Table of Contents


UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


WASHINGTON,
D.C. 20549





FORM
10-Q


(Mark
one)





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




For
the Quarterly Period Ended March 31, 2008





OR





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




For
the Transition Period From ___ to ___





Commission
File Number 333-128885











DESERT
      CAPITAL REIT, INC.(Exact Name of
      Registrant as specified in its charter)Maryland
            20-0495883(State or
      other jurisdiction of incorporation or organization)
            (I.R.S.
      Employer Identification No.)1291
      Galleria Drive, Suite 200, Henderson, NV 89014(Address of
      principal executive office)(Zip
      Code)Registrant's
      telephone number, including area code:  (800)
419-2855







Indicate
by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the past 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.


Yes þ  No o





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 Exchange Act.  (Check
one): Large
      Accelerated Filer o
              Accelerated
      Filer oNon-Accelerated
      Filer þ (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 þ





The
number of shares of the registrant's common stock, par value $0.01 per share,
outstanding as of May 12, 2008 was 16,807,867.





Table of Contents





DESERT
CAPITAL REIT, INC.


FORM
10-Q


For
the Quarter Ended March 31, 2008




INDEX


PagePart I. Financial Information
              
              1Item 1. Financial Statements
      (unaudited)
              
              1a)Consolidated Balance Sheets as of March 31, 2008 and December
      31, 2007
              
              1b)Consolidated Statements of Operations for the three months
      ended March 31, 2008 and 2007
              
              2c)Consolidated Statements of Cash Flows for the
      three months ended March 31, 2008 and 2007
              
              3d)Consolidated Statements of Changes in Stockholders'
      Equity for the three months ended March 31, 2008
              
              4e)Notes to Consolidated Financial Statements
      (unaudited)
              
              5Item 2. Management's Discussion and Analysis of
      Financial Condition and Results of Operations
              
              15Item 3. Quantitative and Qualitative Disclosures About
      Market Risk
              
              23Item 4. Controls and Procedures
              
              24Part II. Other Information
              
              24Item 1. Legal Proceedings
              
              24Item 1A. Risk Factors
              
              24Item 2. Unregistered Sales of Equity Securities and Use
      of Proceeds
              
              24Item 3. Defaults Upon Senior
    Securities
              
              25Item 4. Submission of Matters to a Vote of Security
      Holders
              
              25Item 5. Other Information
              
              25Item 6. Exhibits
              
              25Signatures
              
              26Certification of CEO Pursuant to Section
    302Certification of CFO Pursuant to Section
    302Certification of CEO and CFO Pursuant to Section
      906






Table of Contents





Part I.  Financial InformationItem 1. Consolidated Financial Statements
      (Unaudited)DESERT CAPITAL REIT, INC.Consolidated
      Balance Sheets(unaudited)March
      31,
            
            
            December
      31,2008
            
            
            2007ASSETSMortgage
      investments - net of allowance for loan losses of $24,854,202 at March 31,
      2008and
      $25,444,130 at December 31, 2007
            
            $
            102,078,236
            
            
            $
            118,017,926Loans
      held for sale
            
            
            4,706,800
            
            
            
            2,139,200Real
      estate owned
            
            
            27,052,552
            
            
            
            15,652,282Equity
      investments in real estate
            
            
            2,462,895
            
            
            
            -Note
      receivable from related party
            
            
            15,500,000
            
            
            
            15,500,000Building
      and equipment - net
            
            
            7,181,172
            
            
            
            7,235,939Land
            
            
            1,820,000
            
            
            
            1,820,000Cash
      and cash equivalents
            
            
            655,786
            
            
            
            162,753Interest
      receivable
            
            
            1,416,836
            
            
            
            1,464,261Deferred
      financing costs
            
            
            966,479
            
            
            
            975,043Other
      investments
            
            
            1,928,000
            
            
            
            1,928,000Other
      assets
            
            
            840,298
            
            
            
            818,715Total
      assets
            
            $
            166,609,054
            
            
            $
            165,714,119LIABILITIES
      AND STOCKHOLDERS' EQUITYCredit
      facility
            
            $
            4,706,800
            
            
            $
            2,139,200Mortgages
      payable
            
            
            8,095,127
            
            
            
            8,132,769Junior
      subordinated notes payable
            
            
            30,928,000
            
            
            
            30,928,000Dividends
      payable
            
            
            428,285
            
            
            
            1,675,814Deferred
      income taxes
            
            
            722,749
            
            
            
            738,423Accounts
      payable and accrued expenses
            
            
            1,197,529
            
            
            
            1,052,637Total
      liabilities
            
            
            46,078,490
            
            
            
            44,666,843Preferred
      stock, $0.01 par value: 15,000,000 shares authorized, none
      outstanding
            
            
            -
            
            
            
            -Common
      stock, $0.01 par value: 100,000,000 shares authorized; 16,807,867 and
      16,724,549shares
      issued and outstanding on March 31, 2008, and December 31, 2007,
      respectfully
            
            
            168,079
            
            
            
            167,246Additional
      paid-in capital
            
            
            165,561,654
            
            
            
            164,370,179Accumulated
      deficit
            
            
            (45,199,169
            )
            
            
            (43,490,149
            )Total
      stockholders' equity
            
            
            120,530,564
            
            
            
            121,047,276Total
      liabilities and stockholders' equity
            
            $
            166,609,054
            
            
            $
            165,714,119The
      accompanying condensed notes are an integral part of these consolidated
      financial statements.


1
 Table of Contents


DESERT CAPITAL REIT, INC.Consolidated
      Statements of Operations(unaudited)Three
      Months Ended March 31,2008
            
            
            2007INTEREST
      INCOME:Mortgage
      investments
            
            $
            2,216,087
            
            
            $
            5,570,878Other
      interest
            
            
            548,147
            
            
            
            139,405Total
      interest income
            
            
            2,764,234
            
            
            
            5,710,283Interest
      expense
            
            
            834,481
            
            
            
            992,982Net
      interest income
            
            
            1,929,753
            
            
            
            4,717,301Provision
      for loan losses
            
            
            310,988
            
            
            
            104,402Net
      interest income after provision for loan loss
            
            
            1,618,765
            
            
            
            4,612,899NON-INTEREST
      INCOME:Loan
      brokerage fees
            
            
            -
            
            
            
            1,574,713Service
      and other loan fees
            
            
            -
            
            
            
            446,836Other
            
            
            375,847
            
            
            
            185,823Total
      non-interest income
            
            
            375,847
            
            
            
            2,207,372NON-INTEREST
      EXPENSE:Impairment
      of real estate owned
            
            
            1,057
            
            
            
            -Compensation
            
            
            -
            
            
            
            503,626Management
      fees
            
            
            422,260
            
            
            
            1,278,542Professional
      fees
            
            
            288,071
            
            
            
            280,137Insurance
            
            
            113,007
            
            
            
            107,339Depreciation
            
            
            119,723
            
            
            
            195,641Advertising
            
            
            148
            
            
            
            147,627Other
            
            
            287,554
            
            
            
            290,830Total
      non-interest expense
            
            
            1,231,820
            
            
            
            2,803,742Net
      income before taxes
            
            
            762,792
            
            
            
            4,016,529Income
      tax expense (benefit)
            
            
            (43,104
            )
            
            
            70,177Net
      income
            
            $
            805,896
            
            
            $
            3,946,352Earnings
      per share - basic
            
            $
            0.05
            
            
            $
            0.26Earnings
      per share - diluted
            
            $
            0.05
            
            
            $
            0.26Weighted
      average outstanding shares - basic
            
            
            16,782,728
            
            
            
            15,311,504Weighted
      average outstanding shares - diluted
            
            
            16,782,728
            
            
            
            15,344,856The
      accompanying condensed notes are an integral part of these consolidated
      financial statements.


2
 Table of Contents


DESERT CAPITAL REIT, INC.Consolidated
      Statements of Cash Flows(unaudited)Three
      Months Ended March 31,2008
            
            
            2007OPERATING
      ACTIVITIESNet
      income
            
            $
            805,896
            
            
            $
            3,946,352Adjustments
      to reconcile net income to net cash provided by operating
      activities:Depreciation
      and amortization
            
            
            128,287
            
            
            
            204,205Stock
      based compensation
            
            
            -
            
            
            
            58,333Provision
      for loan losses
            
            
            310,988
            
            
            
            104,402Impairment
      of real estate owned
            
            
            1,057
            
            
            
            -Deferred
      tax benefit
            
            
            (15,674
            )
            
            
            -Mortgage
      loans originated for sale
            
            
            (6,332,000
            )
            
            
            (14,239,100
            )Mortgage
      loan sales
            
            
            3,764,400
            
            
            
            14,194,400Net
      change in:Interest
      receivable
            
            
            47,425
            
            
            
            433,452Other
      assets
            
            
            (21,583
            )
            
            
            (26,598
            )Deferred
      origination fees
            
            
            -
            
            
            
            (45,004
            )Accounts
      payable
            
            
            (153,827
            )
            
            
            (421,620
            )Net
      cash provided by (used in) operating activities
            
            
            (1,465,031
            )
            
            
            4,208,822INVESTING
      ACTIVITIESInvestment
      in real estate mortgages
            
            
            (7,594,594
            )
            
            
            (26,738,543
            )Proceeds
      from repayment/sale of real estate mortgages
            
            
            9,641,239
            
            
            
            17,287,950Other
      investments
            
            
            -
            
            
            
            (1,000,000
            )Acquisition
      of building and equipment
            
            
            (64,956
            )
            
            
            (32,650
            )Net
      cash provided by (used in) investing activities
            
            
            1,981,689
            
            
            
            (10,483,243
            )FINANCING
      ACTIVITIESProceeds
      from credit facilities on mortgage loans held for sale,
net
            
            
            2,567,600
            
            
            
            44,700Principal
      repayments of mortgage loan
            
            
            (37,642
            )
            
            
            (15,203
            )Issuance
      of common stock
            
            
            382,508
            
            
            
            9,915,423Dividends
      on common stock
            
            
            (2,895,549
            )
            
            
            (3,306,547
            )Offering
      costs paid
            
            
            (40,542
            )
            
            
            (1,019,009
            )Shares
      redeemed and retired
            
            
            -
            
            
            
            (381,019
            )Net
      cash provided by (used in) financing activities
            
            
            (23,625
            )
            
            
            5,238,345Net
      increase (decrease) in cash and cash equivalents
            
            
            493,033
            
            
            
            (1,036,076
            )Cash
      and cash equivalents at beginning of period
            
            
            162,753
            
            
            
            2,434,948Cash
      and cash equivalents at end of period
            
            $
            655,786
            
            
            $
            1,398,872Supplemental
      disclosures of cash flow information:Cash
      paid for interest
            
            $
            987,467
            
            
            $
            1,004,931Cash
      paid for taxes
            
            
            -
            
            
            
            250,000Supplemental
      schedule of non-cash investing and financing:Foreclosed
      real estate acquired in exchange for loans
            
            $
            13,864,222
            
            
            $
            -Real
      estate assets owned contributed to equity investments in real
      estate
            
            
            2,462,895
            
            
            
            -Accrued
      property taxes and professional fess associated with
      foreclosure
            
            
            410,780
            
            
            
            -Common
      stock issued for dividend reinvestment program
            
            
            866,897
            
            
            
            1,235,653Common
      stock dividends declared but not paid
            
            
            428,285
            
            
            
            1,559,681Offering
      costs incurred but not paid
            
            
            29,361
            
            
            
            15,964The
      accompanying condensed notes are an integral part of these consolidated
      financial statements.


3
 Table of Contents


DESERT CAPITAL REIT, INC.Consolidated
      Statements of Changes in Stockholders' Equity(unaudited)Common Stock Number
      of Shares
            Common Stock
              Par Value
            
            
            Additional Paid - in
Capital
            Accumulated Deficit
            TotalBalance
      at December 31, 2007
            16,724,549
            
            $
            167,246
            
            
            $
            164,370,179
            
            
            $
            (43,490,149)
            
            
            $
            121,047,276Issuance
      of common stock
            83,318
            
            
            833
            
            
            
            1,248,572
            
            
            
            -
            
            
            
            1,249,405Dividends
      on common stock
            -
            
            
            -
            
            
            
            -
            
            
            
            (2,514,916)
            
            
            
            (2,514,916)Offering
      costs
            -
            
            
            -
            
            
            
            (57,097)
            
            
            
            -
            
            
            
            (57,097)Net
      income
            -
            
            
            -
            
            
            
            -
            
            
            
            805,896
            
            
            
            805,896Balance
      at March 31, 2008
            16,807,867
            
            $
            168,079
            
            
            $
            165,561,654
            
            
            $
            (45,199,169)
            
            
            $
            120,530,564The
      accompanying condensed notes are an integral part of these consolidated
      financial statements.


4
 Table of Contents




DesertCapital REIT, INC.


Condensed
Notes to Unaudited Consolidated Financial Statements


March
31, 2008





Note
1 – Organization





References
herein to “we,” “us,” “our” or “Company” refer to Desert Capital REIT, Inc. and
its subsidiaries unless the context specifically requires
otherwise.




We are a
Maryland corporation formed in December 2003 as a real estate investment trust
("REIT") that specializes in financing of short-term mortgage loans. We
generally invest in 12- to 18- month, first and second lien mortgage loans,
consisting of acquisition and development loans and construction loans to
developers and builders of residential and commercial property. We derive our
revenues primarily from interest payments received from mortgage investments
funded with our equity capital and borrowed funds. We generate net income for
distribution to our stockholders from the spread between interest income on our
mortgage investments, also referred to as loans, and the costs of financing the
acquisition of these investments. We also from time to time fund loans for
resale to private investors as short term investments that we generally hold for
less than 90 days.  While there are typically fees generated and
recognized upon funding, there are no gains or losses realized upon the
sale of these loans.  We generate a spread between the interest income
on the loans held for sale and the interest expense on any borrowings used
to finance the loans.





All of
our loan origination and loan servicing activities were conducted through
Consolidated Mortgage, LLC, (“Consolidated Mortgage”) which was our wholly-owned
subsidiary through November 2007 at which time it was sold to Sandstone Equity
Investors, LLC (“Sandstone” or “Advisor”), a related
party.  Consolidated Mortgage will continue to originate and service
loans for us.  We have a right of first refusal for the purchase of
all new loans originated by Consolidated
Mortgage.





We are
externally managed by Sandstone, which replaced Burton Management Company
(“Burton”) as our Advisor in November 2007 concurrently with the sale of
Consolidated Mortgage.  Sandstone’s management team consists of the
former management of Burton, which is also our management team.  See
Note 6 – Commitments and Related Parties.





We
qualified as a REIT under the Internal Revenue Code commencing with our taxable
year ended December 31, 2004 and expect to continue to qualify for the current
fiscal year. To maintain our tax status as a REIT, we plan to continue to
distribute at least 90% of our taxable income to stockholders.





Basis
of Presentation


The
accompanying unaudited consolidated interim financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States for interim financial information and with the instructions to
Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all
of the information and footnotes required by accounting principles generally
accepted in the United States for complete financial statements. The
accompanying unaudited consolidated interim financial statements should be read
in conjunction with the financial statements filed on Form 10-K/A and the
related management's discussion and analysis of financial condition and results
of operations filed on Form 10-K for the fiscal year ended December 31,
2007.  In our opinion, all adjustments (consisting only of normal
recurring accruals) considered necessary for a fair presentation have been
included.  The results of operations for the three months ended March
31, 2008 are not necessarily indicative of results that may be expected for the
entire year ending December 31, 2008.





Note
2 - Summary of Significant Accounting Policies





Principles
of Consolidation


The
accompanying consolidated financial statements include our accounts and the
accounts of our wholly-owned subsidiaries. All significant intercompany balances
and transactions have been eliminated in consolidation.





Our
interest in Desert Capital TRS Statutory Trust I, a trust formed for the purpose
of issuing trust preferred securities,  is accounted for using the
equity method and the assets and liabilities are not consolidated into our
financial statements due to our determination that Desert Capital TRS Statutory
Trust I is a variable interest entity in which we are not the primary
beneficiary under Financial Accounting Standards Board (FASB) Interpretation No.
46R “Consolidation of Variable Interest Entities – An Interpretation of ARB No.
51”(FIN 46R).   In addition we use the equity method to account
for our equity investments in real estate development ventures for which we have
50% or less ownership and the ability to exercise significant influence over
operating and financial policies, but do not control. Consolidated net income
includes our proportionate share of the net income or net loss of these
entities, which are typically limited liability companies formed for the purpose
of developing the properties upon which we have foreclosed.





We use
the cost method to account for our investments in companies that we do not
control and for which we do not have the ability to exercise significant
influence over operating and financial policies. In accordance with the cost
method, these investments are recorded at cost or fair value, as
appropriate.





5
 Table of Contents


Reclassifications


Certain
reclassifications have been made in the investing activities section of the
consolidated statement of cash flow for the three months ended March 31, 2007
within the captions “Investment in real estate mortgages” and “Proceeds from
repayment/sale of real estate mortgages” to reflect gross receipts and payments
of mortgage investments.  Board of Directors’ compensation has been
reclassed from “Compensation” to “Other” in the non-interest expense section of
the statement of operations for the three months ended March 31,
2007.   These reclassifications had no impact on our cash flow
from investing activities, net income, or balance sheet as previously
reported.





Revenue
Recognition


Interest
income on our mortgage investments is recognized over the life of the investment
and recorded on the accrual basis. Income recognition is suspended for mortgage
investments at the earlier of the date on which payments become 90 days past due
or when, in the opinion of management, a full recovery of income and principal
becomes doubtful. Income recognition is resumed when the loan becomes
contractually current and performance is demonstrated to be
resumed.





Fees
generated upon the funding of loans held for sale are recognized when the loan
is funded.  There are no gains or losses realized upon the sale of
loans held for sale.





Prior to
our sale of Consolidated Mortgage in November 2007, we recognized revenues
related to the loan origination and loan servicing activities of Consolidated
Mortgage. Loan origination fees and certain direct origination costs associated
with mortgage investments that were funded by us, were deferred and recognized
as an adjustment to yield over the lives of the related loans using the
straight-line method. Loan brokerage fees generated by Consolidated Mortgage
were nonrefundable fees for brokering loans to third party investors. Loan
brokerage fees were recognized once the loans associated with the fees were
funded and recorded by the third party investors. Consolidated Mortgage also
charged fees, which were recorded as non-interest income, to service loans
brokered to third party investors, as well as other miscellaneous fees during
the loan term. These service and other loan fees were recognized throughout the
life of the loan as they were earned.





Real
Estate Owned


Real
estate owned consists of property acquired through foreclosures on mortgage
loans.  Our interests in real estate owned may be held directly by the
Company, or through limited liability companies.  In the case where
the Company is one of several investors in a larger loan, such loans are
foreclosed upon using a limited liability company to facilitate foreclosing our
lender interest along with private investors who hold the remaining loan balance
and have similar economic interests. We recorded real estate held directly or
through limited liability companies at the lower of the recorded amount of our
related mortgage loan being foreclosed (net of any impairment reserve), or our
economic interest in the property's estimated fair value, less estimated costs
to sell, with fair value based on appraisals and local market conditions and
inclusive of any senior indebtedness.





On a
periodic basis, management assesses whether there are any indicators that the
value of the Company’s investments in real estate owned may be other than
temporarily impaired. An investment is impaired only if the value of the
investment, as estimated by management, is less than the carrying value of the
investment. To the extent impairment has occurred, the loss shall be measured as
the excess of the carrying amount of the investment over the value of the
investment, as estimated by management.





Equity
Investments in Real Estate


To
facilitate our resolution strategy with respect to nonperforming loans we have
contributed real estate assets acquired through foreclosure to operating joint
ventures with investors/developers who provide additional financing and
development expertise.





We
evaluate our investments in partially owned entities in accordance with
FIN 46R. The Company accounts for its investments in unconsolidated real
estate ventures under the equity method of accounting as it is not the primary
beneficiary for a “variable interest entity,” or a “VIE,” and the Company
exercises significant influence, but does not control these entities under the
provisions of the entities’ governing agreements pursuant to EITF 04-05. These
investments are recorded initially at cost or impaired value, as investments in
real estate entities, and subsequently adjusted for equity in earnings and cash
contributions and distributions in accordance with AICPA (American Institute of
Certified Public Accountants) Statement of Position No. 78-9, Accounting for
Investments in Real Estate Ventures.





On a
periodic basis, management assesses whether there are any indicators that the
value of the Company’s investments in equity investments in real estate may be
other than temporarily impaired. An investment is impaired only if the value of
the investment, as estimated by management, is less than the carrying value of
the investment. To the extent impairment has occurred, the loss shall be
measured as the excess of the carrying amount of the investment over the value
of the investment, as estimated by management.





6
 Table of Contents


Recent
Accounting Developments


In
December 2007, Financial Accounting Standards Board (“FASB”) issued SFAS No.
160, “Noncontrolling Interests in Consolidated Financial Statements – an
amendment of ARB No. 51” (“SFAS No. 160”).  SFAS No. 160 requires that
ownership interests in subsidiaries held by parties other than the parent, and
the amount of consolidated net income, be clearly identified, labeled, and
presented in the consolidated financial statements within equity, but separate
from the parent’s equity. It also requires that once a subsidiary is
deconsolidated, any retained noncontrolling equity investment in the former
subsidiary be initially measured at fair value. Sufficient disclosures are
required to clearly identify and distinguish between the interests of the parent
and the interests of the noncontrolling owners.  In addition to the
amendments to ARB 51, this Statement amends SFAS No. 128 “Earnings per Share”;
so that earnings-per-share data will continue to be calculated the same way
those data were calculated before SFAS No. 160 was issued. SFAS No. 160 is
effective for fiscal years, and interim periods within those fiscal years,
beginning on or after December 15, 2008.  Earlier adoption is
prohibited.  SFAS No. 160 shall be applied prospectively as of the
beginning of the fiscal year in which SFAS No. 160 is initially applied, except
for the presentation and disclosure requirements.  The presentation
and disclosure requirements shall be applied retrospectively for all periods
presented.  SFAS No. 160 will be effective for us beginning January 1,
2009.  We have evaluated SFAS No. 160 and have determined that we have
not entered any business arrangements or corporate joint ventures that would
require the application of SFAS No. 160 for noncontrolling
interests.





In
December 2007, the FASB issued SFAS No. 141R, “Business Combinations” (“SFAS No.
141R”).  This Statement replaces SFAS No. 141.  SFAS No.
141R establishes principles and requirements for how the acquirer of a business
recognizes and measures in its financial statements the identifiable assets
acquired, the liabilities assumed, and any noncontrolling interest in the
acquiree.  SFAS No. 141R also provides guidance for recognizing and
measuring the goodwill acquired in the business combination and determines what
information to disclose to enable users of the financial statements to evaluate
the nature and financial effects of the business combination.  This
Statement 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 do not expect the
adoption of SFAS 141R to have a material impact on our Consolidated Financial
Statements.




In
February 2007, the FASB issued Statement of Financial Accounting Standards
No. 159 (“SFAS 159”), “The Fair Value Option for Financial Assets and
Financial Liabilities.” SFAS 159 permits entities to choose to measure financial
assets and liabilities (except for those that are specifically scoped out of the
Statement) at fair value.  The election to measure a financial asset
or liability at fair value can be made on an instrument-by-instrument basis and
is irrevocable.  The difference between carrying value and fair value
at the election date is recorded as a transition adjustment to opening retained
earnings.  Subsequent changes in fair value are recognized in
earnings.  The Company may decide whether to elect the fair value
option for each eligible item on various defined election dates.  We
did not elect to report any financial assets or liabilities at fair value under
SFAS No. 159 on January 1, 2008.





In
September 2006, the FASB issued Statement of Financial Accounting Standards
No. 157, “Fair Value Measurements” (“SFAS 157”). SFAS 157 defines fair
value, establishes a framework for measuring fair value and expands disclosures
about fair value measurements.  SFAS 157 applies under other accounting
pronouncements that require or permit fair value measurements. Accordingly, SFAS
157 does not require any new fair value measurements. SFAS 157 is effective for
fiscal years beginning after November 15, 2007, and interim periods within those
fiscal years.  This statement has modified the methodology for the
measurement of “Fair Value of Financial Instruments.” This change has had a
significant impact on the estimated fair value of our financial instruments as
of March 31, 2008.  See Note 14 - Fair Value of Financial
Instruments.





Note
3 - Mortgage Investments





Mortgage
investments represent first and second lien positions on acquisition and
development, construction and commercial property loans. As of March 31, 2008,
all of our loans had fixed interest rates and provided for payment of interest
only with a “balloon” payment of principal payable in full at the end of the
term.





March
      31,
            
            
            December
      31,2008
            
            
            2007Acquisition
      and development loans
            
            $
            96,022,804
            
            
            $
            107,598,051Construction
      loans
            
            
            14,598,050
            
            
            
            17,665,105Commercial
      property
            
            
            16,311,584
            
            
            
            18,198,900Balance
      per loan portfolio
            
            
            126,932,438
            
            
            
            143,462,056Allowance
      for loan losses
            
            
            (24,854,202
            )
            
            
            (25,444,130
            )Mortgage
      investments - net
            
            $
            102,078,236
            
            
            $
            118,017,926





As of
March 31, 2008 and December 31, 2007, approximately 16% and 22%, respectively,
of the principal balance of the outstanding mortgage notes were secured by
second liens. As of March 31, 2008 and December 31, 2007, the portfolio had a
weighted average interest rate of 12.95% and 13.37%, respectively.





7
 Table of Contents


Our
mortgage portfolio is primarily concentrated in the Southwestern United States.
As of March 31, 2008 and December 31, 2007, 86% and 87%, respectively, of the
principal balance of our portfolio was invested throughout Nevada, California,
and Arizona. Our borrowers’ ability to repay our notes is dependent upon the
real estate and general economic conditions in this area.





As of
March 31, 2008 we had 58 loans in our portfolio from seven separate borrowers
that were placed on nonaccrual status.  The aggregate balance of these
loans was approximately $91.8 million of which our portion was approximately
$59.2 million, and the remaining balance was held by private
investors.  We provided an allowance for loan loss related to these
nonperforming loans of $20.8 million, leaving a net carrying balance of $38.4
million at March 31, 2008. Our balance on these loans ranged from $2,800 to
$11.0 million. Of the 58 loans, 44 were first lien loans totaling $50.8 million
and 14 were second lien loans totaling $8.4 million.  These loans were
placed on non-accrual of interest status and are the subject of pending
foreclosure proceedings.





Nonperforming
and impaired loans:


Details
on nonperforming and impaired loans and related allowances are as
follows:





March
      31, 2008Balance
            
            
            Allowance
      for
              loan
      losses
            
            
            Balance,
      net
              of
      allowanceNonperforming
      loans – no related allowance
            
            $
            10,304,074
            
            
            $
            -
            
            
            $
            10,304,074Nonperforming
      loans – related allowance
            
            
            48,895,788
            
            
            
            (20,849,202
            )
            
            
            28,046,586Subtotal
      nonperforming loans
            
            
            59,199,862
            
            
            
            (20,849,202
            )
            
            
            38,350,660Performing
      loans – no related allowance
            
            
            46,117,863
            
            
            
            
            
            
            
            46,117,863Performing
      loans – related allowance
            
            
            21,614,713
            
            
            
            (4,005,000
            )
            
            
            17,609,713Subtotal
      performing loans
            
            
            67,732,576
            
            
            
            (4,005,000
            )
            
            
            63,727,576Total
            
            $
            126,932,438
            
            
            $
            (24,854,202
            )
            
            $
            102,078,236











December
      31, 2007Balance
            
            
            Allowance
      for
              loan
      losses
            
            
            Balance,
      net
              of
      allowanceNonperforming
      loans – no related allowance
            
            $
            18,001,625
            
            
            $
            -
            
            
            $
            18,001,625Nonperforming
      loans – related allowance
            
            
            20,734,032
            
            
            
            (7,010,629
            )
            
            
            13,723,403Subtotal
      nonperforming loans
            
            
            38,735,657
            
            
            
            (7,010,629
            )
            
            
            31,725,028Performing
      loans – no related allowance
            
            
            62,378,668
            
            
            
            
            
            
            
            62,378,668Performing
      loans – related allowance
            
            
            42,347,731
            
            
            
            (18,433,501
            )
            
            
            23,914,230Subtotal
      performing loans
            
            
            104,726,399
            
            
            
            (18,433,501
            )
            
            
            86,292,898Total
            
            $
            143,462,056
            
            
            $
            (25,444,130
            )
            
            $
            118,017,926





During
the three month period ended March 31, 2008 we sold a mortgage for $2.7 million
which had a carrying value of $2.7 million, net of an impairment of $300,000
recorded in the fourth quarter of 2007.





Subsequent
to March 31, 2008, and prior to the issuance of this report, an additional $3.6
million of net carrying value of nonperforming loans were foreclosed and the
collateral was acquired. The original amount of these loans prior to allowance
for loan losses was $7.0 million.





Note
4 – Real Estate Owned





Real
estate owned consists of property acquired through foreclosures on mortgage
loans.  Our interests in real estate owned may be held directly by the
Company, or through limited liability companies.  In the case where
the Company is one of several investors in a larger loan, such loans are
foreclosed upon using a limited liability company to facilitate foreclosing our
lender interest along with private investors who hold the remaining loan balance
and have similar economic interests.   At March 31, 2008, we held
real estate through seven limited liability companies with other private
investors, and our ownership percentage ranged from 12.4% to 39.7%. We recorded
real estate held directly or through limited liability companies at the lower of
the recorded amount of our related mortgage loan being foreclosed (net of any
impairment reserve), or our economic interest in the property's estimated fair
value, less estimated costs to sell, with fair value based on appraisals and
local market conditions and inclusive of any senior indebtedness.





8
 Table of Contents


During
the quarter ended March 31, 2008, we foreclosed on properties with an aggregate
original loan balance of approximately $14.2 million, net of related allowance
for loan loss of $600,950, and additional capitalized costs of
$266,715.  We did not dispose of any real estate owned through sale
during the three month period ending March 31, 2008. During March 2008 we
contributed 44 lots valued at $2.5 million to a joint venture in which we have a
50% noncontrolling ownership interest.  (See Note 5 - Equity
Investments in Real Estate)





At March
31, 2008 and December 31, 2007, we had a net carrying balance in real estate
owned of approximately $27.1 million and $15.7 million, respectively. We did not
have any real estate owned as of March 31, 2007.  The following
summary provides an analysis of the changes in real estate owned during the
quarter ended March 31, 2008.





Real
      Estate OwnedBalance
      December 31, 2007
            
            $
            15,652,282Foreclosures
            
            
            13,864,222Impairments
            
            
            (1,057
            )Real
      estate assets owned contributed to equity investment in real
      estate
            
            
            (2,462,895
            )Balance
      March 31, 2008
            
            $
            27,052,552





Following
is a summary of real estate owned as of March 31, 2008 and December 31,
2007:





Description
            State
      Location
            
            March
      31, 2008
            
            
            December
      31, 2007Undeveloped
      land
            AZ,
      CA, NV
            
            $
            20,677,876
            
            
            $
            6,960,794Single
      family residential lots
            AZ,
      NV
            
            
            3,233,322
            
            
            
            5,595,927Office
      building
            TX
            
            
            2,227,574
            
            
            
            2,190,204Other
            NV
            
            
            913,780
            
            
            
            905,357$
            27,052,552
            
            
            $
            15,652,282





Note
5 – Equity Investments in Real Estate




In March
2008, we formed a joint venture with a homebuilder for the construction of 44
single family homes in Las Vegas, Nevada. We contributed 44 lots to the joint
venture, which we previously acquired through foreclosure and classified as real
estate owned. After the date of formation, this venture was accounted for under
the equity method of accounting since we had a 50% noncontrolling ownership
interest at March 31, 2008. Our venture partner manages the operations of the
joint venture. All major decisions require the approval of both joint venturers,
and voting rights and the sharing of profits and losses are in proportion to the
ownership percentages of each joint venturer. We recorded our initial investment
at $2,462,895, the carrying value of the lots, and we will record our net equity
in income and cash contributions and distributions.  There were no
reportable operations for the period ending March 31, 2008.  We have
no responsibility to provide additional funding to the venture. Additional
funding for the construction of homes and sales of such will be provided by our
venture partner.  Our share of losses, if any, would be limited to the
value of lots contributed of approximately $2.5 million.





Note
6 - Commitments and Related Parties





Sandstone
is our Advisor and oversees our day-to-day operations including asset,
liability and capital management. In lieu of paying salaries to officers, we
compensate our Advisor pursuant to an advisory agreement that entitles it to
first-tier management compensation, second-tier management compensation, and
reimbursement of expenses. Our current advisor, Sandstone, replaced Burton in
November 2007 in conjunction with the sale of Consolidated Mortgage. The
officers and majority owners of our Advisor are also our executive officers. The
annual first-tier management compensation is 1% of the first $200 million of
gross average invested assets plus 0.8% of the gross average invested assets in
excess of $200 million, to be paid quarterly. The first-tier management
compensation payable under our current advisory agreement with Sandstone is
calculated in the same manner as the base management fee payable under our prior
advisory agreement with Burton.  The base management fees for the
three months ended March 31, 2008 and 2007, were $422,260 and $379,240,
respectively, and $148,059, and $129,374, remained payable on March 31, 2008 and
2007, respectively, and were included in accounts payable and accrued expense in
the consolidated balance sheet. The second-tier management compensation is a
tiered percentage of the amount of our net income (taxable income) excluding
provision for loan loss and capital losses, before deducting second-tier
compensation less a threshold return, which is the net income that would produce
an annualized return on our average invested assets equal to the 10-year
U.S. Treasury rate plus 1.0%. The tiered percentage is the weighted average
of 20% of the first $200 million of average invested assets and 10% of the
excess over $200 million of average invested assets. The second-tier management
compensation is calculated quarterly and any positive quarterly amount is paid
by us, along with the first-tier management compensation, within 15 days of
receipt of the computations. Second-tier management compensation payable under
our current advisory agreement with Sandstone is calculated in the same manner
as the incentive compensation payable under our prior advisory agreement with
Burton.  Second-tier management compensation for the three months
ended March 31, 2008 and 2007 was $0 and $388,158 respectively, and $0 and
$141,790 remained payable on March 31, 2008 and 2007 respectively.





9
 Table of Contents


Consolidated
Mortgage previously had a management agreement in place with ARJ Management
(“ARJ”), a company of which our president and chief executive officer, Todd
Parriott, is president, director and controlling shareholder, pursuant to
which ARJ was paid a management fee equal to 33% of Consolidated Mortgage's
pre-tax net income. The fee was calculated and paid monthly. The management
agreement with ARJ was mutually terminated by the parties thereto as of November
21, 2007 in connection with the sale of Consolidated Mortgage.  The
management fee for the three months ended March 31, 2007 was $511,144 and
$399,130 remained payable on March 31, 2007.





The
dealer-manager of our offering of common stock, CMC Financial Services, Inc.
(“CMCFS”), directs and oversees the sale of our equity securities. CMCFS
receives a marketing support fee and sales commissions based on the number of
shares of common stock it sells. CMCFS contracts with third party broker-dealers
to have a larger sales distribution of equity securities, and compensates them
out of the sales commissions and marketing support fees it receives from us.
Because Sandstone owns CMCFS, it is our affiliate. CMCFS earned gross sales
commissions and marketing support fees for the three months ended March 31, 2008
and 2007 of $36,124 and $940,117, respectively. There were no amounts
payable on March 31, 2008 and 2007 for the gross sales commissions and marketing
support fees.  CMCFS paid a substantial portion of these fees to third
party broker dealers Sandstone acquired ownership of CMCFS on November 21,
2007.  Our Board of Directors suspended the sale of Desert Capital
REIT shares as of February 22, 2008.  This decision was made in
anticipation of the expiration of the offering, which would not allow sales of
shares to occur after March 22, 2008 per the Prospectus.  The
suspension and ultimate expiration of the sale of Desert Capital REIT shares
also suspends our dividend reinvestment program, which allowed shareholders to
purchase additional shares with their dividend proceeds.





CMCFS
also has an agreement with Consolidated Mortgage to provide investors for loans
brokered and serviced by Consolidated Mortgage for a fee equal to 25 basis
points of every dollar raised. The fee is calculated and paid
monthly.  The fee pursuant to this agreement for the three months
ended March 31, 2007 was $131,603.





In
September 2005, a third-party borrower asked the Company to enter into a land
banking transaction, meaning that the Company would purchase a tract of land,
and simultaneously enter into an option contract with the borrower, pursuant to
which the borrower would purchase smaller parcels of the initial tract from us
over time at a specified price, until it had purchased the entire initial
tract.  Due to the rules with which we must comply to maintain our
REIT status, actual title to that land had to be owned by a separate entity and
could not be held by the Company.  As an accommodation to the Company
and the third-party borrower, our Chairman and CEO, Todd Parriott and Co-COO,
Jonathan Arens formed a company called CM Land, LLC for the specific purpose of
holding title to that land.  We initially funded $10.2 million of the
purchase price of approximately $80 million via a loan to CM Land, LLC secured
by the property.  We earned interest of $506,526 for the three months
ended March 31, 2007. During the third quarter of 2007, we recorded a provision
for loan losses of $1.2 million. In May 2007, the borrower did not exercise its
option under the contract to purchase the remaining portion of the
land.  As a result, we took title to the property directly. During the
fourth quarter of 2007, based upon declines in value of the underlying
collateral, we recorded an impairment of real estate owned in the amount of $3.8
million. The net carrying value of the real estate was $7 million, net of $5
million of impairment losses at March 31, 2008 and December 31, 2007 and is
included in real estate owned in the consolidated balance sheet.





In
November 2007, we sold a nonperforming loan with an outstanding balance of $1.95
million to CM Equity, LLC.  Some of the executive officers of CM
Equity are the same as our executive officers, and our Advisor is also the
manager of CM Equity.  We provided 100% financing on the
sale.  The loan bears a fixed interest rate of 8.25% and matures in
November 2009.  No gain or loss was recognized on the sale. We earned
interest of $40,425 for the three months ended March 31, 2008.





In
November 2007 we sold Consolidated Mortgage to Sandstone, a related
party.  Our subsidiary, Desert Capital TRS, Inc. (“TRS”) sold all of
the issued and outstanding units of Consolidated Mortgage to Sandstone, for
consideration of the following:







●
            293,001
      of our common stock with a value of $4.395 million based on the last
      offering of its common stock at a per share price of $15 per
      share.  We subsequently retired the 293,001 shares of
      stock.


●
            $104,985
      in cash.●
            A
      $15.5 million promissory note payable by Consolidated Mortgage to the
      order of TRS.  The note bears interest at 9.0% per
      annum.  Principal and interest payments are due quarterly
      beginning on March 31, 2008.  The note matures in December
      2017.  The note is secured by all of the outstanding membership
      units of Consolidated Mortgage.   We earned interest of
      $352,625 for the three months ended March 31,
  2008.







In
addition to the consideration received, we will receive a contingent
installment payment from Consolidated Mortgage on loans we fund in the future.
The $8.25 million contingent payment is payable (the “Installment
Payment”) as follows:  Sandstone will pay or cause Consolidated
Mortgage to pay to TRS, on the last day of each calendar quarter, an amount
equal to: (i) 1% of the principal amount of all mortgage loans originated or
brokered by Consolidated Mortgage or any of its affiliates and funded by us
during such calendar quarter for the first $200 million of mortgage loans funded
during each calendar year; and (ii) 0.5% of the principal amount of all mortgage
loans originated or brokered by Consolidated Mortgage and funded by us during
such calendar quarter in excess of $200 million during each calendar year,
commencing on December 31, 2007 and continuing on the last day of each calendar
quarter thereafter, until TRS has received $8.25 million.  TRS’ right
to receive the Installment Payment is secured by all of the outstanding
membership units of Consolidated Mortgage.   For the three month
period ending March 31, 2008, we recognized income of $131,503 related to the
contingent installment payment.





10
 Table of Contents


We also
entered into a loan origination agreement with Consolidated Mortgage and
Sandstone, which terminates one month after the last day of the month in which
the Installment Payment is paid in full.   During the term of the
Loan Origination Agreement we will have the right to fund all mortgage loans
identified by Consolidated Mortgage or any affiliate of Sandstone or
Consolidated Mortgage that becomes engaged in the business of originating or
brokering commercial loans. During the quarter ended March 31, 2008, we funded
$13.2 million of loans originated by Consolidated Mortgage.





We lease
office space to Sandstone, CMCFS, Consolidated Mortgage, and Residential Capital
Mortgage under noncancelable operating leases which expire in July
2010.  We recognized $129,362 and $80,371 rental income during the
quarters ended March 31, 2008 and 2007, respectively.  Rental income
for 2008 included $53,557 paid by Consolidated Mortgage.





Note
7 – Other Investments





As of
March 31, 2008 and December 31, 2007 we had $1,928,000 in investments in other
investments.  Those investments consisted of the
following;





●
            In
      March 2007, we invested $1,000,000, representing equity and profits
      interest of 1.5%, in the development of a resort community near Lincoln
      City, Oregon.  This investment is being accounted for under the
      cost method.●
            In
      June 2006, we invested $928,000 for 100% of the common shares of an
      affiliate entity which was formed to facilitate the issuance of
      $30,928,000 of junior subordinate notes. This entity pays dividends on
      both the common shares and preferred securities on a quarterly basis at a
      variable rate based on LIBOR.





Note
8 - Stock Based Compensation





Our Board
of Directors has adopted the 2004 Stock Incentive Plan of Desert Capital REIT,
Inc. (the “Plan”). Our directors, officers or any affiliate, and individual
consultants or advisors are eligible for stock based compensation under the
Plan. We have authorized 1,000,000 shares of common stock under the Plan. As
of March 31, 2007 we had granted awards for 60,000 restricted shares under
the Plan. The fair value of the shares on the grant dates were $10 and $15 per
share, and the shares vest in three equal annual installments, commencing on the
first anniversary of issuance. Restricted stock expense for the three months
ended March 31, 2008 and 2007 was $0 and $58,333 respectively.





Note
9 - Building and Equipment





Building
and equipment as of March 31, 2008 and December 31, 2007 are as
follows:





March
      31, 2008
            
            
            December
      31, 2007Building
            
            $
            7,811,281
            
            
            $
            7,746,325Equipment
            
            
            7,527
            
            
            
            7,527Furniture
      and fixtures
            
            
            411,328
            
            
            
            411,328Software
            
            
            92,038
            
            
            
            92,0388,322,174
            
            
            
            8,257,218Less
      accumulated depreciation
            
            
            (1,141,002
            )
            
            
            (1,021,279
            )$
            7,181,172
            
            
            $
            7,235,939






We
own an office building in Henderson, NV, which serves as our corporate
headquarters. The total square footage of the building is approximately 40,000
square feet, and as of March 31, 2008, the building was 100% leased to related
(62.5%) and third parties (37.5%) under noncancelable leases, which expire in
2010.  See Note 6 – Commitments and Related Parties.





Note
10 - Income taxes





We
elected to be taxed as a REIT, under Sections 856 through 860 of the Internal
Revenue Code, beginning with our taxable year ended December 31, 2004. To
qualify as a REIT, we must meet certain organizational and operational
requirements, including a requirement to distribute at least 90% of our ordinary
taxable income to stockholders. As a REIT, we generally are not subject to
federal income tax on taxable income that we distribute to our stockholders. If
we failed to qualify as a REIT in any taxable year, we would then be subject to
federal income taxes on our taxable income at regular corporate rates and we
would not be permitted to qualify for treatment as a REIT for federal income tax
purposes for four years following the year during which qualification was lost
unless the Internal Revenue Service granted us relief under certain statutory
provisions. Such an event could materially adversely affect our net income and
net cash available for distributions to stockholders. However, we intend to
continue to operate in the foreseeable future in such a manner so that we will
qualify as a REIT for federal income tax purposes.




11
 Table of Contents


Our
taxable REIT subsidiary  is subject to federal, state, and local taxes. For
the three months ended March 31, 2008, and 2007 we recorded a tax benefit of
($43,104) and an income tax expense of $70,177 respectively, attributable to our
taxable REIT subsidiary. For the three months ended March 31, 2008 our provision
for income tax benefit was comprised of a current benefit of ($27,430) and a
deferred benefit of ($15,674), using an effective tax rate of 34%. For the three
months ended March 31, 2007, we recorded $70,177 of income tax expense for
income attributable to our taxable REIT subsidiary comprised of a current
provision of $0 and a deferred provision of $70,177, using an effective tax rate
of 34%.





Note
11 - Earnings per Share





Earnings
per share is computed in accordance with SFAS No. 128, Earnings per Share. Basic
earnings per share is calculated by dividing net income by the weighted average
number of shares of common stock outstanding during each period. Diluted
earnings per share is calculated by dividing net income by the weighted average
number of shares outstanding plus the additional dilutive effect of unvested
restricted stock during each period.  As of March 31, 2008, there were
no unvested shares outstanding under our stock incentive plan. As of March 31,
2007 there were 26,667 unvested shares outstanding under our stock incentive
plan.





The
following is a reconciliation of the denominator of the basic and diluted
earnings per share computations for the three months ended March 31, 2008 and
2007.








For
      the Three Months EndedMarch 31, 2008
            
            
            March
      31, 2007Basic and
      Diluted
            
            
            Basic
            
            
            DilutedNet
      income
            
            $
            805,896
            
            
            $
            3,946,352
            
            
            $
            3,946,352Weighted
      average number of common shares outstanding
            
            
            16,782,728
            
            
            
            15,311,504
            
            
            
            15,311,504Dilutive
      effect of unvested restricted shares
            
            
            -
            
            
            
            -
            
            
            
            33,352Total weighted
      average common shares outstanding
            
            
            16,782,728
            
            
            
            15,311,504
            
            
            
            15,344,856Earnings per
      common share
            
            $
            0.05
            
            
            $
            0.26
            
            
            $
            0.26






Note
12 – Common Stock and Dividends





Our Board
of Directors declares dividends payable monthly to stockholders of record at the
close of business on the last day of each month, prorated to the date admitted
as a stockholder. The following table lists the declaration dates and per share
amounts for the first three months of 2008 and 2007:




2008
            
            
            2007January
      31
            
            $
            0.100
            
            
            $
            0.100February
      29, and February 28 respectively
            
            
            0.025
            
            
            
            0.100March
      31
            
            
            0.025
            
            
            
            0.100Total
            
            $
            0.150
            
            
            $
            0.300




Our Board
of Directors suspended the sale of Desert Capital REIT shares as of February 22,
2008. This decision was made in anticipation of the expiration of the offering,
which would not allow sales of shares to occur after March 22, 2008 per the
Prospectus.  The suspension and ultimate expiration of the sale of
Desert Capital REIT shares also suspends our dividend reinvestment program,
which allowed shareholders to purchase additional shares with their dividend
proceeds.





12
 Table of Contents


Note
13 - Debt





Credit
Facility


We have a
$7.5 million secured revolving credit facility with a term of one year
that expires February 22, 2009.  At March 31, 2008 and December
31, 2007, we had $4.7 million and $2.1 million outstanding, respectively. We
draw on the facility for short-term funding requirements. Amounts drawn under
this facility bear interest at an interest rate equal to the prime rate plus 75
basis points, with a floor of 7.00%, and must be repaid within 90
days.  Amounts drawn under this facility are secured by the
corresponding loan that is being funded by the advance. The interest rate on
this facility at March 31, 2008 was 7.00%. The principal amount of loans pledged
as collateral for this facility on March 31, 2008 was $19.1 million. Subsequent
to March 31, 2008, the $4.7 million drawn under this facility was
not repaid within the required 90-day period pursuant to the terms of the
facility.  We have requested and the lender
has verbally agreed to extend the maturity date for the advances
outstanding under the facility.





Mortgage
Loans Payable


We have a
mortgage loan payable to a bank, with an outstanding principal balance of $6.4
million and $6.5 million as of March 31, 2008 and December 31, 2007,
respectively.  This loan bears interest at a rate equal to the prime
rate, with a floor of 6.75%. Principal and interest are payable monthly and the
note matures in 2026, with no prepayment penalty. The interest rate on March 31,
2008 and 2007 was 6.75% and 7.25%, respectively. The mortgage is secured by our
office building in Henderson, Nevada. We were in compliance with all
financial covenants related to this loan as of March 31, 2008.





We
assumed a first lien mortgage payable to a bank upon foreclosure of a 10,330
square foot office building in Houston, Texas in November 2007 to preserve our
interest in the property. At March 31, 2008 and December 31, 2007, the loan had
an outstanding principal balance of $1.7 million and bears interest equal to the
prime rate minus 50 basis points (4.75% at March 31, 2008), and matures in
April 2011, with no prepayment penalty.  Principal and interest are
payable monthly.  We were in compliance with all financial covenants
related to this loan as of March 31, 2008.





Junior
Subordinated Notes


In June,
2006 we completed the issuance of $30 million in unsecured trust preferred
securities through a newly formed Delaware statutory trust, Desert Capital
TRS Statutory Trust I, which is our wholly owned subsidiary.  The
securities bear interest at a floating rate based on the three-month LIBOR plus
400 basis points, which sets for three months at one month after a calendar
quarter, which was 7.25% on March 31, 2008.




The trust
preferred securities require quarterly interest distributions. The trust
preferred securities mature in July 2036 and are redeemable, at our option, in
whole or in part, with no prepayment premium any time after July 30,
2011.




Desert
Capital TRS Statutory Trust I issued $928,000 aggregate liquidation amount of
common securities, representing 100% of the voting common stock of Desert
Capital TRS Statutory Trust I to us. Desert Capital TRS Statutory Trust I used
the proceeds from the sale of the trust preferred securities and the common
securities to purchase our junior subordinated notes.  The terms of the
junior subordinated notes match the terms of the trust preferred
securities.  The notes are subordinate and junior in right of payment to
all present and future senior indebtedness and certain other of our financial
obligations.




Our
interest in Desert Capital TRS Statutory Trust I is accounted for using the
equity method and the assets and liabilities of Desert Capital TRS Statutory
Trust I are not consolidated into our financial statements.  Interest on
the junior subordinated notes is included in interest expense on our
consolidated income statements while the junior subordinated notes are presented
as a separate item in our consolidated balance sheet.





Our
covenants contain customary default provisions and require us to maintain
financial ratios at quarterly determination dates, including a minimum tangible
net worth requirement.  Our ability to incur additional subordinated
debt is also limited.  At March 31, 2008, we had entered into an
agreement with our lender to modify the tangible net worth covenant contained in
our indenture through December 31, 2008 so that we would be in compliance with
the covenant.




Note 14 - Fair Value of Financial
Instruments





SFAS No.
107 requires disclosure of the estimated fair value of an entity’s assets and
liabilities considered to be financial instruments. Effective January 1, 2008,
SFAS No. 157 defines fair value, expands disclosure requirements around fair
value and specifies a hierarchy of valuation techniques based on whether the
inputs to those valuation techniques are observable or
unobservable.  Observable inputs reflect market data obtained from
independent sources, while unobservable inputs reflect the Company’s market
assumptions.  These two types of inputs create the following fair
value hierarchy:





●
            Level
      1 – Quoted prices for identical instruments
      in active markets.


●
            Level
      2 – Quoted prices for similar instruments in
      active markets; quoted prices for identical or similar instruments in
      markets that are not active; model –derived valuations in which all
      significant inputs and significant value drivers are observable in active
      markets.


●
            Level
      3 – Valuations derived from valuation techniques in which one or more
      significant inputs or significant value drivers are
      unobservable.





13
 Table of Contents


This
hierarchy requires us to use observable market data, when available, and to
minimize the use of unobservable inputs when determining fair
value.  Under SFAS No. 157, we are required to take into account our
own credit risk when measuring the fair value of our
liabilities.  Fair value is best determined based upon quoted market
prices. However, in many instances there are no quoted market prices for various
financial instruments. In cases where quoted market prices are not available,
fair values are based on estimates using present value or other valuation
techniques. Those techniques are significantly affected by the assumptions used,
including the discount rate, estimates of future cash flows and realization of
collateral. Accordingly, the fair value estimates may not be realized in an
immediate settlement of the instrument. SFAS No. 107 excludes certain
financial instruments and all nonfinancial instruments from its disclosure
requirements. Accordingly, the aggregate fair value amounts presented may not
necessarily represent the underlying economic value.





Fair
Value under SFAS No. 157, is applied prospectively effective January 1, 2008;
therefore, the fair value of December 31, 2007 was computed under the guidance
of SFAS 107.





The
following table summarizes the carrying values and the estimated fair values of
financial instruments as of March 31, 2008 and December 31, 2007.






March
      31, 2008
            
            
            December
      31, 2007Carrying
      Value
            
            
            Estimated Fair
      Value
            
            
            Carrying
      Value
            
            
            Estimated Fair
      ValueFinancial
      assets:Cash and cash
      equivalents
            
            $
            655,786
            
            
            $
            655,786
            
            
            $
            162,753
            
            
            $
            162,753Interest
      receivable
            
            
            1,416,836
            
            
            
            1,415,397
            
            
            
            1,464,261
            
            
            
            1,464,261Note
      receivable - related party
            
            
            15,500,000
            
            
            
            12,733,357
            
            
            
            15,500,000
            
            
            
            13,718,381Mortgage
      investments - net
            
            
            102,078,236
            
            
            
            101,919,584
            
            
            
            118,017,926
            
            
            
            118,017,926Loans
      held-for-sale
            
            
            4,706,800
            
            
            
            4,694,115
            
            
            
            2,139,200
            
            
            
            2,139,200Financial
      liabilities:Credit
      facility
            
            
            4,706,800
            
            
            
            4,703,272
            
            
            
            2,139,200
            
            
            
            2,139,200Mortgages
      payable
            
            
            8,095,127
            
            
            
            8,095,123
            
            
            
            8,132,769
            
            
            
            8,132,769Junior
      subordinated notes
            
            
            30,928,000
            
            
            
            19,805,281
            
            
            
            30,928,000
            
            
            
            30,928,000






We used
the following methods and assumptions in estimating the fair value of each class
of financial instrument:




●
            Cash and cash
      equivalents: The carrying values of cash and short-term
      instruments approximate fair
values.


●
            Interest
      receivable: Carrying values adjusted for a risk free discount
      fact.


●
            Note receivable –
      related party:Fair value is estimated using discounted cash flow
      analyses of a risk free rate of return for a similar period, the fixed
      amount of the note receivable and an estimated risk of default based on
      similar business operations and history of
  operations.


●
            Mortgage
      investments-net: At March 31, 2008 the fair value was computed
      based on the probability of collection of the cash flow, a risk free rate
      of return on all estimated cash flows, the estimated realization of
      collateral, based on recent history and the fixed interest rate of the
      loans.  For December 31, 2007, the carrying value of these
      instruments, net of the allowance for loan losses, approximates the fair
      value due to their short-term maturities. Fair values for loans which are
      delinquent and /or in foreclosure are determined by the underlying
      collateral security the loans.


●
            Loans
      held-for-sale: The carrying value of these instruments approximates
      the fair value due to their short-term maturities, except for a risk free
      rate of return computed for March 31,
2008


●
            Credit
      facility: For March 31, 2008 our credit standing was taken
      into consideration, as well as the excess assigned collateral, and a risk
      free rate of return.  For December 31, 2007, carrying values
      approximate fair values due the variable interest rate this facility
      bears.


●
            Mortgage loan
      payable: For March 31, 2008 our credit standing was taken into
      consideration, the assigned collateral was considered more than adequate
      and estimated risk to the lender of the collateral to the loan balance as
      well as a risk free rate of return were all factors in the computation of
      fair value.  For December 31, 2007, carrying values approximate
      fair values due the variable interest rate this facility
      bears.


●
            Junior subordinated
      notes: For March 31, 2008 our credit standing was taken into
      consideration against other like investment instruments, against a risk
      free rate of return for a twenty-eight year period and potential of
      available remaining collateral, as well as the potential for default. Two
      different methods were used and averaged to estimate the value; 1) based
      on default probability 2) based on the additional credit risk spread for
      an adjustable security in a different credit position from the initiation
      of the loan. For December 31, 2007, carrying values approximate fair
      values due the variable interest rate this facility
  bears.





14
 Table of Contents


Items Measured at Fair Value on a
Recurring Basis





The
following table presents our assets and liabilities that are measured at fair
value for each of the fair-value hierarchy levels on a recurring basis at March
31, 2008.  Level 1 data was not used in the fair value
measure.  (See previous summary)








Estimated
      Fair Value
            
            
            Level
      2
            
            
            Level
      3Financial
      Assets:Interest
      receivable
            
            $
            1,415,397
            
            
            $
            1,415,397
            
            
            $
            -Note
      receivable – related party
            
            
            12,733,357
            
            
            
            -
            
            
            
            12,733,357Mortgage
      investments – net
            
            
            101,919,584
            
            
            
            -
            
            
            
            101,919,584Loans
      held-for-sale
            
            
            4,694,115
            
            
            
            4,694,115
            
            
            
            -Financial
      LiabilitiesCredit
      facility
            
            
            4,703,272
            
            
            
            4,703,272
            
            
            
            -Mortgages
      payable
            
            
            8,095,123
            
            
            
            8,095,123
            
            
            
            -Junior
      subordinated notes
            
            
            19,805,281
            
            
            
            -
            
            
            
            19,805,281








ITEM 2.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS.




Overview





Desert
Capital REIT, Inc. and its subsidiaries (“Desert Capital,” “we,” “us,” ”our” and
“company”) is a Maryland corporation formed in December 2003 as a real estate
investment trust (“REIT”) that specializes in the financing of real estate
projects by providing short-term mortgage loans to homebuilders and commercial
developers in markets where we believe we possess requisite skills and market
knowledge. We generally invest in 12- to 18-month, first and second lien
mortgage loans, consisting of acquisition, development and construction loans to
both local and national developers and homebuilders. We derive our revenues
primarily from interest payments received from mortgage investments funded with
our equity capital and borrowed funds. Our principal business objective is to
generate net income for distribution to our stockholders from the spread between
interest income on our mortgage assets and the costs of financing the
acquisition of these assets. This spread, net of operating expenses, provides
both operating capital and distributable income. The growth of our business
depends on our access to external sources of capital. Our profitability depends
on our ability to obtain that capital at a cost we can absorb while still
generating an attractive risk-adjusted return on the loans we acquire using the
proceeds of our financings. Our business also depends on our ability to locate
suitable investments to keep our capital fully deployed at favorable rates. We
are externally managed and advised by Sandstone Equity Investors, LLC,
(“Sandstone” or “Advisor”) a related party. Officers and majority owners of
Sandstone are also our executive officers.  See Note 6 – Commitment
and Related Parties of the Notes to the Consolidated Financial
Statements.





Our
operating results are affected primarily by: (i) real estate market volatility,
(ii) our level of nonperforming assets, foreclosures and related loan
losses, (iii) our ability to maintain a spread on interest income on loans and
borrowed funds, and (iv) our ability to continually identify suitable borrowers
with attractive real estate projects.





Recent
Developments and Trends





The
effects of the slowdown in housing sales, collapse of the sub-prime residential
mortgage market, and the tightening of the credit markets in 2007 continue to
constrain the performance of our portfolio. During 2007, we experienced
significant loan losses and impairments. However, we have begun to see some
stabilization in the market in the first quarter of 2008, and we believe that
the market will continue to improve and present investment
opportunities.





For the
quarter ended March 31, 2008, our net income was $0.8 million compared to
approximately $3.9 million for the quarter ended March 31, 2007. Our net income
has decreased due to the following circumstances:





●
            the
      current market conditions that resulted in an increase in nonperforming
      loans and a decrease in interest
income;


●
            the
      operations related to Consolidated Mortgage’s loan origination and
      servicing activities were included in our results of operations for the
      quarter ended March 31, 2007, but not for the quarter ended March 31, 2008
      because we sold Consolidated Mortgage  in November 2007;
      and


●
            provisions
      for loan losses increased to $310,988 for the three months ended March 31,
      2008 as compared to  $104,402 for the three months ended March
      31, 2007 .





Although
the real estate and credit market disruptions have presented challenges for us,
we have an operational structure with relatively low debt obligations. We
believe our strong debt to capital ratio of 27% as of March 31, 2008 will
provide us with the necessary resources to carry us through this challenging
real estate market.  We will continue to explore additional investment
and business opportunities as they arise; however, due to the current credit
market disruption, our investment opportunities may be limited. Management
expects that the current difficult real estate and credit market conditions will
continue to have an adverse effect on our operations in
2008.





15
 Table of Contents


Loan
Portfolio Information





As of
March 31, 2008 we had 22 performing loans in our portfolio.  The
aggregate balance of these loans was approximately $111.0 million of which our
portion was approximately $67.7 million, and the remaining balance was held by
private investors. We provided an allowance for loan loss related to these
performing loans of approximately $4.0 million, leaving a net carrying balance
of $63.7 million at March 31, 2008. Our balance on these loans ranged from
$20,000 to $14.4 million. Of the 22 loans, 16 were first lien loans totaling
$56.2 million and 6 were second lien loans totaling $11.5
million.





The
increase in nonperforming loans continues to impact our revenues due to the
default in interest payments and our provision for loan losses due to the
impairment of our loans. As of March 31, 2008 we had 58 loans in our portfolio
from seven separate borrowers that were placed on nonaccrual
status.  The aggregate balance of these loans was approximately $91.8
million of which our portion was approximately $59.2 million, and the remaining
balance was held by private investors. We provided an allowance for loan loss
related to these nonperforming loans of $20.8 million, leaving a net
carrying balance of approximately $38.4 million at March 31, 2008. Our balance
on these loans ranged from $2,800 to $11.0 million.  Of the 58 loans, 44
were first lien loans totaling $50.8 million and 14 were second lien loans
totaling $8.4 million.  Approximately $59.2 million of these
loans had been placed on nonaccrual of interest status and were the subject of
pending foreclosure proceedings.





As of
March 31, 2008 and December 31, 2007, approximately 16% and 22%, respectively,
of the principal balance of the outstanding mortgage notes were secured by
second liens. As of March 31, 2008 and December 31, 2007, the portfolio had a
weighted average interest rate of 12.95% and 13.37% respectively. Our
mortgage portfolio is primarily concentrated in the Southwestern United States.
As of March 31, 2008 and December 31, 2007, 86% and 87%, respectively, of the
principal balance of our portfolio was invested throughout Nevada, California,
and Arizona. Our borrowers’ ability to repay our notes is dependent upon the
real estate and general economic conditions in this area.





We intend
to minimize potential losses of our impaired loans and achieve the greatest
capital realization with respect to each nonperforming loan. We have continued
to implement the following resolution strategies with respect to our
nonperforming loans that we began in 2007:





●
            Cash Sale of the
      Underlying Collateral – If we determine through a thorough review
      process that it is advantageous to sell the property that secures a
      nonperforming loan at a loss rather than to continue to hold the property
      and incur additional costs, we may sell the property for
    cash.●
            New Borrower Assumption
      –If we can identify new qualified borrowers to assume the initial loan
      amount, we will convert the nonperforming loan into a performing
      loan.




●
            Equity Investments in
      Real Estate–We may contribute real estate assets to an operating joint venture
      usually structured as a limited liability company (“LLC”) with other
      private investors in a loan or with a new investor to provide additional
      financing and development expertise to complete the
      project.  Once the project is completed and sold, we will
      distribute the sales proceeds according to the LLC agreement. This
      strategy may significantly reduce our ownership in the
      property.●
            “Mothballing” or Holding
      the Property – If we are unable to implement any of the strategies
      discussed above, or if we determine that it may be advantageous to hold
      the property based upon local real estate market conditions, we will hold
      the property for an undetermined period of time directly or through LLCs.
      This is a temporary strategy, which at the appropriate time will be
      replaced with one of the other options. In most instances, we do not
      intend to become long-term property
  owners.







Real
Estate Owned





Real
estate owned consists of property acquired through foreclosures on mortgage
loans.  Our interests in real estate owned may be held directly by the
Company, or through limited liability companies.  In the case where
the Company is one of several investors in a larger loan, such loans are
foreclosed upon using a limited liability company to facilitate foreclosing our
lender interest along with private investors who hold the remaining loan balance
and have similar economic interests.   At March 31, 2008, we held
real estate through seven limited liability companies with other private
investors, and our ownership percentage ranged from 12.4% to 39.7%. We recorded
real estate held directly or through limited liability companies at the lower of
the recorded amount of our related mortgage loan being foreclosed (net of any
impairment reserve), or our economic interest in the property's estimated fair
value, less estimated costs to sell, with fair value based on appraisals and
local market conditions and inclusive of any senior indebtedness,





At March
31, 2008 and December 31, 2007, we had a carrying balance in real estate owned
of approximately $27.1 million and $15.7 million, respectively. We did not have
any real estate owned as of March 31, 2007. The real estate owned consists of
77% undeveloped land, 12% single family residential lots, 8% existing commercial
buildings, and 3% other.





During
the quarter ended March 31, 2008, we foreclosed on properties with an aggregate
original loan balance of approximately $14.2 million, net of related allowance
for loan loss of $600,950, and additional capitalized costs of
$266,715.  We did not dispose of any real estate owned through sale
during the three month period ending March 31, 2008. During March 2008 we
contributed 44 lots valued at $2.5 million to a joint venture in which we have a
50% noncontrolling ownership interest.





16
 Table of Contents


Equity
Investments in Real Estate





In order
to minimize potential losses and facilitate our resolution strategy with respect
to nonperforming loans, we have contributed real estate assets acquired through
foreclosure to operating joint ventures with investors/developers who provide
additional financing and development expertise.




In March
2008, we formed a joint venture with a homebuilder for the construction of 44
single family homes in Las Vegas, Nevada. We contributed 44 lots to the joint
venture, which we previously acquired through foreclosure and classified as Real
Estate Owned. After the date of formation, this venture was accounted for under
the equity method of accounting since we had a 50% noncontrolling ownership
interest at March 31, 2008. Our venture partner manages the operations of the
joint venture. All major decisions require the approval of both joint venturers,
and voting rights and the sharing of profits and losses are in proportion to the
ownership percentages of each joint venturer. We recorded our initial investment
at $2,462,895, the carrying value of the lots, and we will record our net equity
in income and cash contributions and distributions.  There were no
reportable operations for the period ending March 31, 2008.  We have
no responsibility to provide additional funding to the venture. Additional
funding for the construction of homes and sales of such will be provided by our
venture partner.  Our share of losses, if any, would be limited to the
value of lots contributed of approximately $2.5 million.





Sale
of Consolidated Mortgage





In
November 2007 we sold Consolidated Mortgage to Sandstone, a related
party.  Our subsidiary, Desert Capital TRS, Inc. (“TRS”) sold all of
the issued and outstanding units of Consolidated Mortgage to Sandstone, for
consideration of the following:





●
            293,001
      of our common stock with a value of $4.395 million based on the last
      offering of its common stock at a per share price of $15 per
      share.  We subsequently retired the 293,001 shares of
      stock.


●
            $104,985
      in cash.●
            A
      $15.5 million promissory note payable by Consolidated Mortgage to the
      order of TRS The note bears interest at 9.0% per
      annum.  Principal and interest payments are due quarterly
      beginning on March 31, 2008.  The note matures in December
      2017.  The note is secured by all of the outstanding membership
      units of Consolidated Mortgage.   We earned interest of
      $352,625 for the three months ended March 31,
  2008.







In
addition to the consideration received, we will receive a contingent
installment payment from Consolidated Mortgage on loans we fund in the future.
The $8.25 million contingent payment is payable (the “Installment
Payment”) as follows:  Sandstone will pay or cause Consolidated
Mortgage to pay to TRS, on the last day of each calendar quarter, an amount
equal to: (i) 1% of the principal amount of all mortgage loans originated or
brokered by Consolidated Mortgage or any of its affiliates and funded by us
during such calendar quarter for the first $200 million of mortgage loans funded
during each calendar year; and (ii) 0.5% of the principal amount of all mortgage
loans originated or brokered by Consolidated Mortgage and funded by us during
such calendar quarter in excess of $200 million during each calendar year,
commencing on December 31, 2007 and continuing on the last day of each calendar
quarter thereafter, until TRS has received $8.25 million.  TRS’ right
to receive the Installment Payment is secured by all of the outstanding
membership units of Consolidated Mortgage.   For the three month
period ending March 31, 2008, we recognized income of $131,503 related to the
contingent installment payment.





We also
entered into a loan origination agreement with Consolidated Mortgage and
Sandstone, which terminates one month after the last day of the month in which
the Installment Payment is paid in full.   During the term of the
Loan Origination Agreement, we will have the right to fund all mortgage loans
identified by Consolidated Mortgage or any affiliate of Sandstone or
Consolidated Mortgage that becomes engaged in the business of originating or
brokering commercial loans. During the quarter ended March 31, 2008, we funded
$13.2 million of loans originated by Consolidated Mortgage.





Included
in our Consolidated Statement of Operations for the three month period ending
March 31, 2007 is $0.5 million of net interest income, $2.0 million of
non-interest income, $1.5 non-interest expense and $1.0 million of net income
before taxes related to the operations of Consolidated Mortgage, which are not
presented as discontinued operations, because Consolidated Mortgage continues to
originate and service loans for us, and we share certain members of our
management team in common.





Results
of Operations for the three months ended March 31, 2008 compared to the three
months ended March 31, 2007





Revenues




Interest
income is generated on our mortgage investments and loans held for sale.
Interest income decreased $2.9 million, or 52 %, to $2.8 million for the quarter
ended March 31, 2008 from $5.7 million for the quarter ended March 31, 2007. Our
balance of nonperforming loans increased to $59.2 million as of March 31, 2008
from $0 as of March 31, 2007. The increased balance of nonperforming loans
lowered the average yield on the total portfolio to 6.5 % in the first quarter
of 2008 from 13.1% in the first quarter of 2007.




17
 Table of Contents


Non-interest
income decreased $1.8 million, or 83%, to $0.4 million for the quarter ended
March 31, 2008 from $2.2 million for the quarter ended March 31, 2007 primarily
due to the sale of Consolidated Mortgage in November 2007. During the quarter
ended March 31, 2007, we recognized loan brokerage fees and servicing fees of
$2.0 million related to the activities of Consolidated Mortgage, which are not
presented as discontinued operations, because Consolidated Mortgage continues to
originate and service loans for us, and we share certain members of our
management team in common.





Expenses




Interest
expense consists of interest on our mortgage loans, credit facility, and junior
subordinated notes payable. Interest expense decreased 16%, to $0.8 million
during the first quarter of 2008 from $1.0 million for the first quarter of
2007. This decrease was a result of a decrease in the average interest rate on
our variable rate debt to 7.7% in the first quarter of 2008, from 8.8% in the
first quarter of 2007.  The average outstanding debt during the first
quarter of 2008 also decreased by approximately $700,000 or 2% compared to the
average outstanding debt for the first quarter of 2007, $43.9
million.





The
provision for loan losses was $0.3 million for the quarter ended March 31, 2008
compared to $0.1 million for the quarter ended March 31, 2007.  The
increase in the provision was due to a decline in the real estate and credit
markets, causing the collateral securing our loans to decrease in
value.





Non-interest
expense decreased $1.6 million or 56%, to $1.2 million for the first quarter of
2008 compared to $2.8 million for the first quarter last year. This decrease is
almost entirely attributable to the sale of Consolidated Mortgage and the
expenses associated with its operations which were included in the first quarter
of 2007.  There was also a decrease in the second-tier compensation
paid to the Advisor due to the decrease in portfolio performance.





Taxable Income





REIT
taxable net income is calculated according to the requirements of the Internal
Revenue Code, rather than generally accepted accounting principles (GAAP). The
following table reconciles GAAP net income (loss) to REIT taxable net income
(loss) for the three months ended March 31, 2008 and 2007:




Three
      Months EndedMarch
      31, 2008
            
            
            March
      31, 2007GAAP
      net income (loss)
            
            $
            805,896
            
            
            $
            3,946,352Adjustments
      to GAAP net income (loss):Provision
      for loan losses
            
            
            310,988
            
            
            
            104,402Impairment
      of real estate
            
            
            1,057
            
            
            
            -Actual
      loss on sale of loan
            
            
            (299,965
            )
            
            
            -Net
      adjustment for TRS income
            
            
            60,157
            
            
            
            121,790REIT
      taxable net income (loss)
            
            $
            878,133
            
            
            $
            4,172,544





Our
income (loss) calculated for tax purposes differs from income (loss) calculated
in accordance with GAAP primarily because the financial statements of the REIT
and its taxable REIT subsidiaries are consolidated for GAAP purposes while they
are not consolidated for tax purposes. The distinction between taxable income
and GAAP income is important to our stockholders because distributions are
declared on the basis of REIT taxable income. While we generally will not
be required to pay income taxes on our REIT taxable income as long as we satisfy
the REIT provisions of  the Internal Revenue Code, each year we will
be required to complete a U.S. federal income tax return wherein taxable income
is calculated. This taxable income level will determine the minimum level of
distribution we must pay to our stockholders. There are limitations associated
with REIT taxable net income. For example, this measure does not reflect net
capital losses during the period and, thus, by itself is an incomplete measure
of our financial performance over any period. As a result, our REIT taxable net
income should be considered in addition to, and not as a substitute for, our
GAAP-based net income as a measure of our financial performance.





Liquidity and Capital
Resources:




We
believe that our principal sources of working capital and funds for additional
investments will primarily include: cash flow from operations; borrowings under
our credit facilities and, to a lesser extent, the proceeds from principal
payments on our investments.  We believe these sources of financing will be
sufficient to meet our short-term liquidity needs. We believe our strong debt to
capital ratio of 27% as of March 31, 2008 will provide us with the necessary
resources to carry us through this challenging real estate market.  We
expect cash flows from operating activities to increase as the market conditions
improve and we are able to implement our resolution strategy on real estate
investment owned properties to generate additional revenue.





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Cash
Flows





Net cash
used in operating activities for the three months ended March 31, 2008, was
approximately ($1.5) million compared to approximately $4.2 million provided by
operating activities for the quarter ended March 31, 2007. The decrease in net
cash flow from operating activities is due to a decrease in net income and the
net activity in mortgage loans originated for sale and mortgage loans
sales.





Net cash
provided by investing activities for the three months ended March 31, 2008, was
approximately $2.0 million compared to approximately ($10.5) million of cash
used in investing activities for the quarter ended March 31,
2007.  The increase in net cash flow from investing activities was a
result of a decrease in the amount of investments in real estate
mortgages.  We expect cash flows from investing activities to continue
to decrease as outstanding loans are paid off and that money is reinvested into
new investments in real estate mortgages.





Net cash
used in financing activities for the three months ended March 31, 2008, was
($23,625) compared to approximately $5.2 million of cash provided by financing
activities for the quarter ended March 31, 2007.  The decrease in cash
flow from financing activities is primarily a result of the decrease in the
issuance of common stock during the first quarter of 2008 compared to the first
quarter of 2007.  We do not expect cash flow from financing activities
to increase significantly due to the suspension and expiration of the offering
of shares of our common stock during the first quarter of 2008, and we are
currently not pursuing additional debt financing.





Since we
rely primarily upon repayment of outstanding loans to provide capital, the
significant level of defaults on our outstanding loans has reduced the funds we
have available for investing in new loans.  Additional defaults on our
outstanding loans could further reduce the funds we have available for
investing in new loans. Extended foreclosure proceedings may also result in
significant delays in the return of invested funds. These circumstances
have reduced and may further reduce our capital resources and impair our ability
to invest in new loans. Nonperforming mortgage loans and real estate assets as
of March 31, 2008, had a carrying balance of approximately $38.4 and $29.5
million respectively, net of reserves of approximately $20.8 million and $12.0
million respectively. We also had performing loans as of March 31,
2008 with a carrying balance of $63.7 million net of reserves of $4.0
million.





It is
likely that nonperforming and real estate assets will produce minimal, if any,
current earnings until they are sold or an alternative resolution option becomes
available. The disposition of these assets cannot be predicted; however our
Advisor believes that over time the proceeds generated from the resolution of
these nonperforming and real estate assets will provide capital for reinvestment
into performing assets or reduction in outstanding debt as deemed appropriate by
our Advisor. Because of the estimated value of the underlying properties, we do
not currently believe that any losses beyond those we have already recognized
will be incurred upon final disposition of these assets.  However, the
amount of further losses, if any, on any individual assets or on the portfolio
as a whole may vary. These estimates are based upon a thorough evaluation
by our Advisor for collectability based on prevailing economic conditions,
historical experience, unique characteristics of the loan, borrowers’ financial
condition, industry trend and an estimated net realizable value of any
underlying collateral in relation to the real estate loan amount.





Our
operating costs are relatively low.  We have no employees, a
relatively low debt level, low overhead costs and low net carrying costs
associated with our assets.  Our operating revenues are used primarily
to pay our operating expenses and make distributions to our
stockholders.  In order to continue to qualify as a REIT and to avoid
corporate-level tax on the income we distribute to our stockholders, we are
required to distribute at least 90% of our REIT taxable income on an annual
basis. In general, our liquidity requirements consist of new loan fundings,
operating expenses, and principal and interest payment obligations on our
debt.  Since we are not currently publicly offering our equity
securities for sale, we will utilize principal and interest collections on
existing mortgage loan investments, proceeds from the sale of foreclosed assets,
proceeds from the disposition of nonperforming loans, and borrowings under our
revolving credit facility as our primary sources of funds to invest in new
loans, pay operating expenses, service our debt, and pay dividends to our
stockholders as available.





We
believe that we will be able to obtain financing in amounts and on terms that
are acceptable to us and consistent with our business strategy. We believe that
these cash resources are sufficient to satisfy our immediate liquidity
requirements, and we do not anticipate a need to raise funds from other than
these sources within the next 12 months.  We believe we have
sufficient financial resources to continue our operations into the foreseeable
future.  However, given the current market conditions, there can be no
assurance that we will be able to continue to generate funds through these
sources.  A reduction in the availability of the above sources of
funds could have a material adverse effect on our financial condition and
results of operations.





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Contractual
Obligations:





The
following table sets forth information about certain of our contractual
obligations as of March 31, 2008:


Payments
      due by PeriodTotal
            
            
            Less
      than 1 year
            
            
            1 –
      3 years
            
            
            3 –
      5 years
            
            
            More
      than 5 yearsLong-Term
      Debt ObligationsJunior
      subordinated notes
            
            $
            30,928,000
            
            
            $
            -
            
            
            $
            -
            
            
            $
            -
            
            
            $
            30,928,000Mortgages
            
            
            8,095,127
            
            
            
            197,103
            
            
            
            2,192,822
            
            
            
            727,534
            
            
            
            4,977,668Short-Term
      Obligations
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            -
            
            
            
            -Line
      of Credit
            
            $
            4,706,800
            
            
            $
            4,706,800
            
            
            $
            -
            
            
            $
            -
            
            
            $
            -





Credit
Facility


We have a
$7.5 million secured revolving credit facility with a term of one year
that expires February 22, 2009.  At March 31, 2008 and December
31, 2007, we had $4.7 million and $2.1 million outstanding, respectively. We
draw on the facility for short-term funding requirements. Amounts drawn under
this facility bear interest at an interest rate equal to the prime rate plus 75
basis points, with a floor of 7.00%, and must be repaid within 90
days.  Amounts drawn under this facility are secured by the
corresponding loan that is being funded by the advance. The interest rate on
this facility at March 31, 2008 was 7.00%. The principal amount of loans pledged
as collateral for this facility on March 31, 2008 was $19.1 million. Subsequent
to March 31, 2008, the $4.7 million drawn under this facility was
not repaid within the required 90-day period pursuant to the terms of the
facility.  We have requested and the lender
has verbally agreed to extend the maturity date for the advances
outstanding under the facility.





Mortgage
Loans Payable


We have a
mortgage loan payable to a bank, with an outstanding principal balance of $6.4
million and $6.5 million as of March 31, 2008 and December 31, 2007,
respectively.  This loan bears interest at a rate equal to the prime
rate, with a floor of 6.75%. Principal and interest are payable monthly and the
note matures in 2026, with no prepayment penalty. The interest rate on March 31,
2008 and 2007 was 6.75% and 7.25%, respectively. The mortgage is secured by our
office building in Henderson, Nevada. We were in compliance with all
financial covenants related to this loan as of March 31, 2008.





We
assumed a first lien mortgage payable to a bank upon foreclosure of a 10,330
square foot office building in Houston, Texas in November 2007 to preserve our
interest in the property. At March 31, 2008 and December 31, 2007, the loan had
an outstanding principal balance of $1.7 million and bears interest equal to the
prime rate minus 50 basis points (4.75% at March 31, 2008), and matures in
April 2011, with no prepayment penalty.  Principal and interest are
payable monthly.  We were in compliance with all financial covenants
related to this loan as of March 31, 2008.





Junior
Subordinated Notes


In June,
2006 we completed the issuance of $30 million in unsecured trust preferred
securities through a newly formed Delaware statutory trust, Desert Capital
TRS Statutory Trust I, which is our wholly owned subsidiary.  The
securities bear interest at a floating rate based on the three-month LIBOR plus
400 basis points, which sets for three months at one month after a calendar
quarter, which was 7.25% on March 31, 2008.




The trust
preferred securities require quarterly interest distributions. The trust
preferred securities mature in July 2036 and are redeemable, at our option, in
whole or in part, with no prepayment premium any time after July 30,
2011.




Desert
Capital TRS Statutory Trust I issued $928,000 aggregate liquidation amount of
common securities, representing 100% of the voting common stock of Desert
Capital TRS Statutory Trust I to us. Desert Capital TRS Statutory Trust I used
the proceeds from the sale of the trust preferred securities and the common
securities to purchase our junior subordinated notes.  The terms of the
junior subordinated notes match the terms of the trust preferred
securities.  The notes are subordinate and junior in right of payment to
all present and future senior indebtedness and certain other of our financial
obligations.




Our
interest in Desert Capital TRS Statutory Trust I is accounted for using the
equity method and the assets and liabilities of Desert Capital TRS Statutory
Trust I are not consolidated into our financial statements.  Interest on
the junior subordinated notes is included in interest expense on our
consolidated income statements while the junior subordinated notes are presented
as a separate item in our consolidated balance sheet.





Our
covenants contain customary default provisions and require us to maintain
financial ratios at quarterly determination dates, including a minimum tangible
net worth requirement.  Our ability to incur additional subordinated
debt is also limited.  At March 31, 2008, we had entered into an
agreement with our lender to modify the tangible net worth covenant contained in
our indenture through December 31, 2008 so that we would be in compliance with
the covenant.





Critical
Accounting Policies and Management Estimates





Our
discussion and analysis of financial condition and results of operations is
based on our financial statements, which have been prepared in accordance with
accounting principles generally accepted in the United States, known as GAAP.
These accounting principles require us to make some complex and subjective
decisions and assessments.  Our most critical accounting policies involve
decisions and assessments, which could significantly affect our reported assets,
liabilities and contingencies, as well as our reported revenues and
expenses.  We believe that all of the decisions and assessments upon which
our financial statements are based were reasonable at the time made based upon
information available to us at that time.  We evaluate these decisions and
assessments on an ongoing basis.  Actual results may differ from these
estimates under different assumptions or conditions.  We have identified
our most critical accounting policies to be the following:




20
 Table of Contents


Use
of 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 affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the consolidated
financial statements and the reported amounts of revenues and expenses during
the reporting period. Actual results may ultimately differ from those
estimates.





Revenue
Recognition





Interest
income on our mortgage investments is recognized over the life of the investment
and recorded on the accrual basis. Income recognition is suspended for mortgage
investments at the earlier of the date on which payments become 90 days past due
or when, in the opinion of management, a full recovery of income and principal
becomes doubtful. Income recognition is resumed when the loan becomes
contractually current and performance is demonstrated to be
resumed.





Fees
generated upon the funding of loans held for sale are recognized when the loan
is funded.  There are no gains or losses realized upon the sale of
loans held for sale.





Prior to
our sale of Consolidated Mortgage in November 2007, we recognized revenues
related to the loan origination and loan servicing activities of Consolidated
Mortgage. Loan origination fees and certain direct origination costs associated
with mortgage investments that were funded by us, were deferred and recognized
as an adjustment to yield over the lives of the related loans using the
straight-line method. Loan brokerage fees generated by Consolidated Mortgage
were nonrefundable fees for brokering loans to third party investors. Loan
brokerage fees were recognized once the loans associated with the fees were
funded and recorded by the third party investors. Consolidated Mortgage also
charged fees, which were recorded as non-interest income, to service loans
brokered to third party investors, as well as other miscellaneous fees during
the loan term. These service and other loan fees were recognized throughout the
life of the loan as they were earned.





Mortgage
Investments




Mortgage
investments are intended to be held to maturity and, accordingly are carried at
cost, net of any unamortized deferred fees and costs, and any allowance for loan
losses. The carrying value of these investments is adjusted for origination
discounts/premiums, nonrefundable fees and direct costs for originating loans
which are amortized into income over the terms of the loans using the effective
yield method adjusted for the effects of estimated prepayments based on
Statement of Financial Accounting Standards  (“SFAS”) No. 91,
“Accounting for Nonrefundable Fees and Costs Associated with Originating or
Acquiring Loans and Initial Direct Costs of Leases” (“SFAS
No. 91”).





Loans
Held for Sale




Loans
held for sale represent short term investments in loans where we intend to sell
all or part to third party investors within 90 days. These loans are carried at
the lower of cost or market value.





Real
Estate Owned





Real
estate owned consists of property acquired through foreclosures on mortgage
loans.  Our interests in real estate owned may be held directly by the
Company, or through limited liability companies.  In the case where
the Company is one of several investors in a larger loan, such loans are
foreclosed upon using a limited liability company to facilitate foreclosing our
lender interest along with private investors who hold the remaining loan balance
and have similar economic interests. We recorded real estate held directly or
through limited liability companies at the lower of the recorded amount of our
related mortgage loan being foreclosed (net of any impairment reserve), or our
economic interest in the property's estimated fair value, less estimated costs
to sell, with fair value based on appraisals and local market conditions and
inclusive of any senior indebtedness.





On a
periodic basis, management assesses whether there are any indicators that the
value of the Company’s investments in real estate owned may be other than
temporarily impaired. An investment is impaired only if the value of the
investment, as estimated by management, is less than the carrying value of the
investment. To the extent impairment has occurred, the loss shall be measured as
the excess of the carrying amount of the investment over the value of the
investment, as estimated by management.





Equity
Investments in Real Estate





To
facilitate our resolution strategy with respect to nonperforming loans we have
contributed real estate assets acquired through foreclosure to operating joint
ventures with investors/developers who provide additional financing and
development expertise.





We
evaluate our investments in partially owned entities in accordance with
FIN 46R. The Company accounts for its investments in unconsolidated real
estate ventures under the equity method of accounting as it is not the primary
beneficiary for a “variable interest entity,” or a “VIE,” and the Company
exercises significant influence, but does not control these entities under the
provisions of the entities’ governing agreements pursuant to EITF 04-05. These
investments are recorded initially at cost or impaired value, as investments in
real estate entities, and subsequently adjusted for equity in earnings and cash
contributions and distributions in accordance with AICPA (American Institute of
Certified Public Accountants) Statement of Position No. 78-9, Accounting for
Investments in Real Estate Ventures.





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 Table of Contents


On a
periodic basis, management assesses whether there are any indicators that the
value of the Company’s investments in equity investments in real estate may be
other than temporarily impaired. An investment is impaired only if the value of
the investment, as estimated by management, is less than the carrying value of
the investment. To the extent impairment has occurred, the loss shall be
measured as the excess of the carrying amount of the investment over the value
of the investment, as estimated by management.





Allowance
for Loan Losses





An
allowance for loan losses is reflected in our financial statements based upon an
evaluation of known and inherent risks affecting our portfolio of mortgage
investments including, but not limited to, economic conditions, delinquency
status, value of collateral underlying the loan, credit losses to date on
underlying mortgages and any remaining credit protection. Management monitors
the delinquencies and defaults on mortgage investments and, if an impairment of
the related loan is noted, the carrying value of the related loan will be
reduced to fair value through a charge to the allowance for loan
losses.  We consider mortgages to be delinquent when principal or
interest is contractually past due or the loan is past its maturity
date.




The value
of the underlying collateral, which is based upon an appraisal at origination,
also requires estimates and assumptions as to market
conditions.  Updated appraisals are periodically obtained but in
recent months appraisals have not been readily available due to lack of
significant sales comparables and therefore estimates of fair value necessarily
include other factors.  Specific allowances for losses may be
established for nonperforming and potentially impaired loans based on a
comparison of the recorded carrying value of the loan to either the present
value of the loan’s expected cash flow, the loan’s estimated market price or the
estimated fair value of the underlying collateral. The allowance is increased by
charges to operations and decreased by charge-offs (net of recoveries). Loan
loss estimates are reviewed periodically and adjustments are reported in
earnings when they become known.  Because any decision regarding the
allowance for loan losses reflects a judgment about the probability of future
events, there is an inherent risk that such judgments will prove
incorrect.  In such event, actual losses may exceed (or be less than)
the amount of any allowance.  To the extent that we experience losses
greater than the amount of our allowances, we may incur a charge to our earnings
that will adversely affect our operating results and the amount of any
distributions payable to our stockholders.





Impairment
Policy





We have
adopted Statement of Financial Accounting Standards No. 144, “Accounting for the
Impairment or Disposal of Long-Lived Assets” (SFAS No. 144). Impairment is
measured on a loan-by-loan basis on the fair value of the related collateral
since all loans subject to this measurement are collateral dependent. There were
impairment losses recognized for the three months ended March 31, 2008 of
$1,057.





Income
Taxes





We
elected to be taxed as a REIT, under Sections 856 through 860 of the Internal
Revenue Code, beginning with our taxable year ended December 31, 2004. To
qualify as a REIT, we must meet certain organizational and operational
requirements, including a requirement to distribute at least 90% of our ordinary
taxable income to stockholders. As a REIT, we generally are not subject to
federal income tax on taxable income that we distribute to our stockholders. If
we failed to qualify as a REIT in any taxable year, we would then be subject to
federal income taxes on our taxable income at regular corporate rates and we
would not be permitted to qualify for treatment as a REIT for federal income tax
purposes for four years following the year during which qualification was lost
unless the Internal Revenue Service granted us relief under certain statutory
provisions. Such an event could materially adversely affect our net income and
net cash available for distributions to stockholders. However, we intend to
continue to operate in the foreseeable future in such a manner so that we will
qualify as a REIT for federal income tax purposes. Our taxable REIT
subsidiary(s) is subject to federal, state, and local taxes. For the three
months ended March 31, 2008, and 2007 we recorded a tax benefit of ($43,104) and
an income tax expense of $70,177 respectively.





Recent
Accounting Developments





In
December 2007, Financial Accounting Standards Board (“FASB”) issued SFAS No.
160, “Noncontrolling Interests in Consolidated Financial Statements – an
amendment of ARB No. 51” (“SFAS No. 160”).  SFAS No. 160 requires that
ownership interests in subsidiaries held by parties other than the parent, and
the amount of consolidated net income, be clearly identified, labeled, and
presented in the consolidated financial statements within equity, but separate
from the parent’s equity. It also requires that once a subsidiary is
deconsolidated, any retained noncontrolling equity investment in the former
subsidiary be initially measured at fair value. Sufficient disclosures are
required to clearly identify and distinguish between the interests of the parent
and the interests of the noncontrolling owners.  In addition to the
amendments to ARB 51, this Statement amends SFAS No. 128 “Earnings per Share”;
so that earnings-per-share data will continue to be calculated the same way
those data were calculated before SFAS No. 160 was issued. SFAS No. 160 is
effective for fiscal years, and interim periods within those fiscal years,
beginning on or after December 15, 2008.  Earlier adoption is
prohibited.  SFAS No. 160 shall be applied prospectively as of the
beginning of the fiscal year in which SFAS No. 160 is initially applied, except
for the presentation and disclosure requirements.  The presentation
and disclosure requirements shall be applied retrospectively for all periods
presented.  SFAS No. 160 will be effective for us beginning January 1,
2009.  We have evaluated SFAS No. 160 and have determined that we have
not entered any business arrangements or corporate joint ventures that would
require the application of SFAS No. 160 for noncontrolling
interests.





22
 Table of Contents


In
December 2007, the FASB issued SFAS No. 141R, “Business Combinations” (“SFAS No.
141R”).  This Statement replaces SFAS No. 141.  SFAS No.
141R establishes principles and requirements for how the acquirer of a business
recognizes and measures in its financial statements the identifiable assets
acquired, the liabilities assumed, and any noncontrolling interest in the
acquiree.  SFAS No. 141R also provides guidance for recognizing and
measuring the goodwill acquired in the business combination and determines what
information to disclose to enable users of the financial statements to evaluate
the nature and financial effects of the business combination.  This
Statement 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 do not expect the
adoption of SFAS 141R to have a material impact on our Consolidated Financial
Statements.





In
February 2007, the FASB issued Statement of Financial Accounting Standards
No. 159 (“SFAS 159”), “The Fair Value Option for Financial Assets and
Financial Liabilities.” SFAS 159 permits entities to choose to measure financial
assets and liabilities (except for those that are specifically scoped out of the
Statement) at fair value.  The election to measure a financial asset
or liability at fair value can be made on an instrument-by-instrument basis and
is irrevocable.  The difference between carrying value and fair value
at the election date is recorded as a transition adjustment to opening retained
earnings.  Subsequent changes in fair value are recognized in
earnings.  The Company may decide whether to elect the fair value
option for each eligible item on various defined election dates.  We
did not elect to report any financial assets or liabilities at fair value under
SFAS No. 159 on January 1, 2008.





In
September 2006, the FASB issued Statement of Financial Accounting Standards
No. 157, “Fair Value Measurements” (“SFAS 157”). SFAS 157 defines fair
value, establishes a framework for measuring fair value and expands disclosures
about fair value measurements.  SFAS 157 applies under other accounting
pronouncements that require or permit fair value measurements. Accordingly, SFAS
157 does not require any new fair value measurements. SFAS 157 is effective for
fiscal years beginning after November 15, 2007, and interim periods within those
fiscal years.  This statement has modified the methodology for the
measurement of “Fair Value of Financial Instruments.” This change has had a
significant impact on the estimated fair value of our financial instruments as
of March 31, 2008.  See Note 14 - Fair Value of Financial
Instruments.





Item 3. Quantitative and Qualitative Disclosures about Market
Risk





Market
risk refers to the risk of loss from adverse changes in the level of one or more
market prices, rate indices or other market factors. We are exposed to market
risk primarily from changes in interest rates that are very sensitive to a
variety of factors including political, economic and other factors outside of
our control.





Interest
rate risk arises primarily as a result of our core business activities of
acquiring mortgage loans and funding a portion of the purchases with borrowings
and the associated asset and liability management required to match maturities
of loans to funding sources. The principal objective of our asset and liability
management is to maximize net interest income while operating within acceptable
limits established for interest rate risk and maintaining adequate levels of
liquidity.





The
primary interest rate exposure to which we are subject relates to our mortgage
loan portfolio. Any change in the general level of interest rates in the market
can affect our net interest income and net income in either a positive or
negative manner. Net interest income is the difference between the income earned
from interest bearing assets less the expense incurred relating to interest
bearing liabilities. Fluctuations in the interest rate environment can also
affect our ability to acquire new loans, the value of our loans for sale
portfolio and our ability to sell the loans held for sale and the related income
associated with a sale. Our entire mortgage loan portfolio is comprised of fixed
rate investments while all of the debt that we have is variable rate
debt.





Based on
our loans and liabilities as of March 31, 2008, and assuming the balances
of these loans and liabilities remain unchanged for the subsequent twelve
months, a 1% increase in interest rates would decrease our annual net income and
cash flows by approximately $0.4 million. This decrease is due to our fixed rate
investments and variable rate debt. Based on our loans and liabilities as of
March 31, 2008, and assuming the balances of these loans and liabilities
remain unchanged for the subsequent twelve months, a 1 % decrease in interest
rates would increase our annual net income and cash flows by approximately
$0.4 million. This increase again is due to our fixed rate investments and
variable rate debt.





In the
event of a significant rising interest rate environment and/or future economic
downturn, defaults could increase and result in credit losses to us, which could
adversely affect our liquidity and operating results. Further, such additional
delinquencies or defaults could have an adverse effect on the spreads between
interest-earning assets and interest-bearing liabilities.





We do not
intend to use any derivative instruments to manage our interest rate exposure.
Given the short time horizon of our anticipated investments and our related
borrowings, we do not believe a hedging strategy is necessary. In addition, our
actions are limited by rules with which REITs must comply.





23
 Table of Contents


Item 4.Controls and Procedures




Under the supervision and with the
participation of our management, including
our chief executive officer
and chief financial officer, we evaluated the effectiveness of
the design and operation of our disclosure controls and procedures (as defined
in Rule 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the
“Exchange Act”)). Based upon that evaluation, and subsequent
evaluations, our chief executive officer
and chief financial officer concluded that, as of the end of the
period covered by this report and as a result of the material weakness in our
internal controls that was identified in connection with
our December 31, 2007 audit, described below, our disclosure controls and
procedures were not effective to ensure that information required to be
disclosed by us in the reports we file or submit under the Exchange Act is
recorded, processed, summarized and reported within the time periods specified
in applicable rules and forms.   However, notwithstanding the material
weakness that existed as of December 31, 2007, management has concluded that the
consolidated financial statements included in this Quarterly Report on Form 10-Q
present fairly, in all material respects, our financial position, results
of operations and cash flows in conformity with accounting principles
generally accepted in the United States.




The material weakness that management
identified was that we failed to design and implement controls related to the
interpretation and implementation of certain accounting principles,
primarily related to business combinations in connection with the sale
of Consolidated Mortgage and accounting for loan impairment in connection with a
troubled debt restructuring.  The fact that these accounting principles
were not properly applied, together with certain other factors led our
management to conclude that this situation was an indication of a material
weakness in our internal control over financial reporting as of December 31,
2007.




We have
discussed the material weakness in our internal control over financial reporting
with the Audit Committee of our Board of Directors and with Hancock
Askew & Co. LLP, our independent registered public accounting firm. In
response, beginning in March 2008, we began taking measures to remediate
the material weakness in our internal control, which measures have included the
following:




·
            expanding
      our external consulting expertise and engaging additional external
      consulting expertise; and




·
            expanding
      the capacity and expertise of our internal accounting
    staff.




During
the most recent quarter ended March 31, 2008, other than as discussed
above, there have been no significant changes in our internal control over
financial reporting or in other factors that have materially affected,
or are reasonably likely to materially affect, our internal control over
financial reporting. However, as discussed above, changes have been
implemented that will continue to occur subsequent to the period covered by
this Form 10-Q to add additional controls to continue to remediate and
correct the material weakness in internal control over financial
reporting.




Part II.Other Information





Item 1.Legal Proceedings


During
the period covered by this report, there are no material changes to legal
proceedings discussed in our Annual Report on Form 10-K for the year ended
December 31, 2007.





Item 1A.Risk Factors


During
the period covered by this report, there were no material changes to the risk
factors discussed in our Annual Report on Form 10-K for the year ended December
31, 2007.




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


Desert
Capital REIT’s Form S-11 Registration Statement, File No. 333-128885,
registering the sale of up to 15,000,000 shares of Desert Capital’s common
stock, was declared effective by the Securities and Exchange Commission on March
22, 2006. The offering commenced on April 1, 2006.





For the
quarter ended March 31, 2008 Desert Capital REIT sold 25,515 shares, with an
aggregate offering price of $382,508, and issued 57,803 shares pursuant to the
dividend reinvestment plan. For the quarter ended March 31, 2008, Desert Capital
incurred offering expenses of approximately $57,097, consisting of $36,124 in
commissions paid to CMC Financial Services, Inc., the dealer-manager, and
$20,973 for legal, accounting, and filing fees. The net offering proceeds to
Desert Capital REIT, during the first quarter of 2008, after deducting
total offering expenses for the quarter were $325,411, which was invested
in loans secured by real estate.





The
offering was a “best efforts” offering, and the dealer-manager for the offering
is CMC Financial Services, Inc. The offering price was $15.00 per share, with
discounts and commissions payable to the dealer-manager equaling $1.425 per
share. The aggregate price of the 15,000,000 shares of common stock registered
was $225,000,000.  Of the total shares registered, 3,008,208 shares
were sold to investors meeting our suitability standards, and 639,455 shares
were issued pursuant to our dividend reinvestment program.  Todd B.
Parriott, the Chairman of the Board and Chief Executive Officer of Desert
Capital is a director and principal of CMC Financial Services, Inc.




24
 Table of Contents


Purchases
of equity securities by the issuer and affiliated purchasers


None.





Item 3. Defaults Upon Senior Securities


None.




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


None.





Item 5.Other Information


None.




Item 6. Exhibits


a)
Exhibits







31.1
            Certification
      of Chief Executive Officer, Pursuant to Section 302 of the Sarbanes-Oxley
      Act of 2002*31.2
            Certification
      of Chief Financial Officer, Pursuant to Section 302 of the Sarbanes-Oxley
      Act of 2002*32.1
            Certification
      of Chief Executive Officer and Chief Financial Officer, Pursuant to 18
      U.S.C Section 1350, as Adopted Pursuant to Section 906 of the
      Sarbanes-Oxley Act of 2002**






*Filed
herewith






**
Furnished herewith







25
 Table of Contents







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.













DESERT
      CAPITAL REIT, INC.May
      15, 2008
            /s/ TODD B.
      PARRIOTTTodd
      B. Parriott,Chairman
      of the Board, Chief Executive Officer, President and Chief Investment
      Officer
              (Principal
      Executive Officer)








May
      15, 2008
            /s/G. STEVEN
      DAWSONG.
      Steven Dawson,Chief
      Financial Officer
              (Principal
      Accounting Officer)








26
 Table of Contents


EXHIBIT
INDEX




31.1
            Certification
      of Chief Executive Officer, Pursuant to Section 302 of the Sarbanes-Oxley
      Act of 2002*31.2
            Certification
      of Chief Financial Officer, Pursuant to Section 302 of the Sarbanes-Oxley
      Act of 2002*32.1
            Certification
      of Chief Executive Officer and Chief Financial Officer, Pursuant to 18
      U.S.C Section 1350, as Adopted Pursuant to Section 906 of the
      Sarbanes-Oxley Act of 2002**




*Filed
herewith




**
Furnished herewith