have the opposite effect.

We
also invest in fixed rate investments. The value of these investments may be affected by changes in long-term interest rates. To the extent that long-term
interest rates increase, the value of long-term fixed rate assets is diminished. Any fixed rate real estate debt investments which we hold would be similarly impacted. We do not generally
seek to hedge this type of risk unless the asset is leveraged as we believe the costs of such a hedging transaction over the term of such an investment would generally outweigh the benefits. If fixed
rate real estate debt is funded with floating rate liabilities, we typically convert the floating rate to fixed through the use of interest rate swaps, caps or other hedges. Because the interest rates
on our fixed rate investments are generally fixed through maturity of the investment, changes in interest rates do not affect the income we earn from our fixed rate investments.

In
our real estate debt business we are also exposed to credit risk, which is the risk that the borrower under our loan agreements cannot repay its obligations to us in a timely manner.
While we have not experienced a payment default as of the date of this Quarterly Report on Form 10-Q, our position in the capital structure may expose us to losses as a result of
such default in the future. In the event that the borrower cannot repay our loan, we may exercise our remedies under the loan documents, which may include a foreclosure against the collateral if we
have a foreclosure right as a real estate debtholder under the loan agreement. The real estate debt that we intend to invest in will often allow us to demand foreclosure as a real estate debtholder if
our loan is in default. To the extent the value of our collateral exceeds the amount of our loan (including all debt senior to us) and the expenses we incur in collecting on our loan, we would collect
100% of our loan amount. To the extent that the amount of our loan plus all debt senior to our position exceeds the realizable value of our collateral, then we would incur a loss. We also incur credit
risk in our periodically scheduled interest payments which may be interrupted as a result of the operating performance of the underlying collateral.

We
seek to manage credit risk through a thorough financial analysis of a transaction before we make such an investment. Our analysis is based upon a broad range of real estate,
financial, economic and borrower-related factors which we believe are critical to evaluating the credit risk inherent in a transaction.

We
expect our investments to be denominated in U.S. dollars or, if they are denominated in another currency, to be converted back to U.S. dollars through the use of currency swaps. It
may not be possible to eliminate all of the currency risk as the payment characteristics of the currency swap may not exactly match the payment characteristics of the investments.

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Real Estate Securities

In our real estate securities business, we mitigate credit risk through credit analysis, subordination and diversification. The CMBS we
invest in are generally junior in right of payment of interest and principal to one or more senior classes, but benefit from the support of one or more subordinate classes of securities or other form
of credit support within a securitization transaction. The senior unsecured REIT debt securities we invest in reflect comparable credit risk. Credit risk refers to each individual borrower's ability
to make required interest and principal payments on the scheduled due dates. We believe that these securities offer attractive risk-adjusted returns with reasonable long-term
principal protection under a variety of default and loss scenarios. While the expected yield on these securities is sensitive to the performance of the
underlying assets, the more subordinated securities and certain other features of a securitization, in the case of mortgage backed securities, and the issuer's underlying equity and subordinated debt,
in the case of REIT securities, are designed to bear the first risk of default and loss. The real estate securities portfolios of our investment grade term debt transactions are diversified by asset
type, industry, location and issuer. We further minimize credit risk by monitoring the real estate securities portfolios of our investment grade term debt transactions and the underlying credit
quality of their holdings.

The
real estate securities underlying our investment grade term debt transactions are also subject to spread risk. The majority of these securities are fixed rate securities, which are
valued based on a market credit spread over the rate payable on fixed rate U.S. Treasuries of like maturity. In other words, their value is dependent on the yield demanded on such securities by the
market, based on their credit relative to U.S. Treasuries. An excessive supply of these securities combined with reduced demand will generally cause the market to require a higher yield on these
securities, resulting in the use of a higher or "wider" spread over the benchmark rate (usually the applicable U.S. Treasury security yield) to value these securities. Under these conditions, the
value of our real estate securities portfolio would tend to decrease. Conversely, if the spread used to value these securities were to decrease or "tighten," the value of our real estate securities
would tend to increase. Such changes in the market value of our real estate securities portfolio may affect our net equity or cash flow either directly through their impact on unrealized gains or
losses on available for sale securities by diminishing our ability to realize gains on such securities, or indirectly through their impact on our ability to borrow and access capital.

Returns
on our real estate securities are sensitive to interest rate volatility. If interest rates increase, the funding cost on liabilities that finance the securities portfolio will
increase if these liabilities are at a floating rate or have maturities shorter than the assets.

Our
general financing strategy focuses on the use of "match-funded" structures. This means that we seek to align the maturities of our debt obligations with the maturities of our
investments in order to minimize the risk of being forced to refinance our liabilities prior to the maturities of our assets, as well as to reduce the impact of fluctuating interest rates on earnings.
In addition, we generally match interest rates on our assets with like-kind debt, so that fixed rate assets are financed with fixed rate debt and floating rate assets are financed with
floating rate debt, directly or through the use of interest rate swaps, caps or other financial instruments or through a combination of these strategies. Our investment grade term debt transactions
utilize interest rate swaps to minimize the mismatch between their fixed rate assets and floating rate liabilities.

Our
financing strategy is dependent on our ability to place the match-funded debt we use to finance our real estate securities at spreads that provide a positive arbitrage. If spreads on
the bonds issued by term debt transactions widen or if demand for these liabilities ceases to exist, then our ability to execute future term debt transaction financings will be severely restricted.

Interest
rate changes may also impact our net book value as our investments in debt securities are marked-to-market each quarter with changes in fair value
reflected in other comprehensive income (a

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separate
component of owners' equity). Generally, as interest rates increase, the value of fixed rate securities within the term debt transaction, such as CMBS, decreases and as interest rates
decrease, the value of these securities will increase. These swings in value have a corresponding impact on the value of our investment in the term debt transaction. Within the term debt transaction,
we seek to hedge against changes in cash flows attributable to changes in interest rates by entering into interest rate swaps/caps and other derivative instruments. Such derivatives are typically
designated as cash flow hedge relationships according to SFAS No. 133.

Net Lease Properties

Our ability to manage the interest rate risk and credit risk associated with the assets we acquire is integral to the success of our
net lease properties investment strategy. Although we may, in special situations, finance our purchase of net lease assets with floating rate debt, our general policy will be to mitigate our exposure
to rising interest rates by financing our purchases with non-recourse fixed rate mortgages. We seek to match the term of fixed rate mortgages to our expected holding period for the underlying asset.
Factors we consider to assess the expected holding period include, among others, the primary term of the lease as well as any extension options that may exist.

In
order to ensure that we have as complete an understanding as possible of a tenant's ability to satisfy its obligations under its lease, we undertake a rigorous credit evaluation of
each tenant prior to executing sale/leaseback or net lease asset acquisitions. This analysis includes an extensive due diligence investigation of the tenant's business as well as an assessment of the
strategic importance of the underlying real estate to the tenant's core business operations. Where appropriate, we may seek to augment the tenant's commitment to the facility by structuring various
credit enhancement mechanisms into the underlying leases. These mechanisms could include security deposit requirements or affiliate guarantees from entities we deem to be creditworthy.

Derivatives and Hedging Activities

We use derivatives primarily to manage interest rate risk exposure. These derivatives are typically in the form of interest rate swap
agreements and the primary objective is to minimize interest rate risks associated with the our investment and financing activities. The
counterparties of these arrangements are major financial institutions with which we may also have other financial relationships. We are exposed to credit risk in the event of
non-performance by these counterparties and we monitor their financial condition; however, we currently do not anticipate that any of the counterparties will fail to meet their obligations
because of their high credit ratings and financial support from the U.S. Government. The objective in using interest rate derivatives is to add stability to interest expense and to manage exposure to
interest rate movements.

In
January 2008, we adopted SFAS 159 and elected the fair value option for our bonds payable and our liability to subsidiary trusts issuing preferred securities. Under
SFAS 159, the changes in fair value of these financial instruments are now recorded in earnings. As a result of this election, the interest rate swap agreements associated with these debt
instruments no longer qualify for hedge accounting, in accordance with SFAS 133 "Derivatives and Hedging Activity", since the underlying debt is remeasured with changes in the fair value
recorded in earnings. The unrealized gains or losses accumulated in other comprehensive income, related to these interest rate swaps, will be reclassified into earning over the shorter of either the
life of the swap or the associated debt with current mark-to-market unrealized gains or losses recorded in earnings. For the three months ended September 30, 2008, we
recorded in earnings a mark-to-market unrealized loss of $1.8 million and a $1.4 million reclassification from accumulated other comprehensive income for the
non-qualifying interest rate swaps. For the nine months ended September 30, 2008, we recorded in earnings a mark-to-market unrealized gain of
$8.3 million and a $4.1 million reclassification from accumulated other comprehensive income for the non-qualifying interest rate swaps.

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The
following tables summarize our derivative financial instruments as of September 30, 2008 (in thousands).

Notional
Amount

Fair Value
Net Asset/
(Liability)

Range of
Fixed LIBOR

Range of MaturityInterest rate swaps and basis swapsAs of September 30, 2008


1,495,212


(44,860
)
3.02% - 5.96%

October 2009 - August 2018


Item 4.    Controls and Procedures

As of the end of the period covered by this report, our management conducted an evaluation (as required under
Rules 13a-15(b) and 15d-15(b) under the Securities Exchange Act), under the supervision and with the participation of our Chief Executive Officer and Chief Financial
Officer, of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act). Based on this evaluation, our Chief Executive
Officer and Chief Financial Officer concluded that, as of the end of the period covered by this report, our disclosure controls and procedures are effective. Notwithstanding the foregoing, a control
system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that it will detect or uncover failures to disclose material information otherwise required to be
set forth in our periodic reports.

Internal Control over Financial Reporting

Changes in internal control over financial reporting.There have not been any changes in our internal control over financial reporting (as defined in
Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect,
the Company's internal control over financial reporting.

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PART II. OTHER INFORMATION

Item 6.    Exhibits

(a)    Exhibits

Exhibit
Number

Description of Exhibit3.1

Articles of Amendment and Restatement of NorthStar Realty Finance Corp., as filed with the State Department of Assessments and Taxation of Maryland on October 20, 2004 (incorporated by reference to Exhibit 3.1
to the NorthStar Realty Finance Corp. Registration Statement on Form S-11 (File No. 333-114675))3.2

Bylaws of NorthStar Realty Finance Corp. (incorporated by reference to Exhibit 3.2 to the NorthStar Realty Finance Corp. Registration Statement on Form S-11 (File No. 333-114675))3.3

Amendment No. 1 to the Bylaws of NorthStar Realty Finance Corp. (incorporated by reference to Exhibit 3.3 to the NorthStar Realty Finance Corp. Current Report on Form 8-K filed on April 27,
2005)3.4

Articles Supplementary Classifying NorthStar Realty Finance Corp.'s 8.75% Series A Preferred Stock, liquidation preference $25.00 per share (incorporated by reference to Exhibit 3.2 to NorthStar Realty
Finance Corp.'s Registration Statement on Form 8-A, dated September 14, 2006)3.5

Articles Supplementary Classifying NorthStar Realty Finance Corp.'s 8.25% Series B Preferred Stock, liquidation preference $25.00 per share (incorporated by reference to Exhibit 3.2 to NorthStar Realty
Finance Corp.'s Registration Statement on Form 8-A, dated February 7, 2007)3.6

Articles Supplementary Classifying and Designating Additional Shares of NorthStar Realty Finance Corp.'s 8.25% Series B Preferred Stock, liquidation preference $25.00 per share (incorporated by reference to
Exhibit 3.6 to NorthStar Realty Finance Corp.'s Quarterly Report on Form 10-Q for the quarter ended June 30, 2007)Certain instruments defining the rights of holders of long-term debt securities of the Registrant and its subsidiaries are omitted pursuant to Item 601(b)(4)(iii) of Regulation S-K. The Registrant hereby
undertakes to furnish to the SEC, upon request, copies of any such instruments.10.1

Agreement of Limited Partnership of NorthStar Realty Finance Limited Partnership, dated as of October 19, 2004, by and among NorthStar Realty Finance Corp., as sole general partner and initial limited partner and
the other limited partners a party thereto from time to time (incorporated by reference to Exhibit 10.1 to the NorthStar Realty Finance Corp. Quarterly Report on Form 10-Q for the quarter ended September 30, 2004)10.2

NorthStar Realty Finance Corp. 2004 Omnibus Stock Incentive Plan (incorporated by reference to Exhibit 10.9 to the NorthStar Realty Finance Corp. Quarterly Report on Form 10-Q for the quarter ended
September 30, 2004)10.3

LTIP Unit Vesting Agreement under the NorthStar Realty Finance Corp. 2004 Omnibus Stock Incentive Plan among NorthStar Realty Finance Corp., NorthStar Realty Finance Limited Partnership and NRF Employee, LLC
(incorporated by reference to Exhibit 10.10 to the NorthStar Realty Finance Corp. Quarterly Report on Form 10-Q for the quarter ended September 30, 2004)


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Exhibit
Number

Description of Exhibit10.4

Form of Vesting Agreement for Units of NRF Employee, LLC, each dated as of October 29, 2004, between NRF Employee, LLC and certain employees and co-employees of NorthStar Realty Finance Corp. (incorporated
by reference to Exhibit 10.11 to the NorthStar Realty Finance Corp. Quarterly Report on Form 10-Q for the quarter ended September 30, 2004)10.5

Form of Restricted Stock Agreement (incorporated by reference to Exhibit 10.7(a) to the NorthStar Realty Finance Corp. Registration Statement on Form S-11 (File No. 333-114675))10.6

NorthStar Realty Finance Corp. 2004 Long-Term Incentive Bonus Plan (incorporated by reference to Exhibit 10.13 to the NorthStar Realty Finance Corp. Quarterly Report on Form 10-Q for the quarter ended
September 30, 2004)10.7

Form of Notification under NorthStar Realty Finance Corp. 2004 Long-Term Incentive Bonus Plan (incorporated by reference to Exhibit 10.14 to the NorthStar Realty Finance Corp. Quarterly Report on Form 10-Q
for the quarter ended September 30, 2004)10.8

Form of Indemnification Agreement for directors and officers of NorthStar Realty Finance Corp. (incorporated by reference to Exhibit 10.15 to the NorthStar Realty Finance Corp. Registration Statement on
Form S-11 (File No. 333-114675))10.9

Junior Subordinated Indenture, dated as of March 10, 2006, between NorthStar Realty Finance Limited Partnership, NorthStar Realty Finance Corp. and Wilmington Trust Company, as trustee (incorporated by reference
to Exhibit 10.31 to NorthStar Realty Finance Corp.'s Annual Report on Form 10-K for the year ended December 31, 2005)10.10

Amended and Restated Trust Agreement, dated as of March 10, 2006, between NorthStar Realty Finance Limited Partnership, as depositor, NorthStar Realty Finance Corp., a guarantor, Wilmington Trust Company, as
property trustee and Delaware trustee and Andrew Richardson, David Hamamoto and Richard McCready, each as administrative trustees (incorporated by reference to Exhibit 10.32 to NorthStar Realty Finance Corp.'s Annual Report on Form 10-K for
the year ended December 31, 2005)10.11

Amendment No. 1 to Agreement of Limited Partnership of NorthStar Realty Finance Limited Partnership, dated as of March 14, 2006, by and among NorthStar Realty Finance Corp., as sole general partner and
initial limited partner and the other limited partners a party thereto from time to time (incorporated by reference to Exhibit 10.34 to NorthStar Realty Finance Corp.'s Annual Report on Form 10-K for the year ended December 31,
2005)10.12

Junior Subordinated Indenture, dated as of August 1, 2006, between NorthStar Realty Finance Limited Partnership, NorthStar Realty Finance Corp. and Wilmington Trust Company, as trustee (incorporated by reference
to Exhibit 10.39 to NorthStar Realty Finance Corp.'s Quarterly Report on Form 10-Q for the quarter ended September 30, 2006)10.13

Amended and Restated Trust Agreement, dated as of August 1, 2006, between NorthStar Realty Finance Limited Partnership, as depositor, NorthStar Realty Finance Corp., a guarantor, Wilmington Trust Company, as
property trustee and Delaware trustee and David Hamamoto, Andrew Richardson and Richard McCready, each as administrative trustees (incorporated by reference to Exhibit 10.40 to NorthStar Realty Finance Corp.'s Quarterly Report on Form 10-Q
for the quarter ended September 30, 2006)10.14

Second Amendment to the Agreement of Limited Partnership of NorthStar Realty Finance Limited Partnership, dated as of September 14, 2006 (incorporated by reference to Exhibit 3.2 to the NorthStar Realty
Finance Corp. Current Report on Form 8-K filed September 14, 2006)


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Exhibit
Number

Description of Exhibit10.15

Junior Subordinated Indenture, dated as of October 6, 2006, between NorthStar Realty Finance Limited Partnership, NorthStar Realty Finance Corp. and Wilmington Trust Company, as trustee (incorporated by reference to
Exhibit 10.42 to the NorthStar Realty Finance Corp. Quarterly Report on Form 10-Q for the quarter ended September 30, 2006)10.16

Amended and Restated Trust Agreement, dated as of October 6, 2006, between NorthStar Realty Finance Limited Partnership, as depositor, NorthStar Realty Finance Corp., a guarantor, Wilmington Trust Company, as
property trustee and Delaware trustee and David Hamamoto, Andrew Richardson and Richard McCready, each as administrative trustees (incorporated by reference to Exhibit 10.43 to the NorthStar Realty Finance Corp. Quarterly Report on
Form 10-Q for the quarter ended September 30, 2006)10.17

Third Amendment to the Agreement of Limited Partnership of NorthStar Realty Finance Limited Partnership, dated as of February 7, 2007 (incorporated by reference to Exhibit 3.2 to the NorthStar Realty Finance
Corp. Current Report on Form 8-K filed February 9, 2007)10.18

Junior Subordinated Indenture, dated as of March 30, 2007, between NorthStar Realty Finance Limited Partnership, NorthStar Realty Finance Corp. and Wilmington Trust Company, as trustee (incorporated by reference
to Exhibit 10.46 to NorthStar Realty Finance Corp.'s Quarterly Report on Form 10-Q for the quarter ended March 31, 2007)10.19

Amended and Restated Trust Agreement, dated as of March 30, 2007, between NorthStar Realty Finance Limited Partnership, as depositor, NorthStar Realty Finance Corp., a guarantor, Wilmington Trust Company, as
property trustee and Delaware trustee and David Hamamoto, Andrew Richardson and Richard McCready, each as administrative trustees (incorporated by reference to Exhibit 10.47 to NorthStar Realty Finance Corp.'s Quarterly Report on Form 10-Q
for the quarter ended March 31, 2007)10.20

Form of NorthStar Realty Finance Corp. 2006 Outperformance Plan Award Agreement (incorporated by reference to Exhibit 99.3 to the NorthStar Realty Finance Corp. Post-Effective Amendment No. 2 to
Form S-8 filed on April 13, 2007)10.21

Amendment No. 1 to NorthStar Realty Finance Corp. 2004 Omnibus Stock Incentive Plan (incorporated by reference to Exhibit 99.2 to the NorthStar Realty Finance Corp. Post-Effective Amendment No. 2 to
Form S-8 filed on April 13, 2007)10.22

Amendment No. 2 to NorthStar Realty Finance Corp. 2004 Omnibus Stock Incentive Plan (incorporated by reference to Exhibit 99.3 to the NorthStar Realty Finance Corp. Post-Effective Amendment No. 3 to
Form S-8 filed on June 6, 2007)10.23

Fourth Amendment to the Agreement of Limited Partnership of NorthStar Realty Finance Limited Partnership, dated as of May 24, 2007 (incorporated by reference to Exhibit 3.3 to the NorthStar Realty Finance
Corp. Current Report on Form 8-K filed May 29, 2007)10.24

Junior Subordinated Indenture, dated as of June 7, 2007, between NorthStar Realty Finance Limited Partnership, NorthStar Realty Finance Corp. and Wilmington Trust Company, as trustee (incorporated by reference to
Exhibit 10.52 to NorthStar Realty Finance Corp.'s Quarterly Report on Form 10-Q for the quarter ended June 30, 2007)


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Exhibit
Number

Description of Exhibit10.25

Amended and Restated Trust Agreement, dated as of June 7, 2007, between NorthStar Realty Finance Limited Partnership, as depositor, NorthStar Realty Finance Corp., a guarantor, Wilmington Trust Company, as property
trustee and Delaware trustee and David Hamamoto, Andrew Richardson and Richard McCready, each as administrative trustees (incorporated by reference to Exhibit 10.53 to NorthStar Realty Finance Corp.'s Quarterly Report on Form 10-Q for the
quarter ended June 30, 2007)10.26

Registration Rights Agreement relating to the 7.25% Exchangeable Senior Notes due 2027 of NorthStar Realty Finance Limited Partnership, dated June 18, 2007 (incorporated by reference to Exhibit 4.2 to the
NorthStar Realty Finance Corp. Registration Statement on Form S-3 (File No. 333-146679))10.27

Master Repurchase Agreement, dated as of August 8, 2007, by and among NRFC JP Holdings, LLC and JPMorgan Chase Bank, N.A. (incorporated by reference to Exhibit 10.56 to NorthStar Realty Finance Corp.'s
Quarterly Report on Form 10-Q for the quarter ended June 30, 2007)10.28

Executive Employment and Non-Competition Agreement, dated as of October 4, 2007, between the Company and David T. Hamamoto (incorporated by reference to Exhibit 99.1 to the NorthStar Realty Finance Corp.
Current Report on Form 8-K filed October 5, 2007)10.29

Executive Employment and Non-Competition Agreement, dated as of October 4, 2007, between the Company and Andrew C. Richardson (incorporated by reference to Exhibit 99.2 to the NorthStar Realty Finance Corp.
Current Report on Form 8-K filed October 5, 2007)10.30

Executive Employment and Non-Competition Agreement, dated as of October 4, 2007, between the Company and Daniel R. Gilbert (incorporated by reference to Exhibit 99.3 to the NorthStar Realty Finance Corp.
Current Report on Form 8-K filed October 5, 2007)10.31

Executive Employment and Non-Competition Agreement, dated as of October 4, 2007, between the Company and Richard J. McCready (incorporated by reference to Exhibit 99.4 to the NorthStar Realty Finance Corp.
Current Report on Form 8-K filed October 5, 2007)10.32

Executive Employment and Non-Competition Agreement, dated as of October 4, 2007, between the Company and Daniel Raffe (incorporated by reference to Exhibit 99.5 to the NorthStar Realty Finance Corp. Current
Report on Form 8-K filed October 5, 2007)10.33

Credit Agreement, dated as of November 6, 2007, by and among NRFC WA Holdings, LLC, NRFC WA Holdings II, LLC, NRFC WA Holdings VII, LLC, NRFC WA Holdings X, LLC, NRFC WA Holdings XII, LLC,
 NorthStar Realty Finance Corp., NorthStar Realty Finance L.P. and Wachovia Bank, National Association, as Administrative Agent (incorporated by reference to Exhibit 10.53 to NorthStar Realty Finance Corp.'s Quarterly Report on
Form 10-Q for the quarter ended September 30, 2007)10.34

Limited Guaranty Agreement, dated as of November 6, 2007, by and among NorthStar Realty Finance Corp., NorthStar Realty Finance Limited Partnership and Wachovia Bank, National Association, as Administrative Agent
(incorporated by reference to Exhibit 10.54 to NorthStar Realty Finance Corp.'s Quarterly Report on Form 10-Q for the quarter ended September 30, 2007)10.35

Registration Rights Agreement relating to the 11.50% Exchangeable Senior Notes due 2013 of NRFC NNN Holdings, LLC, dated May 28, 2008 (incorporated by reference to Exhibit 4.2 to the NorthStar Realty
Finance Corp. Registration Statement on Form S-3 (File No. 333-152545))


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Exhibit
Number

Description of Exhibit10.36

Fifth Amendment to the Agreement of Limited Partnership of NorthStar Realty Finance Limited Partnership, dated as of May 29, 2008 (incorporated by reference to Exhibit 10.37 to NorthStar Realty Finance Corp.'s
Quarterly Report on Form 10-Q for the quarter ended June 30, 2008)10.37

Amendment No. 1 to Master Repurchase Agreement, dated as of October 7, 2008, by and among NRFC JP Holdings, LLC, and JP Morgan Chase Bank, N.A.10.38

Amended and Restated Guarantee Agreement, dated as of October 7, 2008, made by NorthStar Realty Finance Corp., in favor of JP Morgan Chase Bank, N.A.31.1

Certification by the Chief Executive Officer pursuant to 17 CFR 240.13a-14(a)/15(d)-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.31.2

Certification by the Chief Financial Officer pursuant to 17 CFR 240.13a-14(a)/15(d)-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.32.1

Certification by the Chief Executive Officer pursuant to Rule 13a-14(b) under the Securities Exchange Act of 1934 and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002.32.2

Certification by the Chief Financial Officer pursuant to Rule 13a-14(b) under the Securities Exchange Act of 1934 and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002.


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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.

NORTHSTAR REALTY FINANCE CORP.Date: November 6, 2008

By:

/s/ DAVID T. HAMAMOTO David T. Hamamoto Chief Executive OfficerBy:

/s/ ANDREW C. RICHARDSON Andrew C. Richardson Chief Financial Officer


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