UNITEDSTATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC20549

FORM 10-Q

QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGEACT OF 1934

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER30, 2004

COMMISSION FILE NUMBER: 001-32330

NORTHSTAR REALTY FINANCECORP.(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITSCHARTER)

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| MARYLAND                                                     |  | 11-3707493                           |
| (STATEOR OTHER JURISDICTION OFINCORPORATION OR ORGANIZATION) |  | (IRS EMPLOYER IDENTIFICATION NUMBER) |
|                                                         |  |
| 527MADISON AVENUE, NEW YORK, NY                              |  | 10022                                |
| (ADDRESSOF PRINCIPAL EXECUTIVE OFFICE)                       |  | (ZIPCODE)                            |
|                                                              |

(212) 319-8801(REGISTRANT'S TELEPHONE NUMBER INCLUDING AREA CODE)

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INDICATE BY CHECK MARKWHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS REQUIRED TO BE FILEDBY SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 DURINGTHE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE REGISTRANTWAS REQUIRED TO FILE SUCH REPORTS) YES [X]NO[    ], AND (2) HAS BEEN SUBJECT TO SUCH FILINGREQUIREMENTS FOR THE PAST 90 DAYS. YES [X]NO[    ].

INDICATE BY CHECK MARK WHETHER THEREGISTRANT IS AN ACCELERATED FILER (AS DEFINED IN RULE 12B-2 OF THEEXCHANGE ACT).

YES [    ] NO [X].

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THE COMPANY HAS ONE CLASSOF COMMON STOCK, PAR VALUE $.01 PER SHARE, WITH 21,249,736 SHARESOUTSTANDING AS OF DECEMBER 30,2004.

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NORTHSTAR REALTY FINANCECORP. PREDECESSOR QUARTERLY REPORT FOR THE THREE MONTHS ENDEDSEPTEMBER 30, 2004

TABLE OF CONTENTS

|            |  |                                                                                                            |  |               |  |  |  |  |  |  |
|------------|--|------------------------------------------------------------------------------------------------------------|--|---------------|--|--|--|--|--|--|
| INDEX      |  |                                                                                                       |  | PAGE          |
| PARTI.     |  | FINANCIALINFORMATION                                                                                       |  |          |
|       |  |                                                                                                       |  |          |
| Item1.     |  | FinancialStatements                                                                                        |  |          |
|       |  |                                                                                                       |  |          |
|       |  | CombinedBalance Sheets as of September 30, 2004 (unaudited) and December 31,2003                           |  | 4   |
|       |  | CombinedStatements of Operations for the three and nine months ended September30, 2004 and 2003(unaudited) |  | 5   |
|       |  | CombinedStatements of Cash Flows for the nine months ended September 30, 2004and 2003(unaudited)           |  | 6   |
|       |  | Notes tothe Combined Financial Statements(unaudited)                                                       |  | 7   |
| Item2.     |  | Management's Discussion and Analysis of FinancialCondition and Results ofOperations                        |  | 23            |
| Item3.     |  | Quantitative and Qualitative Disclosures about MarketRisk                                                  |  | 39            |
| Item 4.    |  | Controls andProcedures                                                                                     |  | 41            |
|       |  |                                                                                                       |  |          |
| PARTII.    |  | OTHERINFORMATION                                                                                           |  |          |
|       |  |                                                                                                       |  |          |
| Item1.     |  | Legal Proceedings                                                                                          |  | 44            |
| Item2.     |  | Changes in Securities, Use of Proceeds and Issuer Purchasesof Equity Securities                            |  | 44            |
| Item3.     |  | Defaults Upon Senior Securities                                                                            |  | 45            |
| Item 4.    |  | Submission of Matters toa Vote of Securities Holders                                                       |  | 45            |
| Item5.     |  | Other Information                                                                                          |  | 45            |
| Item6.     |  | Exhibits and Reports on Form8-K                                                                            |  | 45            |
|       |  |                                                                                                       |  |          |
| SIGNATURES |  |                                                                                                       |  | 48            |
|            |

2

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EXPLANATORYNOTE

On October 29, 2004, NorthStar Realty Finance Corp. (the"Company") completed its initial publicoffering and began operating as a separate company. Simultaneously withthe closing of the initial public offering, an initial portfolio ofassets was contributed to the Company. The financial statements for thethree and nine months ended September 30, 2004 and 2003 and as ofSeptember 30, 2004 and December 31 2003 included in this report are forNorthStar Realty Finance Corp. Predecessor, a combination of certaincontrolling and non-controlling interests in real estate-relatedentities which represent the initial portfolio of assets contributed tothe Company subsequent to September 30, 2004. Management does notbelieve that the financial statements of the Company'spredecessor are necessarily indicative of the Company's futureresults as a separate operating company after the closing of itsinitial public offering.

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ITEM 1. FINANCIALSTATEMENTS

NORTHSTAR REALTY FINANCE CORP. PREDECESSOR

COMBINED BALANCE SHEETS

|                                                                   |  |                  |            |                 |  |        |            |        |  |  |
|-------------------------------------------------------------------|--|------------------|------------|-----------------|--|--------|------------|--------|--|--|
|                                                              |  | September30,2004 |            | December31,2003 |
|                                                              |  | (Unaudited)      |            |
| Assets:                                                           |  |
| Investmentsin and advances to uncombinedventures:                 |  |
| ALGM                                                              |  |             | 10,479,000 |            |  | $      | 9,786,000  |   |
| NSFVenture                                                        |  |             | 6,138,000  |            |  |   | 5,751,000  |   |
| Totalinvestments in and advances to uncombinedventures            |  |             | 16,617,000 |            |  |   | 15,537,000 |   |
| Debtsecurities available forsale                                  |  |             | 36,995,000 |            |  |   | 9,187,000  |   |
| Collateralheld bybroker                                           |  |             | 12,933,000 |            |  |   | —    |   |
| Cash andcashequivalents                                           |  |             | 2,064,000  |            |  |   | 1,013,000  |   |
| Receivablefrom affiliates                                         |  |             | 2,056,000  |            |  |   | 931,000    |   |
| CDO deposit andwarehouseagreements                                |  |             | 329,000    |            |  |   | 5,967,000  |   |
| Advisoryand asset management fees receivable — relatedparty |  |             | 113,000    |            |  |   | 157,000    |   |
| Otherassets                                                       |  |             | 400,000    |            |  |   | 23,000     |   |
| Totalassets                                                       |  | $                | 71,507,000 |            |  | $      | 32,815,000 |   |
| Liabilities:                                                      |  |
| Accruedexpenses & otherliabilities                            |  | $                | 270,000    |            |  | $      | 322,000    |   |
| Loanpayable                                                       |  |             | 17,517,000 |            |  |   | —    |   |
| Securities sold,not yet purchased                                 |  |             | 12,944,000 |            |  |   | —    |   |
| Unearnedrevenue                                                   |  |             | 120,000    |            |  |   | —    |   |
| Totalliabilities                                                  |  |             | 30,851,000 |            |  |   | 322,000    |   |
| Combinedowners'equity                                             |  |             | 40,656,000 |            |  |   | 32,493,000 |   |
| Totalliabilities and owners'equity                                |  | $                | 71,507,000 |            |  | $      | 32,815,000 |   |
|                                                                   |

Seeaccompanying notes to combined financial statements.

4

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NORTHSTAR REALTY FINANCE CORP.PREDECESSOR

COMBINED STATEMENTS OF OPERATIONS (UNAUDITED)

|                                                          |  |                                 |           |                               |  |        |           |         |  |        |            |         |  |        |            |         |  |  |
|----------------------------------------------------------|--|---------------------------------|-----------|-------------------------------|--|--------|-----------|---------|--|--------|------------|---------|--|--------|------------|---------|--|--|
|                                                     |  | ThreeMonths Ended September 30, |           | Nine Months EndedSeptember30, |
|                                                     |  | 2004                            |           | 2003                          |  | 2004   |           | 2003    |
| Revenuesand other income:                                |  |
| Advisory and management feeincome                        |  | $                               | 57,000    |                          |  | $      | 28,000    |    |  | $      | 165,000    |    |  | $      | 28,000     |    |
| Advisoryand management fee income — relatedparties |  |                            | 952,000   |                          |  |   | 326,000   |    |  |   | 2,134,000  |    |  |   | 463,000    |    |
| Interestincome — debtsecurities                    |  |                            | 928,000   |                          |  |   | 158,000   |    |  |   | 1,491,000  |    |  |   | 158,000    |    |
| Totalrevenues                                            |  |                            | 1,937,000 |                          |  |   | 512,000   |    |  |   | 3,790,000  |    |  |   | 649,000    |    |
| Expenses:                                                |  |
| Interestexpense                                          |  |                            | 201,000   |                          |  |   | —   |    |  |   | 201,000    |    |  |   | —    |    |
| Generalandadministrative:                                |  |
| Direct:                                                  |  |
| Salariesand othercompensation                            |  |                            | 238,000   |                          |  |   | 647,000   |    |  |   | 838,000    |    |  |   | 990,000    |    |
| Othergeneral andadministrative                           |  |                            | 46,000    |                          |  |   | 5,000     |    |  |   | 147,000    |    |  |   | 163,000    |    |
| Totaldirectexpenses                                      |  |                            | 485,000   |                          |  |   | 652,000   |    |  |   | 1,186,000  |    |  |   | 1,153,000  |    |
| Allocated:                                               |  |
| Salariesand othercompensation                            |  |                            | 1,520,000 |                          |  |   | 538,000   |    |  |   | 2,764,000  |    |  |   | 1,567,000  |    |
| Insurance                                                |  |                            | 90,000    |                          |  |   | 96,000    |    |  |   | 285,000    |    |  |   | 159,000    |    |
| Othergeneral andadministrative                           |  |                            | 323,000   |                          |  |   | 213,000   |    |  |   | 845,000    |    |  |   | 784,000    |    |
| Totalallocatedexpenses                                   |  |                            | 1,933,000 |                          |  |   | 847,000   |    |  |   | 3,894,000  |    |  |   | 2,510,000  |    |
| Totalexpenses                                            |  |                            | 2,418,000 |                          |  |   | 1,499,000 |    |  |   | 5,080,000  |    |  |   | 3,663,000  |    |
| Lossfromoperations                                       |  |                            | (481,000  | )                        |  |   | (987,000  | )  |  |   | (1,290,000 | )  |  |   | (3,014,000 | )  |
| Equityin earnings of uncombinedventures:                 |  |
| ALGM                                                     |  |                            | 343,000   |                          |  |   | 509,000   |    |  |   | 943,000    |    |  |   | 1,142,000  |    |
| NSFVenture                                               |  |                            | 144,000   |                          |  |   | 114,000   |    |  |   | 408,000    |    |  |   | 284,000    |    |
| Totalequity in earnings of uncombinedventures            |  |                            | 487,000   |                          |  |   | 623,000   |    |  |   | 1,351,000  |    |  |   | 1,426,000  |    |
| OtherGains and losses:                                   |  |
| Unrealized loss on shortsale ofsecurity                  |  |                            | (358,000  | )                        |  |   | —   |    |  |   | (358,000   | )  |  |   | —    |    |
| Gainsand losses on warehouse agreements:                 |  |
| Realized                                                 |  |                            | 636,000   |                          |  |   | 1,866,000 |    |  |   | 636,000    |    |  |   | 1,866,000  |    |
| Unrealized                                               |  |                            | 66,000    |                          |  |   | (851,000  | )  |  |   | 783,000    |    |  |   | 1,018,000  |    |
| Totalgains and losses on warehouseagreements             |  |                            | 702,000   |                          |  |   | 1,015,000 |    |  |   | 1,419,000  |    |  |   | 2,884,000  |    |
| Netincome                                                |  |                            | 350,000   |                          |  |   | 651,000   |    |  |   | 1,122,000  |    |  |   | 1,296,000  |    |
| Othercomprehensive income:                               |  |
| Unrealized gains on debtsecurities available forsale     |  |                            | 655,000   |                          |  |   | 13,000    |    |  |   | 1,131,000  |    |  |   | 13,000     |    |
| Comprehensiveincome                                      |  | $                               | 1,005,000 |                          |  | $      | 664,000   |    |  | $      | 2,253,000  |    |  | $      | 1,309,000  |    |
|                                                          |

Seeaccompanying notes to combined financial statements.

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NORTHSTAR REALTY FINANCE CORP.PREDECESSOR

COMBINED STATEMENTS OF CASH FLOWS (UNAUDITED)

|                                                                                           |  |                              |             |         |  |        |            |         |  |  |
|-------------------------------------------------------------------------------------------|--|------------------------------|-------------|---------|--|--------|------------|---------|--|--|
|                                                                                      |  | NineMonths EndedSeptember30, |
|                                                                                      |  | 2004                         |             | 2003    |
| Cashflows from operating activities:                                                      |  |
| Net income fromcontinuingoperations                                                       |  | $                            | 1,122,000   |    |  | $      | 1,296,000  |    |
| Adjustmentsto reconcile net income to net cash provided by (used in) operatingactivities: |  |
| Equity in (earnings) of uncombinedventures                                                |  |                         | (1,351,000  | )  |  |   | (1,426,000 | )  |
| Unrealizedgains on warehouseagreements                                                    |  |                         | (783,000    | )  |  |   | (1,018,000 | )  |
| Unrealizedloss on short sale ofsecurity                                                   |  |                         | 358,000     |    |  |   | —    |    |
| Amortizationof bonddiscount                                                               |  |                         | (41,000     | )  |  |   | —    |    |
| Allocatedgeneral and administrativeexpenses                                               |  |                         | 3,894,000   |    |  |   | 2,510,000  |    |
| Allocatedadvisoryfee                                                                      |  |                         | (566,000    | )  |  |   | (362,000   | )  |
| (Increase)decrease in advisory and asset management fees receivable —relatedparties |  |                         | 44,000      |    |  |   | (405,000   | )  |
| (Increase)inreceivables                                                                   |  |                         | —     |    |  |   | (2,366,000 | )  |
| (Increase)in otherassets                                                                  |  |                         | (377,000    | )  |  |   | (158,000   | )  |
| (Decrease)increase in accruedexpenses                                                     |  |                         | (52,000     | )  |  |   | 133,000    |    |
| Increasein unearnedrevenue                                                                |  |                         | 120,000     |    |  |   | —    |    |
| Netcash provided by (used in) operatingactivities                                         |  |                         | 2,368,000   |    |  |   | (1,796,000 | )  |
| Cashflows from investing activities:                                                      |  |
| Return ofinvestment in debtsecurities                                                     |  |                         | 818,000     |    |  |   | —    |    |
| Purchaseof debt securities available forsale                                              |  |                         | (27,499,000 | )  |  |   | (9,500,000 | )  |
| CDOwarehousedeposits                                                                      |  |                         | (3,034,000  | )  |  |   | (5,000,000 | )  |
| Proceedsfrom CDOwarehouse                                                                 |  |                         | 9,500,000   |    |  |   | 10,000,000 |    |
| Contributionsto uncombinedventures                                                        |  |                         | (1,048,000  | )  |  |   | —    |    |
| Distributionsfrom uncombinedventures                                                      |  |                         | 1,319,000   |    |  |   | —    |    |
| Netcash (used in) investingactivities                                                     |  |                         | (19,944,000 | )  |  |   | (4,500,000 | )  |
| Cashflows from financing activities:                                                      |  |
| Proceeds from loanpayable                                                                 |  |                         | 17,517,000  |    |  |   | —    |    |
| Proceedsfrom securities sold, not yetpurchased                                            |  |                         | 12,585,000  |    |  |   | —    |    |
| Collateralheld bybroker                                                                   |  |                         | (12,933,000 | )  |  |   | —    |    |
| (Increase)decrease in receivable fromaffiliates                                           |  |                         | (1,125,000  | )  |  |   | 7,000,000  |    |
| Capitalcontributions by owners of thePredecessor                                          |  |                         | 9,392,000   |    |  |   | —    |    |
| Distributionsto owners of thePredecessor                                                  |  |                         | (6,809,000  | )  |  |   | —    |    |
| Netcash provided by financingactivities                                                   |  |                         | 18,627,000  |    |  |   | 7,000,000  |    |
| Netincrease in cash & cashequivalents                                                 |  |                         | 1,051,000   |    |  |   | 704,000    |    |
| Cash& cash equivalents — beginning ofperiod                                     |  |                         | 1,013,000   |    |  |   | —    |    |
| Cash& cash equivalents — end ofperiod                                           |  | $                            | 2,064,000   |    |  | $      | 704,000    |    |
|                                                                                           |

Seeaccompanying notes to combined financialstatements.

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NORTHSTARREALTY FINANCE CORP. PREDECESSOR

NOTES TOCOMBINED FINANCIAL STATEMENTS

1.    Organization and Basis of Presentation

On October 29, 2004, NorthStar Realty Finance Corp.(the "Company") completed its initial publicoffering (the "IPO") and began operating as aseparate company. Simultaneously with the closing of the IPO, aninitial portfolio of investments was contributed to NorthStar RealtyFinance Limited Partnership, a subsidiary and the operating partnershipof the Company (the "Operating Partnership").NorthStar Realty Finance Corp. Predecessor (the"Predecessor") is a combination of certaincontrolling and non-controlling interests in real estate-relatedentities which represent the initial portfolio of investmentscontributed to the Operating Partnership subsequent to September 30,2004. The Company succeeded to the business of the Predecessor as ofthe consummation of the IPO and the contribution of the initialportfolio of investments to the Operating Partnership. The financialstatements covered in this report represent the results of operationsand financial condition of the Predecessor for the three and ninemonths ended September 30, 2004 and 2003 and as of September 30, 2004and December 31, 2003.

Prior to the contributionof the initial portfolio of investments to the Operating Partnership,the Predecessor was engaged in the business of investing in subordinatereal estate debt, commercial real estate securities and net leaseproperties. The ultimate owners of the components of the Predecessorare NorthStar Capital Investment Corp.("NCIC") and certain others who have minorityownership interests (collectively, the"Participants").

Concurrently with theconsummation of the IPO, NCIC and the other Participants contributedcertain controlling and non-controlling interests in the companiesdescribed below (the "Initial Investments"),all of which are included in the combined financial statements of thePredecessor, to the Operating Partnership (the"Contribution Transactions").

|                                                                        |  |                                           |  |         |  |                    |  |                               |  |  |  |  |  |  |  |  |  |  |
|------------------------------------------------------------------------|--|-------------------------------------------|--|---------|--|--------------------|--|-------------------------------|--|--|--|--|--|--|--|--|--|--|
| Entity                                                                 |  | Predecessor'sOwnership and VotingInterest |  | Control |  | AccountingBasis(1) |  | OwnershipInterestType         |
| CDO Business:                                                          |  |
| NSAdvisors LLC("NSA")                                                  |  | 100%                                      |  | Yes     |  | Combined           |  | ManagingMember                |
| NS CDO Holdings I, LLC NS CDO Holdings II,LLC                          |  | 100%100%                                  |  | YesYes  |  | CombinedCombined   |  | ManagingMemberManaging Member |
| Subordinate DebtBusiness:NorthStar Funding Managing Member LLC("NFMM") |  | 75%                                       |  | Yes     |  | Combined           |  | ManagingMember                |
| NorthStar Funding ManagementLLC(2)                                     |  | 37.5%                                     |  | No      |  | Uncombined         |  | Co-ManagingMember             |
| NorthStar Funding Investor MemberLLC                                   |  | 100%                                      |  | Yes     |  | Combined           |  | ManagingMember                |
| NorthStar Funding LLC (the "NSFVenture")                               |  | 4.995%                                    |  | No      |  | Uncombined         |  | Member                        |
| NetLease Business:ALGM I Owners LLC("ALGM")                            |  | 97.50%                                    |  | No      |  | Uncombined         |  | Member                        |
|                                                                        |

|           |                                                                                                                                                                      |
|-----------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (1)  | Theuncombined equity interests are held either directly or indirectly bythe Predecessor and are accounted for under the equity method asfurther described in Note 2. |

|           |                                     |
|-----------|-------------------------------------|
| (2)  | Owns0.01% of NorthStar Funding LLC. |

Prior to the ContributionTransactions, the Company and the Operating Partnership were controlledsubsidiaries of NCIC. Since the Operating Partnership was controlled byNCIC prior to the IPO, the contribution of the Initial Investments bycertain controlled subsidiaries of NCIC to the Operating Partnershipfor cash and ownership interests in the Operating Partnership wereaccounted for at NCIC's historical cost basis as reflected in theaccompanying combined financial statements of the Predecessor, with theexception of certain minority interests.

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NORTHSTARREALTY FINANCE CORP. PREDECESSOR

NOTES TOCOMBINED FINANCIAL STATEMENTS (Continued)

A summary of the Contribution Transactionsand the accounting treatment by the Operating Partnership for theminority interests on consummation of the Contribution Transactions isas follows:

|                                      |  |                                                       |                 |                                                                                                                        |  |                                                                                                    |    |                                                                   |  |        |         |            |  |           |  |  |  |  |
|--------------------------------------|--|-------------------------------------------------------|-----------------|------------------------------------------------------------------------------------------------------------------------|--|----------------------------------------------------------------------------------------------------|----|-------------------------------------------------------------------|--|--------|---------|------------|--|-----------|--|--|--|--|
|                                 |  | PercentageOwnership Contributed by theParticipants(d) |                 | Percentage Ownership ofControlled Subsidiaries Owned by Third Parties andParticipating in the ContributionTransactions |  | Percentage of ContributedSubsidiaries Acquired from Employee Prior to theContribution Transactions |    | Basis at whichParticipants/ Employees Interest will beContributed |
| CDOBusiness:                         |  |
| NSA                                  |  |                                                  | 100             | %                                                                                                                 |  |                                                                                               | 23 | %(a)                                                         |  |   | — | %(b)  |  | FairValue |
| NS CDO I Holding, LLC                |  |                                                  |   100 | %                                                                                                                 |  |                                                                                               | 23 | %(a)                                                         |  |   |    |       |  | FairValue |
| NS CDO II Holding,LLC                |  |                                                  | 100             | %                                                                                                                 |  |                                                                                               | 23 | %(a)                                                         |  |   |    |       |  | FairValue |
| Subordinate DebtBusiness:            |  |
| NFMM                                 |  |                                                  | 100             | %                                                                                                                 |  |                                                                                               | 0  | %(c)                                                         |  |   | 25      | %(c)  |  | FairValue |
| NorthStar Funding Investor MemberLLC |  |                                                  | 100             | %                                                                                                                 |  |                                                                                               | 0  | %                                                            |  |   |    |       |  | N/A       |
| NetLease Business:                   |  |
| ALGM                                 |  |                                                  | 97.50           | %                                                                                                                 |  |                                                                                               | 0  | %                                                            |  |   |    |       |  | N/A       |
|                                      |

|           |                                                                                                                                                                                |
|-----------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (a)  | Representsminority interest in Presidio Capital Investment Company LLC, acontrolled subsidiary of NorthStar Partnership, L.P. which directlyowns and controls the CDObusiness. |

|           |                                                                                                                                                                                                                                                                                                               |
|-----------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (b)  | A 15% profitsharing right in NSA which was held by an employee and was acquired bya controlled NCIC subsidiary immediately prior to the ContributionTransactions. This profit sharing right which does not represent legalownership, is a compensation arrangement and does not represent aminority interest. |

|           |                                                                                                                                                            |
|-----------|------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (c)  | A 25%profits interest in NFMM was held by two employees and was acquired bya controlled NCIC subsidiary immediately prior to the ContributionTransactions. |

|           |                                                                                                                                                                                                                                                                                                                                                                                                 |
|-----------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (d)  | A minorityownership exists in NorthStar Partnership, L.P. of approximately26.7%. However, such interest is not directly participating inthe Contribution Transactions with the Company and the OperatingPartnership. Accordingly such interest together with all of theinterest of NCIC, other than as described above were contributed to theOperating Partnership on a historical cost basis. |

Principles ofCombination

The combined and uncombined interests in entitiescontributed to the Operating Partnership have been aggregated to formthe Predecessor.

The interests in entities contributed to theOperating Partnership, which were controlled by NCIC, are reflected inthe Predecessor on a combined basis similar to a consolidation. Allintercompany accounts have been eliminated in combination.

Theinterest in entities contributed to the Operating Partnership which arenot controlled by NCIC were not combined, but are reflected asinvestments accounted for by the Predecessor on the equity method. Allintercompany revenues and expenses are eliminated on a proportionatebasis in the application of the equity method.

The IPO and theContribution Transactions were designed to (i) continue the operationsof the Predecessor as a consolidated enterprise, (ii) enable theCompany and Operating Partnership to raise the necessary capital toacquire the remaining 2.5% equity interest in ALGM, which owns aportfolio of substantially net leased retail and commercial propertieslocated in New York City, and (iii) provide a vehicle for futureacquisitions of real estate-related investments and facilitatepotential securitized debt financings.

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NORTHSTARREALTY FINANCE CORP. PREDECESSOR

NOTES TOCOMBINED FINANCIAL STATEMENTS (Continued)

Pursuant to the contribution agreementsamong the owners of the Predecessor and the Operating Partnership, theOperating Partnership received a contribution of interests in the realestate-related entities in exchange for issuing units of limitedpartnership interest in the Operating Partnership ("OPUnits") and the Company paid $36.1 million in cash toNorthStar Partnership, L.P. ("NPLP"). Of thecash payment, NPLP used $32 million to reduce the outstanding principalamount under NPLP's senior secured credit facility in order torelease liens associated with real estate-related investments whichwere transferred to the Operating Partnership, and $4.1 million toreimburse Presidio Capital Investment Company LLC for a cash depositmade under the warehouse agreement for the acquisition of the realestate securities accumulated for the second issuance of collateralizeddebt obligations ("CDOs") by a subsidiary ofNCIC, N-Star Real Estate CDO II Ltd.

The accompanying unauditedcombined financial statements of the Predecessor have been prepared bythe Company pursuant to the rules and regulations of the Securities andExchange Commission (the "SEC") regardinginterim financial reporting. Accordingly, they do not include all ofthe information and footnotes required by generally accepted accountingprinciples for audited annual financial statements. The followingfinancial statements should be read in conjunction withManagement's Discussion and Analysis of Financial Condition andResults of Operations of the Predecessor contained in this report. Theyshould also be read in conjunction with the audited annual combinedfinancial statements and notes related thereto of the Predecessor andthe related Management's Discussion and Analysis of FinancialCondition and Results of Operations of the Predecessor, each of whichare included in the Company's prospectus, dated October 25, 2004,as the Company filed such prospectus with the SEC pursuant to Rule424(b) of the rules and regulations of the SEC (the "IPOProspectus").

The accompanyingunaudited combined financial statements reflect all adjustments,consisting of normal recurring adjustments, which are, in the opinionof management, necessary for a fair presentation of the financialposition and the results of operations for the interim periodspresented. Preparing financial statements requires management to makeestimates and assumptions that affect the amounts that are reported inthe combined financial statements and accompanying disclosures.Although these estimates are based on management's best knowledgeof current events and actions that the Company may undertake in thefuture, actual results may be different from the estimates.

The results of operations for the three and ninemonths ended September 30, 2004 and 2003 are not necessarily indicativeof the results of operations to be expected for any future period orthe full year. The combined balance sheet at December 31, 2003 wasderived from the audited combined financial statements of thePredecessor included in the IPO Prospectus and does not include alldisclosures required by accounting principles generally accepted in theUnited States of America for annual audited combined financialstatements.

2.    Summary of Significant AccountingPolicies

Comprehensive Income

Comprehensive income isdefined as the change in equity of a business enterprise during aperiod from transactions and other events and circumstances, excludingthose resulting from investments by and distributions to owners. Forthe Predecessor's purposes, comprehensive income represents netincome, as presented in the combined statements of operations, andunrealized gains or losses on debt securities available for sale.

Revenue Recognition

Interest income from debt securitiesavailable for sale is recognized on the accrual basis of accountingover the life of the investment on a yield-to-maturity basis.

9

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NORTHSTARREALTY FINANCE CORP. PREDECESSOR

NOTES TOCOMBINED FINANCIAL STATEMENTS (Continued)

Advisory fees from both third parties andaffiliates are recognized on the accrual basis as services are renderedand the fee income contractually earned in accordance with therespective agreements. Fees from affiliated ventures accounted forunder the equity method, such as from the NSF Venture, are partiallyeliminated against the related equity in earnings in such affiliatedventures to the extent of the Predecessor's ownership.

ThePredecessor earns incentive income related to the performance of theNSF Venture through NFMM, who, as the managing member of NSF Venture,is entitled to a promoted interest (i.e. the distribution of adisproportionate allocation of cash flow) after other members haveobtained a specified return threshold and return of capital. ThePredecessor follows Method 1 of Emerging Issues Task Force("EITF") Topic D-96 for recording suchincentive income. Under Method 1 of EITF Topic D-96, no incentiveincome is recorded until all contingencies have been eliminated.Incentive income distributions received by NFMM, which are subject torefund to NSF Venture if certain return thresholds are not met, arerecorded as unearned income (a liability) on the combined balancesheet. In the first quarter of 2004, the Predecessor, through NFMM,received its first incentive income distribution from the NSF Venturein the amount of approximately $0.1 million.

Short Sales

The Predecessor may sell securities that it does not own("short sales"). Short sales are typicallyentered into by the Predecessor as a hedge to offset a future liabilityor changes in the market value of an asset resulting from changes ininterest rates. To complete a short sale, the Predecessor may arrangethrough a broker to borrow the securities to be delivered to the buyer.The proceeds received by the Predecessor from the short sale areretained by the broker until the Predecessor replaces the borrowedsecurities. In borrowing the securities to be delivered to the buyer,the Predecessor becomes obligated to replace the securities borrowed attheir market price at the time of the replacement, whatever that pricemay be. A gain, limited to the price at which the Predecessor sold thesecurity short, or a loss, unlimited as to dollar amount, will berealized upon the termination of a short sale if the market price isless than or greater than the proceeds originally received. ThePredecessor's liability under the short sales is recorded at fairvalue, which is the market price of the security to be acquired toeffect repayment. Unrealized gains or losses on such short saleobligation are included in unrealized loss on short sales of securitiesin the combined statement of operations. The Predecessor is exposed tocredit loss in the event of nonperformance by the broker that holds adeposit as collateral for securities borrowed. However, the Predecessordoes not anticipate nonperformance by the broker. In connection with ashort sale of a FNMA security used for hedging purposes in July 2004,the Predecessor has recognized a liability of $12.9 million which isreflected on the combined balance sheet as securities sold, not yetpurchased. In addition, there is an unrealized loss of $0.4 million onthe sale of shorted securities for the three months ended September 30,2004.

Adjustment to the June 30, 2004 and 2003 FinancialStatements

The June 30, 2004 financial statements of thePredecessor have been adjusted to reflect a decrease of $953,000 to thenet income for the six months ended June 30, 2004, a decrease in totalassets of $930,000 and a decrease in contributed capital of $23,000 atJune 30, 2004. This adjustment relates to an error in calculating theestimated fair value of the Predecessor's investment in the CDOdeposit and warehouse agreement for CDO II during the warehouse periodof $930,000 and an adjustment to the allocation of general andadministrative expenses from NCIC of $23,000. The June 30, 2003financial statements of the Predecessor have been adjusted to reflect adecrease in net income and contributed capital of $40,000 at June 30,2003, relating to an adjustment to the allocation of general andadministrative expenses from NCIC of $40,000.

The financialstatements for the three and nine months ended September 30, 2004appropriately reflect the impact of this restatement and fairly presentthe financial position and results of operations 

10

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NORTHSTARREALTY FINANCE CORP. PREDECESSOR

NOTES TOCOMBINED FINANCIAL STATEMENTS (Continued)

of the Predecessor for the periods thenended. Therefore, these financial statements are not consistent withthe previously filed interim financial statements of the Predecessorfor the six months ended June 30, 2004 included in the Company'sregistration statement on Form S-11 (No. 333-114675) and the relatedprospectus, dated October 25, 2004.

Reclassifications

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

3.    Debt SecuritiesAvailable for Sale

CDO I

On August 21, 2003, the firstCDO Offering was completed by the Predecessor through itsmajority-owned subsidiaries, N-Star Real Estate CDO I Ltd. and N-StarReal Estate CDO I Corp., the issuer and co-issuer, respectively(collectively "CDO I"). CDO I purchased allof the securities accumulated under the CDO Deposit and WarehouseAgreement and financed the purchase through the issuance ofcollateralized debt obligations and the issuance of certain equitysecurities. The Predecessor, through NS CDO Holdings I LLC, acquired15,833 preferred shares of CDO I with a liquidation preference of $15.8million for $10 million. These preferred shares represent 83.33%of the preferred equity of CDO I. Unlike the other participants in CDOI, who are debt holders, the Predecessor and the other preferred equityholders have residual interests in the net cash flow of CDO I, andtherefore bear the first risk of loss. Based on an analysis of thePredecessor's interest in CDO I as a variable interest entityunder FIN 46R, management considered the impact of all cash flows fromthe Predecessor's equity interest in CDO I and all collateralmanagement fees to be received by the Predecessor from CDO I. ThePredecessor's variable interest in these cash flows was comparedto the other variable interests including the minority preferred equityholder, the swap counterparty, the senior classes of CDO debt and theClass D CDO debt. Based on management's analysis, no singlevariable interest holder absorbs a majority of the expected losses oris entitled to a majority of the expected residual returns.Accordingly, CDO I's financial statements were not consolidatedinto the Predecessor's financial statements as of September 30,2004 or December 31, 2003 because the Predecessor is not the primarybeneficiary. The Predecessor's interest in CDO I is accounted foras a debt security available for sale pursuant to EITF 99-20. ThePredecessor has recorded an unrealized gain of approximately $1.2million for the nine months ended September 30, 2004 which has beenrecorded as a component of other comprehensive income in owners'equity. The Predecessor's potential loss in CDO I is limited toits investment in CDO I of approximately $ 9.6 million, which isincluded in the Predecessor's combined balance sheet at September30, 2004.

11

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NORTHSTARREALTY FINANCE CORP. PREDECESSOR

NOTES TOCOMBINED FINANCIAL STATEMENTS (Continued)

Condensed balance sheet and operatinginformation for CDO I is presented below (in thousands):

|                                                    |  |                   |         |                 |  |        |         |        |  |  |
|----------------------------------------------------|--|-------------------|---------|-----------------|--|--------|---------|--------|--|--|
|                                               |  | September30, 2004 |         | December31,2003 |
| **Balance SheetData**                              |  |              |    |            |  |
| Assets                                             |  |              |    |            |  |
| CDOcollateral                                      |  | $                 | 376,933 |            |  | $      | 395,939 |   |
| Cashand cash equivalents, including restrictedcash |  |              | 6,589   |            |  |   | 3,040   |   |
| Accrued interestreceivable                         |  |              | 2,579   |            |  |   | 3,449   |   |
| Deferredcosts,net                                  |  |              | 4,296   |            |  |   | 4,773   |   |
| Totalassets                                        |  | $                 | 390,397 |            |  | $      | 407,201 |   |
| Liabilitiesand shareholder's equity                |  |
| CDO bonds payable,net                              |  | $                 | 340,280 |            |  | $      | 370,549 |   |
| Derivativeliability                                |  |              | 20,782  |            |  |   | 21,277  |   |
| Other                                              |  |              | 1,851   |            |  |   | 2,225   |   |
| Totalliabilities                                   |  |              | 362,913 |            |  |   | 394,051 |   |
| Owners'equity                                      |  |              | 27,484  |            |  |   | 13,150  |   |
| Totalliabilities and owners'equity                 |  | $                 | 390,397 |            |  | $      | 407,201 |   |
|                                                    |

|                                                |  |                                 |        |                               |  |        |       |         |  |        |        |         |  |        |       |         |  |  |
|------------------------------------------------|--|---------------------------------|--------|-------------------------------|--|--------|-------|---------|--|--------|--------|---------|--|--------|-------|---------|--|--|
|                                           |  | ThreeMonths Ended September 30, |        | Nine Months EndedSeptember30, |
|                                           |  | 2004                            |        | 2003                          |  | 2004   |       | 2003    |
| **OperatingData**                              |  |
| Revenues                                       |  | $                               | 5,862  |                          |  | $      | 2,763 |    |  | $      | 18,790 |    |  | $      | 2,763 |    |
| Unrealizedgain /(loss)                         |  |                            | (8,858 | )                        |  |   | (325  | )  |  |   | (2,499 | )  |  |   | (325  | )  |
| Interestexpense                                |  |                            | 5,604  |                          |  |   | 1,593 |    |  |   | 16,667 |    |  |   | 1,593 |    |
| Costsand expenses, excluding related partyfees |  |                            | 29     |                          |  |   | 31    |    |  |   | 56     |    |  |   | 31    |    |
| Relatedpartyfees                               |  |                            | 360    |                          |  |   | 160   |    |  |   | 1,082  |    |  |   | 160   |    |
| Netincome(loss)                                |  | $                               | (8,989 | )                        |  | $      | 654   |    |  | $      | (1,514 | )  |  | $      | 654   |    |
| Othercomprehensive income                      |  |                            | 16,027 |                          |  |   | 1,521 |    |  |   | 17,889 |    |  |   | 1,521 |    |
| Totalcomprehensiveincome                       |  | $                               | 7,038  |                          |  | $      | 2,175 |    |  | $      | 16,375 |    |  | $      | 2,175 |    |
|                                                |

Thefollowing is a summary of the real estate securities which are held byCDO I at September 30, 2004:

|                   |  |           |             |              |  |               |        |                 |  |        |             |             |  |           |  |        |      |         |  |        |      |        |  |  |  |  |
|-------------------|--|-----------|-------------|--------------|--|---------------|--------|-----------------|--|--------|-------------|-------------|--|-----------|--|--------|------|---------|--|--------|------|--------|--|--|--|--|
|              |  |      |             |         |  |          |        | WeightedAverage |
|              |  | Principal |             | %ofPrincipal |  | CarryingValue |        | Rating          |  | Coupon |             | Term(Years) |
| CMBS              |  | $         | 227,424,000 |         |  |          | 63     | %          |  | $      | 235,773,000 |        |  | Baa3/Ba1  |  |   | 6.43 | %  |  |   | 7.17 |   |
| UnsecuredREITDebt |  |      | 115,520,000 |         |  |          | 33     | %          |  |   | 122,905,000 |        |  | Baa2/Baa3 |  |   | 6.46 | %  |  |   | 7.67 |   |
| RealEstateCDO     |  |      | 18,000,000  |         |  |          | 4      | %          |  |   | 18,255,000  |        |  | Baa3/Ba1  |  |   | 7.74 | %  |  |   | 8.26 |   |
| Total             |  | $         | 360,944,000 |         |  |          | 100.00 | %          |  | $      | 376,933,000 |        |  | Baa3      |  |   | 6.50 | %  |  |   | 7.39 |   |
|                   |

12

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NORTHSTARREALTY FINANCE CORP. PREDECESSOR

NOTES TOCOMBINED FINANCIAL STATEMENTS (Continued)

The following table lists the CDO bondspayable for CDO I at September 30, 2004 (in thousands):

|        |  |                     |         |                    |  |                         |         |                        |  |          |        |                    |  |                                |         |        |  |              |  |          |  |                      |  |  |  |  |  |  |  |  |
|--------|--|---------------------|---------|--------------------|--|-------------------------|---------|------------------------|--|----------|--------|--------------------|--|--------------------------------|---------|--------|--|--------------|--|----------|--|----------------------|--|--|--|--|--|--|--|--|
| Class  |  | OriginalNoteBalance |         | PrincipalRepayment |  | UnamortizedBondDiscount |         | CarryingValueAt9/30/04 |  | NoteRate |        | StatedMaturityDate |  | Ratings(Moody's/S&P/Fitch) |
| A-1    |  | $                   | 250,000 |               |  | $                       | (37,804 | )                 |  |     |   |               |  | $                              | 212,196 |   |  | LIBOR+0.42%  |  | 8/1/2038 |  | Aaa/AAA/AAA          |
| A-2A   |  |                | 45,000  |               |  |                    |    |                   |  |     |   |               |  |                           | 45,000  |   |  | LIBOR+0.95%  |  | 8/1/2038 |  | Aa2/AAA/AAA          |
| A-2B   |  |                | 15,000  |               |  |                    |    |                   |  |     |   |               |  |                           | 15,000  |   |  | 5.68%        |  | 8/1/2038 |  | Aa2/AAA/AAA          |
| B-1    |  |                | 15,000  |               |  |                    |    |                   |  |     |   |               |  |                           | 15,000  |   |  | LIBOR+1.675% |  | 8/1/2038 |  | NR/A/A               |
| B-2    |  |                | 10,000  |               |  |                    |    |                   |  |     |   |               |  |                           | 10,000  |   |  | LIBOR+1.80%  |  | 8/1/2038 |  | A3/A–/A– |
| C-1A   |  |                | 5,000   |               |  |                    |    |                   |  |     |   |               |  |                           | 5,000   |   |  | LIBOR+3.00%  |  | 8/1/2038 |  | Baa3/BBB+/BBB+       |
| C-1B   |  |                | 5,000   |               |  |                    |    |                   |  |     |   |               |  |                           | 5,000   |   |  | 7.70%        |  | 8/1/2038 |  | Baa3/BBB+/BBB+       |
| C-2    |  |                | 24,000  |               |  |                    |    |                   |  | $        | (2,234 | )             |  |                           | 21,766  |   |  | 7.01%        |  | 8/1/2038 |  | NR/BBB/BBB           |
| D-1A   |  |                | 10,000  |               |  |                    |    |                   |  |     | (1,921 | )             |  |                           | 8,079   |   |  | LIBOR+2.30%  |  | 8/1/2038 |  | NR/BB+/BB+           |
| D-1B   |  |                | 4,000   |               |  |                    |    |                   |  |     | (761   | )             |  |                           | 3,239   |   |  | 7.01%        |  | 8/1/2038 |  | NR/BB+/BB+           |
|   |  | $                   | 383,000 |               |  | $                       | (37,804 | )                 |  | $        | (4,916 | )             |  | $                              | 340,280 |   |  |
|        |

CDOII

In July 2004, the Predecessor completed its second CDOissuance through a majority-owned subsidiary, NS CDO II, Ltd., theissuer of the CDO ("CDO II"). CDO II acquiredapproximately $400 million of securities accumulated by a majorcommercial bank under the CDO II warehouse agreement and financed thepurchase through the issuance of collateralized debt securities andunrated income notes. The Predecessor purchased $35.0 million ofsubordinated securities of this CDO issuance at a price of $27.4million. This investment was recorded at $27.5 million as it includesthe rollover of the Predecessor's share of the unrealized gainson the warehouse agreement accumulated during the warehouse period.These securities consist of the "BB" ratedjunior classes of debt securities and the unrated income notes whicheffectively represent the residual interest in CDO II. The warehousefacility was terminated upon closing of CDO II in July 2004. ThePredecessor's deposit was applied to the purchase price, $17.4million was borrowed under a short-term facility with the warehousebank and the balance of the purchase price was paid from workingcapital and an additional capital contribution by NSA. The Predecessorhas recorded an unrealized loss of approximately $0.1 million for thenine months ended September 30, 2004, related to the change in the fairvalue of the CDO II equity income and BB notes, which has been recordedas a component of other comprehensive income in owners'equity.

Based on an analysis of the Predecessor's interestin CDO II as a variable interest entity under FIN 46R, managementconsidered the impact of all cash flows from the Predecessor'sequity interest in CDO II, the BB notes, and all collateral managementfees to be received by the Predecessor from CDO II. ThePredecessor's variable interest in these cash flows was comparedto the other variable interests including the unrated income noteholder, the swap counterparty, the senior classes of CDO debt and theClass D CDO debt. Based on management's analysis, no singlevariable interest holder absorbs a majority of the expected losses oris entitled to a majority of the expected residual returns.Accordingly, CDO II's financial statements were not consolidatedinto the Predecessor's financial statements as of September 30,2004, because the Predecessor is not the primary beneficiary. ThePredecessor's investment in the equity income notes of CDO II isaccounted for as a debt security available for sale pursuant to EITF99-20. The Predecessor's potential loss in CDO II is limited toits investment in CDO II of approximately $27.4 million, which isincluded in the Predecessor's combined balance sheet at September30, 2004.

13

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NORTHSTARREALTY FINANCE CORP. PREDECESSOR

NOTES TOCOMBINED FINANCIAL STATEMENTS (Continued)

Condensed balance sheet and operatinginformation is presented below for CDO II as follows (inthousands):

|                                     |  |                  |         |        |  |  |
|-------------------------------------|--|------------------|---------|--------|--|--|
|                                |  | September30,2004 |
|                                |  | (unaudited)      |
| **BalanceSheetData**                |  |
| Assets                              |  |
| CDOcollateral                       |  | $                | 399,735 |   |
| Otherassets                         |  |             | 8,568   |   |
| Totalassets                         |  | $                | 408,303 |   |
| Liabilitiesand shareholder's equity |  |
| CDO bondspayable, net               |  | $                | 375,947 |   |
| Derivativeliability                 |  |             | 15,966  |   |
| Other                               |  |             | 667     |   |
| Totalliabilities                    |  |             | 392,580 |   |
| Owners'equity                       |  |             | 15,723  |   |
| Total liabilitiesand owners'equity  |  | $                | 408,303 |   |
|                                     |

|                                                 |  |                                     |        |         |  |  |
|-------------------------------------------------|--|-------------------------------------|--------|---------|--|--|
|                                            |  | Threemonths ended September 30,2004 |
| **OperatingData**                               |  |                                |   |    |
| Revenues                                        |  | $                                   | 5,677  |    |
| Realizedgain on sale of securities              |  |                                | 788    |    |
| Unrealizedloss                                  |  |                                | (2,262 | )  |
| Interestexpense                                 |  |                                | 3,317  |    |
| Costs and expenses, excludingrelated party fees |  |                                | 56     |    |
| Related partyfees                               |  |                                | 356    |    |
| Netincome                                       |  | $                                   | 474    |    |
|                                                 |

The following is asummary of the real estate securities which are held by CDO II atSeptember 30,2004:

|                   |  |        |             |         |  |               |        |                 |  |        |             |             |  |                |  |        |      |         |  |        |      |        |  |  |  |  |
|-------------------|--|--------|-------------|---------|--|---------------|--------|-----------------|--|--------|-------------|-------------|--|----------------|--|--------|------|---------|--|--------|------|--------|--|--|--|--|
|              |  |   |             |    |  |          |        | WeightedAverage |
|              |  | Cost   |             | %ofCost |  | CarryingValue |        | Rating          |  | Coupon |             | Term(Years) |
| CMBS              |  | $      | 280,064,000 |    |  |          | 71     | %          |  | $      | 286,695,000 |        |  | BBB−/BB+ |  |   | 6.24 | %  |  |   | 7.75 |   |
| UnsecuredREITDebt |  |   | 93,984,000  |    |  |          | 24     | %          |  |   | 92,423,000  |        |  | BBB−     |  |   | 5.13 |    |  |   | 8.18 |   |
| RealEstateCDO     |  |   | 20,412,000  |    |  |          | 5      | %          |  |   | 20,617,000  |        |  | BBB/BBB− |  |   | 5.63 |    |  |   | 9.48 |   |
| Total             |  | $      | 394,460,000 |    |  |          | 100.00 | %          |  | $      | 399,735,000 |        |  | BBB−/BB+ |  |   | 5.94 | %  |  |   | 7.95 |   |
|                   |

14

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NORTHSTARREALTY FINANCE CORP. PREDECESSOR

NOTES TOCOMBINED FINANCIAL STATEMENTS (Continued)

The following table lists the CDO bondspayable for CDO II at September 30, 2004 (in thousands):

|        |  |                     |         |                    |  |                         |        |                        |  |          |        |                    |  |                                |         |        |  |             |  |          |  |                      |  |  |  |  |  |  |  |  |
|--------|--|---------------------|---------|--------------------|--|-------------------------|--------|------------------------|--|----------|--------|--------------------|--|--------------------------------|---------|--------|--|-------------|--|----------|--|----------------------|--|--|--|--|--|--|--|--|
| Class  |  | OriginalNoteBalance |         | PrincipalRepayment |  | UnamortizedBondDiscount |        | CarryingValueAt9/30/04 |  | NoteRate |        | StatedMaturityDate |  | Ratings(Moody's/S&P/Fitch) |
| A-1    |  | $                   | 236,000 |               |  | $                       | (307   | )                 |  |     |   |               |  | $                              | 235,693 |   |  | LIBOR+0.35% |  | 6/1/2039 |  | Aaa/AAA/AAA          |
| A-2A   |  |                | 42,000  |               |  |                    |   |                   |  |     |   |               |  |                           | 42,000  |   |  | LIBOR+0.55% |  | 6/1/2039 |  | NR/AAA/AAA           |
| A-2B   |  |                | 15,000  |               |  |                    |   |                   |  |     |   |               |  |                           | 15,000  |   |  | 5.55%       |  | 6/1/2039 |  | NR/AAA/AAA           |
| B-1    |  |                | 12,000  |               |  |                    |   |                   |  |     |   |               |  |                           | 12,000  |   |  | LIBOR+0.8%  |  | 6/1/2039 |  | A2/A/A               |
| B-2    |  |                | 14,000  |               |  |                    |   |                   |  |     |   |               |  |                           | 14,000  |   |  | LIBOR+1.05% |  | 6/1/2039 |  | A3/A–/A– |
| C-1    |  |                | 24,000  |               |  |                    |   |                   |  | $        | (125   | )             |  |                           | 23,875  |   |  | LIBOR+2.00% |  | 6/1/2039 |  | Baa3/BBB+/BBB+       |
| C-2a   |  |                | 6,000   |               |  |                    |   |                   |  |     |   |               |  |                           | 6,000   |   |  | LIBOR+2.35% |  | 6/1/2039 |  | NR/BBB/BBB           |
| C-2b   |  |                | 16,000  |               |  |                    |   |                   |  |     | (1,000 | )             |  |                           | 15,000  |   |  | 6.591%      |  | 6/1/2039 |  | NR/BBB/BBB           |
| D      |  |                | 15,000  |               |  |                    |   |                   |  |     | (2,621 | )             |  |                           | 12,379  |   |  | 6.820%      |  | 6/1/2039 |  | NR/BB/BB             |
|   |  | $                   | 380,000 |               |  | $                       | (307   | )                 |  | $        | (3,746 | )             |  | $                              | 375,947 |   |  |
|        |

4.    CDODeposit and Warehouse Agreement

In September 2004, thePredecessor entered into a warehouse arrangement with a majorcommercial bank whereby the bank has agreed to purchase up to $400million of CMBS and other real estate debt securities under thePredecessor's direction, with the expectation of selling suchsecurities to the Predecessor's third CDO issuer("CDO III"). The Predecessor was required topledge up to $10 million as security for the purpose of covering aportion of any losses or costs associated with the accumulation ofthese securities under the warehouse agreement. This security was inthe form of a pledge of the Predecessor's preferred shares of CDOI for acquisitions of securities up to $150 million and cash depositsof up to $5.7 million to cover the accumulation of securities from $150million to the maximum of $400 million. The bank has accumulatedapproximately $100 million of real estate securities as of September30, 2004. The other terms of the CDO III warehouse agreement aresubstantially similar to those of the CDO II warehouse agreement, whichprovides for the Predecessor's notional participation in theincome that the assets generate after deducting a notional debt cost.The Predecessor recognized an unrealized gain on the warehouseagreement for CDO III of $0.3 million for the three months endedSeptember 30, 2004, which is shown in the combined statements ofoperations.

5.    Investments in and Advances to UncombinedVentures

The Predecessor has a non-controlling, uncombinedownership interest in various entities that are accounted for using theequity method. Capital contributions, distributions, and profits andlosses of the real estate entities are allocated in accordance with theterms of the applicable partnership and limited liability companyagreements. Such allocations may differ from the stated percentageinterests, if any, in such entities as a result of preferred returnsand allocation formulas as described in such agreements.

ALGM:

The Predecessor owns a 97.5% non-controllinginterest in ALGM as of September 30, 2004 and December 31, 2003. ALGMowns leasehold interests in eight net leased retail properties and feesimple interests in two retail/office properties.

15

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NORTHSTARREALTY FINANCE CORP. PREDECESSOR

NOTES TOCOMBINED FINANCIAL STATEMENTS (Continued)

Condensed combined balance sheets andoperating information is presented below for ALGM (in thousands):

Balance Sheet Data:

|                                      |  |                  |        |                 |  |        |        |        |  |  |
|--------------------------------------|--|------------------|--------|-----------------|--|--------|--------|--------|--|--|
|                                 |  | September30,2004 |        | December31,2003 |
| Assets                               |  |
| Realestate,net                       |  | $                | 42,485 |            |  | $      | 43,851 |   |
| Cash andotherassets                  |  |             | 13,997 |            |  |   | 13,097 |   |
| Totalassets                          |  | $                | 56,482 |            |  | $      | 56,948 |   |
| Liabilitiesand owner's equity        |  |             |   |            |  |
| Mortgagenotespayable                 |  | $                | 40,899 |            |  | $      | 41,881 |   |
| Accountspayable and otherliabilities |  |             | 5,038  |            |  |   | 5,239  |   |
| Totalliabilities                     |  |             | 45,937 |            |  |   | 47,120 |   |
| Predecessor'sequity                  |  |             | 10,281 |            |  |   | 9,583  |   |
| Otherowners'equity                   |  |             | 264    |            |  |   | 245    |   |
| Totalliabilities and owners'equity   |  | $                | 56,482 |            |  | $      | 56,948 |   |
|                                      |

OperatingData:

|                                                |  |                                 |       |                              |  |        |       |        |  |        |       |        |  |        |       |        |  |  |
|------------------------------------------------|--|---------------------------------|-------|------------------------------|--|--------|-------|--------|--|--------|-------|--------|--|--------|-------|--------|--|--|
|                                           |  | ThreeMonths Ended September 30, |       | Nine MonthsEndedSeptember30, |
|                                           |  | 2004                            |       | 2003                         |  | 2004   |       | 2003   |
| Revenues                                       |  | $                               | 2,642 |                         |  | $      | 2,874 |   |  | $      | 7,775 |   |  | $      | 8,357 |   |
| Costsand expenses, excluding related partyfees |  |                            | 1,990 |                         |  |   | 2,054 |   |  |   | 5,937 |   |  |   | 6,233 |   |
| Allowancefor uncollectible and unbilledrents   |  |                            | 109   |                         |  |   | 103   |   |  |   | 293   |   |  |   | 362   |   |
| Relatedparty managementfees                    |  |                            | 190   |                         |  |   | 193   |   |  |   | 572   |   |  |   | 584   |   |
| Netincome                                      |  | $                               | 353   |                         |  | $      | 524   |   |  | $      | 973   |   |  | $      | 1,178 |   |
|                                                |

NSFVenture:

In 2001, the Predecessor formed the NSF Venture, aninvestment fund with an institutional pension fund (the"NSF Venture Investor"), and committed tofund $10 million in equity or 5% of the total equity commitmentof $200 million. The NSF Venture was formed to acquire and originatesubordinate debt instruments on real estate assets. The NSF Venture wasdetermined to be a variable interest entity pursuant to FIN 46R,although the Predecessor was not determined to be the primarybeneficiary. Accordingly, the NSF Venture is not consolidated into thePredecessor and is accounted for under the equity method.

As ofSeptember 30, 2004, the Predecessor has an investment of approximately$6.1 million, which is included in investments in and advances touncombined ventures in the accompanying combined balance sheets.Through September 30, 2004, the NSF Venture has invested approximately$135.9 million of its total committed equity capital, $6.7 million ofwhich was funded by the Predecessor.

16

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NORTHSTARREALTY FINANCE CORP. PREDECESSOR

NOTES TOCOMBINED FINANCIAL STATEMENTS (Continued)

Condensed combined balance sheets andoperating information is presented below for the NSF Venture (inthousands):

Balance SheetData:

|                                           |  |                  |         |                 |  |        |         |        |  |  |
|-------------------------------------------|--|------------------|---------|-----------------|--|--------|---------|--------|--|--|
|                                      |  | September30,2004 |         | December31,2003 |
| Assets                                    |  |
| Unsecuredloan investments and otherassets |  | $                | 124,243 |            |  | $      | 115,702 |   |
| Totalassets                               |  | $                | 124,243 |            |  | $      | 115,702 |   |
| Liabilitiesand owner's equity             |  |             |    |            |  |
| Accountspayable and otherliabilities      |  | $                | 1,238   |            |  | $      | 1,230   |   |
| Totalliabilities                          |  |             | 1,238   |            |  |   | 1,230   |   |
| Predecessor'sequity                       |  |             | 6,143   |            |  |   | 5,716   |   |
| Otherowners'equity.                       |  |             | 116,862 |            |  |   | 108,756 |   |
| Totalliabilities and owners'equity        |  | $                | 124,243 |            |  | $      | 115,702 |   |
|                                           |

|                                                |  |                                 |       |                               |  |        |       |        |  |        |        |        |  |        |       |        |  |  |
|------------------------------------------------|--|---------------------------------|-------|-------------------------------|--|--------|-------|--------|--|--------|--------|--------|--|--------|-------|--------|--|--|
|                                           |  | ThreeMonths Ended September 30, |       | Nine Months EndedSeptember30, |
|                                           |  | 2004                            |       | 2003                          |  | 2004   |       | 2003   |
| Revenues                                       |  | $                               | 3,379 |                          |  | $      | 2,302 |   |  | $      | 10,064 |   |  | $      | 4,064 |   |
| Costsand expenses, excluding related partyfees |  |                            | 34    |                          |  |   | 8     |   |  |   | 85     |   |  |   | 64    |   |
| Relatedpartyfees                               |  |                            | 264   |                          |  |   | 181   |   |  |   | 783    |   |  |   | 333   |   |
| Netincome                                      |  | $                               | 3,081 |                          |  | $      | 2,113 |   |  | $      | 9,196  |   |  | $      | 3,667 |   |
|                                                |

Reconciliationbetween the operating data for all uncombined ventures and thePredecessor's equity in earnings from uncombined ventures forthree and nine months ended September 30, 2004 and 2003 is as follows(in thousands):

|                                               |  |                                |        |                               |  |        |        |         |  |        |        |         |  |        |        |         |  |  |
|-----------------------------------------------|--|--------------------------------|--------|-------------------------------|--|--------|--------|---------|--|--------|--------|---------|--|--------|--------|---------|--|--|
|                                          |  | ThreeMonths EndedSeptember 30, |        | Nine Months EndedSeptember30, |
|                                          |  | 2004                           |        | 2003                          |  | 2004   |        | 2003    |
| Netincome                                     |  | $                              | 3,434  |                          |  | $      | 2,637  |    |  | $      | 10,169 |    |  | $      | 4,845  |    |
| Otherpartners' share of income                |  |                           | (2,958 | )                        |  |   | (2,020 | )  |  |   | (8,851 | )  |  |   | (3,435 | )  |
| Eliminationentries                            |  |                           | 13     |                          |  |   | 8      |    |  |   | 39     |    |  |   | 23     |    |
| Stepupcosts                                   |  |                           | (2     | )                        |  |   | (2     | )  |  |   | (6     | )  |  |   | (7     | )  |
| Predecessor'searnings from uncombinedventures |  | $                              | 487    |                          |  | $      | 623    |    |  | $      | 1,351  |    |  | $      | 1,426  |    |
|                                               |

17

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NORTHSTARREALTY FINANCE CORP. PREDECESSOR

NOTES TOCOMBINED FINANCIAL STATEMENTS (Continued)

Reconciliation between thePredecessor's investments in uncombined entities and its portionof underlying equity is as follows (inthousands):

|                                                 |  |                  |        |                 |  |        |         |        |  |  |
|-------------------------------------------------|--|------------------|--------|-----------------|--|--------|---------|--------|--|--|
|                                            |  | September30,2004 |        | December31,2003 |
| Predecessor's equity inuncombinedentities       |  | $                | 16,425 |            |  | $      | 15,299  |   |
| Eliminationentry.                               |  |             | 74     |            |  |   | 35      |   |
| Purchase price basisdifference                  |  |             | 197    |            |  |   | 203     |   |
| Other                                           |  |             | (79    | )          |  |   | — |   |
| Investmentin and advances to uncombinedventures |  | $                | 16,617 |            |  | $      | 15,537  |   |
|                                                 |

6.    Shortterm loan payable

On July 21, 2004, NS CDO Holdings II, LLCentered into a financing arrangement with Citigroup Global Markets Inc.("Citigroup") and originally borrowed $17.4million under a repurchase agreement that is being accounted for as asecured borrowing since the Predecessor maintains effective control ofthe financed assets. This financing is secured by the"BB" rated junior classes of debt securitiesand unrated income notes of CDO II.  The financing matures onJuly 21, 2005 and bears interest at LIBOR plus 125 basis points. InSeptember 2004 Citigroup made an additional advance under the financingagreement of $129,000. The principal amount outstanding at September30, 2004 is $17.5 million and the aggregate interest rate is2.875%. The Company has incurred interest expense on these loansof approximately $0.2 million, from July 21, 2004 through September 30,2004.

7.    Related Party Transactions

Advisory Fee— CDO II:

The Predecessor earned a structuring fee of$500,000 in connection with the closing of CDO II which was used toreduce the Predecessor's investment in CDO II, during the threemonths ended September 30, 2004. As the $500,000 fee was used to reducethe $10 million cash required to acquire the Predecessor'sinterest in CDO II, such amount is a non-cash activity and has beenexcluded from the statement of cash ows.

Receivable fromAffiliates:

Receivable from affiliate represents the cashbalance held in the bank account of an affiliate of the parent companyof NSA. The Predecessor can draw on this cash account at any time. Theaccount had a balance of $2.1 million and $0.9 million at September 30,2004 and December 31, 2003, respectively.

8.     SegmentReporting

The Predecessor has three reportable segments: (i)subordinate real estate debt, (ii) real estate securities and (iii) netlease real estate investments. The Predecessor evaluates performanceprimarily based on its proportionate share of the earnings of suchinvestments. General and administrative expenses are not allocated bymanagement to various segments and therefore are presented asunallocated. The reportable segments are managed separately due to thediffering nature of the business operations. The following tables setsforth certain segment information for the Predecessor, as of and forthe three months ended September 30, 2004 and 2003 and the year endedDecember 31, 2003 (in thousands):

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NORTHSTARREALTY FINANCE CORP. PREDECESSOR

NOTES TOCOMBINED FINANCIAL STATEMENTS (Continued)

|                                          |  |                        |         |                           |  |                          |         |             |  |        |         |         |  |        |         |         |  |        |        |         |  |  |
|------------------------------------------|--|------------------------|---------|---------------------------|--|--------------------------|---------|-------------|--|--------|---------|---------|--|--------|---------|---------|--|--------|--------|---------|--|--|
|                                     |  | NetLeaseInvestmentALGM |         | SubordinateRealEstateDebt |  | Real EstateSecuritiesCDO |         | Unallocated |  | Total  |
| **Threemonths ended September 30, 2004** |  |
| Totalrevenues                            |  | $                      | — |                      |  | $                        | 308     |        |  | $      | 1,629   |    |  | $      | — |    |  | $      | 1,937  |    |
| Equityin earnings of uncombinedventures  |  |                   | 343     |                      |  |                     | 144     |        |  |   | — |    |  |   | 487     |    |  |
| Gainson warehouseagreements              |  |                   | — |                      |  |                     | — |        |  |   | 702     |    |  |   | — |    |  |   | 702    |    |
| Losson shortedsecurity                   |  |                   | — |                      |  |                     | — |        |  |   | (358    | )  |  |   | — |    |  |   | (358   | )  |
| Totalexpenses                            |  |                   | — |                      |  |                     | — |        |  |   | 485     |    |  |   | 1,933   |    |  |   | 2,418  |    |
| NetIncome (loss) fromoperations          |  | $                      | 343     |                      |  | $                        | 452     |        |  | $      | 1,488   |    |  | $      | (1,933  | )  |  | $      | 350    |    |
| TotalAssets                              |  | $                      | 10,479  |                      |  | $                        | 6,138   |        |  | $      | 54,890  |    |  | $      | — |    |  | $      | 71,507 |    |
| **Yearended December 31, 2003**          |  |
| TotalAssets                              |  | $                      | 9,786   |                      |  | $                        | 5,751   |        |  | $      | 17,278  |    |  | $      | — |    |  | $      | 32,815 |    |
| **Threemonths ended September 30, 2003** |  |
| Totalrevenues                            |  | $                      | — |                      |  | $                        | 202     |        |  | $      | 310     |    |  | $      | — |    |  | $      | 512    |    |
| Equityin earnings of uncombinedventures  |  |                   | 509     |                      |  |                     | 114     |        |  |   | — |    |  |   | — |    |  |   | 623    |    |
| Gainson warehouseagreements              |  |                   | — |                      |  |                     | — |        |  |   | 1,015   |    |  |   | — |    |  |   | 1,015  |    |
| Totalexpenses                            |  |                   | — |                      |  |                     | — |        |  |   | 652     |    |  |   | 847     |    |  |   | 1,499  |    |
| NetIncome (loss) fromoperations          |  | $                      | 509     |                      |  | $                        | 316     |        |  | $      | 673     |    |  | $      | (847    | )  |  | $      | 651    |    |
|                                          |

Thefollowing tables set forth certain segment information for thePredecessor, as of and for the nine months ended September 30, 2004 and2003 (inthousands):

|                                         |  |                        |         |                           |  |                          |         |             |  |        |         |         |  |        |         |         |  |        |        |         |  |  |
|-----------------------------------------|--|------------------------|---------|---------------------------|--|--------------------------|---------|-------------|--|--------|---------|---------|--|--------|---------|---------|--|--------|--------|---------|--|--|
|                                    |  | NetLeaseInvestmentALGM |         | SubordinateRealEstateDebt |  | Real EstateSecuritiesCDO |         | Unallocated |  | Total  |
| **Ninemonths ended September 30, 2004** |  |
| Totalrevenues                           |  | $                      | — |                      |  | $                        | 908     |        |  | $      | 2,882   |    |  | $      | — |    |  | $      | 3,790  |    |
| Equityin earnings of uncombinedventures |  |                   | 943     |                      |  |                     | 408     |        |  |   | — |    |  |   | — |    |  |   | 1,351  |    |
| Gainson warehouseagreements             |  |                   | — |                      |  |                     | — |        |  |   | 1,419   |    |  |   | — |    |  |   | 1,419  |    |
| Losson shortedsecurity                  |  |                   | — |                      |  |                     | — |        |  |   | (358    | )  |  |   | — |    |  |   | (358   | )  |
| Totalexpenses                           |  |                   | — |                      |  |                     | — |        |  |   | 1,186   |    |  |   | 3,894   |    |  |   | 5,080  |    |
| NetIncome (loss) fromoperations         |  | $                      | 943     |                      |  | $                        | 1,316   |        |  | $      | 2,757   |    |  | $      | (3,894  | )  |  | $      | 1,122  |    |
| TotalAssets                             |  | $                      | 10,479  |                      |  | $                        | 6,138   |        |  | $      | 54,890  |    |  | $      | — |    |  | $      | 71,507 |    |
| **Ninemonths ended September 30, 2003** |  |
| Totalrevenues                           |  | $                      | — |                      |  | $                        | 339     |        |  | $      | 310     |    |  | $      | — |    |  | $      | 649    |    |
| Equityin earnings of uncombinedventures |  |                   | 1,142   |                      |  |                     | 284     |        |  |   | — |    |  |   | — |    |  |   | 1,426  |    |
| Gainson warehouseagreements             |  |                   | — |                      |  |                     | — |        |  |   | 2,884   |    |  |   | — |    |  |   | 2,884  |    |
| Totalexpenses                           |  |                   | — |                      |  |                     | — |        |  |   | 1,153   |    |  |   | 2,510   |    |  |   | 3,663  |    |
| NetIncome (loss) fromoperations         |  | $                      | 1,142   |                      |  | $                        | 623     |        |  | $      | 2,041   |    |  | $      | (2,510  | )  |  | $      | 1,296  |    |
|                                         |

9.    SubsequentEvents

Initial Public Offering

On October 29, 2004,the Company closed its IPO, pursuant to which it issued 20,000,000shares of common stock, with proceeds to the Company of approximately$160.4 million, net of issuance costs of $19.6 million. On November 19,2004, the Company issued an additional 1,160,750 shares of common stockpursuant to the exercise of the overallotment option by theunderwriters of the IPO, with proceeds to the Company of $9.7 million,net of issuance costs of $0.7 million. In connection with the IPO, theCompany also issued 50,000 shares of common stock, as partialcompensation for underwriting services to the lead underwriter of theIPO.

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NORTHSTARREALTY FINANCE CORP. PREDECESSOR

NOTES TOCOMBINED FINANCIAL STATEMENTS (Continued)

On October 29, 2004, three subsidiariesof NCIC contributed the Initial Investments to the OperatingPartnership in exchange for an aggregate of 4,705,915 OP Units.Immediately prior to such contribution, the Predecessor acquired (i) a15% profit sharing right in NSA from an employee of NCIC who iscurrently the Company's chief investment officer and (ii) aprofits interest in NFMM from a current employee of NCIC and a formeremployee of NCIC. In exchange for the acquisition of the 15%profit sharing right in NSA, the Company's chief investmentofficer will receive 206,900 of the 4,705,915 OP Units. In exchange forthe acquisition of the profits interest in NFMM, the two employees ofNCIC will receive an aggregate of 164,537 of the 4,705,915 OPUnits.

Concurrently with the contribution of the InitialInvestments to the Operating Partnership and the consummation of theIPO, the Company purchased the remaining 2.5% managing equityinterest, which is also entitled to a special allocation of profits inALGM, from ALGM I Equity LLC, a related party, with $1.6 million of theproceeds of the IPO. Going forward, the results of these propertieswill be reflected on a consolidated basis.

On November 3, 2004,the Company repaid $7.3 million of its short-term loan payableincluding accrued interest which was secured by the Company'sinterest in the unrated income notes of CDO II.

InvestmentActivity

In October 2004, the Company pledged its 83%equity interest in CDO I as collateral under a warehouse agreement forCDO III. On November 23, 2004, the Company made a $2.5 million depositrequired under the warehouse agreement for CDO III. Approximately $226million of the $400 million in securities required to close CDO IIIhave been accumulated as of December 22, 2004 under the warehouseagreement.

On November 12, 2004, the Company purchased a $24million subordinate debt participation from a bank in an $82 millionsenior mortgage loan secured by a 417,922 square foot, 17 story,class-B office building in New York City. The subordinate debtparticipation bears interest at LIBOR plus 375 basis points, with $6million of the principal subject to a LIBOR floor of 1.5% andmatures on August 9, 2006. In connection with the purchase of thisparticipation, the Company received a 1% origination fee. Inaddition, the borrower has three one-year extension options.

OnNovember 16, 2004, the Company purchased a $22 million mezzanine loanfrom a bank which is secured by an equity interest in the borrower thatis the owner of nine Embassy Suites hotels with 2,150 rooms. Themezzanine loan bears interest at LIBOR plus 475 basis points andmatures on June 9, 2006. In addition, the borrower has three one-yearextension options.

On November 19, 2004 the Company entered intoa contract for $63.5 million to purchase a portfolio of threenet-leased office properties totaling 257,336 square feet of rentablespace in Chatsworth, CA. The properties are net leased to a bank underleases that expire in June 2015. In connection with the contract, theCompany made a deposit of $1.5 million, which is non-refundable unlesscertain conditions are not met by the seller of the properties prior toclosing.

Subsequent to the IPO in October 2004, the Company hasmade temporary investments in $1.32 billion of primarily AAA-rated,short-term, floating rate securities which are backed by commercial orresidential mortgage loans. These investments have been financedthrough repurchase agreements with major banks and securities firmswhereby the Company borrowed approximately $1.27 billion and funded theremaining balance of $51 million in cash. In December 2004, the Companysold $431.9 million of these temporary investments and repaid theassociated repurchase agreements with major banks. The Company'stemporary investment strategy is designed to generate sufficientqualifying income during the two-month period before theCompany's fiscal year end so that it will be able to meet all ofthe REIT compliance requirements in advance of deploying capitalpursuant to the Company's long-term business plan.

OnDecember 21, 2004, the Company entered into a $150 million masterrepurchase agreement with Deutsche Bank AG, Cayman Islands Branch tofinance its investment in first mortgage loans, B 

20

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NORTHSTARREALTY FINANCE CORP. PREDECESSOR

NOTES TOCOMBINED FINANCIAL STATEMENTS (Continued)

notes, mezzanine loans and rated real estatesecurities. The agreement has a three-year term and one one-yearextension option. Advances under the agreement bear interest at onemonth LIBOR plus a spread ranging from 0.75% to 2.25%,which is reset monthly. The master repurchase agreement containscertain covenants, the most restrictive of which, is a requirement thatthe Company maintain a minimum tangible net worth, including theminority interest in the Operating Partnership, of no less than $125million. As of December 30, 2004, $27.8 million was outstanding underthis facility.

On December 30, 2004, the Company purchased anapproximately $24.8 million subordinate participation interest in asenior mortgage loan secured by a 700,000 square foot hotel located inMiami, Florida that will be converted into residential condominiums. Inconnection with the purchase, the Company received a .50%origination fee. The subordinate debt participation initially bearsinterest at LIBOR plus 560 basis points, decreasing to LIBOR plus 440basis points after certain principal repayments are made by theborrower. The subordinate participation has an initial maturity ofSeptember 14, 2006 and the borrower has the ability to extend the termfor one additional year under certain conditions including the paymentof a .25% fee.

NSF Venture

On December 11, 2004,the NSF Venture's $7.65 million subordinate loan participationcollateralized by a portfolio of multifamily properties in the PacificNorthwest was repaid in full. There were no additional fees associatedwith the repayment since the yield maintenance period for the loanexpired on October 11, 2004. The second extended maturity date for theloan was September 11, 2005.

On December 10, 2004, the borrowerunder the $9.48 million junior participation in a mezzanine loancollateralized by an office property in northern Florida held by theNSF Venture notified the Company that it would repay the loan in fullon January 11, 2005. There will be no additional fees associated withthe repayment since the yield maintenance period expired on November11, 2004. The initial extended maturity date for the loan was August11, 2005.

Omnibus Stock Incentive Plan

On September 14,2004, the board of directors of the Company adopted the NorthStarRealty Finance Corp. 2004 Omnibus Stock Incentive Plan (the Stock"Incentive Plan"). The Stock Incentive Planprovides for the issuance of stock-based incentive awards, includingincentive stock options, non-qualified stock options, stockappreciation rights, shares of common stock of the Company, includingrestricted shares, and other equity-based awards, including OP Unitswhich are structured as profits interests ("LTIPUnits") or any combination of the foregoing. The eligibleparticipants in the Stock Incentive Plan include directors, officersand employees of the Company, co-employees of the Company and NCIC andemployees of NCIC who will provide services to the Company pursuant tothe shared facilities and services agreement. An aggregate of 1,443,750shares of common stock of the Company are currently reserved andauthorized for issuance under the Stock Incentive Plan, subject toequitable adjustment upon the occurrence of certain corporate events.On October 29, 2004, an aggregate of 38,886 shares of restricted commonstock were granted to the Company's non-employee directorspursuant to the Stock Incentive Plan. In addition, an aggregate of798,582 LTIP Units have been granted to the Company's officers,employees and co-employees of the Company and NCIC pursuant to theStock Incentive Plan.

Long-Term Incentive Bonus Plan

OnSeptember 14, 2004, the board of directors of the Company adopted theNorthStar Realty Finance Corp. 2004 Long-Term Incentive Bonus Plan (the"Incentive Bonus Plan"), in order to retainand incentivize officers and certain key employees of the Company,co-employees of the Company and 

21

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NORTHSTARREALTY FINANCE CORP. PREDECESSOR

NOTES TOCOMBINED FINANCIAL STATEMENTS (Continued)

NCIC and employees of NCIC who will provideservices to the Company pursuant to the shared facilities and servicesagreement. Up to 2.5% of the Company's totalcapitalization as of consummation of the IPO is available to be paidunder the Incentive Bonus Plan in cash, shares of common stock of theCompany or other share-based form at the discretion of the compensationcommittee of the Company's board of directors, if certain returnhurdles are met.

An aggregate of 685,851 shares of common stockof the Company are currently reserved and authorized for issuance underthe Incentive Bonus Plan, subject to equitable adjustment upon theoccurrence of certain corporate events. As of November 19, 2004, anaggregate of 665,346 shares of common stock of the Company wereallocated to officers, employees and co-employees of the Company andNCIC for awards under the Incentive Bonus Plan if the Company achievesthe return hurdles established by the compensation committee. If theCompany achieves these return hurdles, the awards allocated may be paidin cash, shares of common stock, LTIP units or other shared-basedform.

ALGM

On December 28, 2004, ALGM terminated itsexisting asset management agreement with Emmes Asset Management Co. LLC("Emmes"), an affiliate of Northstar Capital.Pursuant to the termination provisions of the agreement, ALGM paidEmmes a contractual termination payment of approximately $380,000,which is equal to two quarters of payments of the annual existing feeof $760,000. In addition, ALGM and Emmes entered into a new assetmanagement agreement which is cancelable on 30 days notice by ALGM. Theannual asset management fee under the new agreement is equal to3.5% of gross collections from tenants of the properties not toexceed $350,000 or be less than $300,000 per year, subject to certainprovisions.

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| ITEM2.  | MANAGEMENT'S DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS |

The followingdiscussion should be read in conjunction with the unaudited interimhistorical financial statements of our predecessor, Northstar RealtyFinance Corp. Predecessor and notes related thereto included in thisreport.

Forward-Looking Statements

We consider certainstatements set forth herein to be forward-looking statements within themeaning of the Private Securities Litigation Reform Act.Forward-looking statements include, without limitation, statementsrelating to the operating performance of our investments and ourfinancing needs and are generally identifiable by use offorward-looking terminology such as "may,""will," "should,""potential,""intend," "expect,""seek,""anticipate,""estimate,""believe," "could,""project,""predict,""continue" or other similar words orexpressions. These statements are based on management's currentexpectations and beliefs and are subject to a number of trends anduncertainties that could cause actual results to differ materially fromthose described in the forward-looking statements. We cannot give anyassurances that its expectations will be attained. Factors that couldcause actual results to differ materially from our expectationsinclude, but are not limited to changes in economic conditionsgenerally and the real estate and bond markets specifically,legislative or regulatory changes (including changes to laws governingthe taxation of REITs), availability of capital, interest rates andinterest rate spreads, policies and rules applicable to REITs, thecontinued service of key management personnel, the effect ofcompetition in the real estate finance industry, the costs associatedwith compliance and corporate governance, including the Sarbanes-OxleyAct and related regulations and requirements, and other risks detailedfrom time to time in the reports filed by us with the Securities andExchange Commission. Such forward-looking statements speak only as ofthe date of this report. We expressly disclaim any obligation torelease publicly any updates or revisions to any forward-lookingstatements contained herein to reflect any change in its expectationswith regard thereto or change in events, conditions or circumstances onwhich any statement is based.

Organization and Overview

As of the completion of the our initial public offering on October29, 2004, we are an integrated, self-administered and self-managed realestate investment trust ("REIT") formed tocontinue the business of our predecessor.

Results for the threeand nine months ended September 30, 2004 and 2003 do not include thecontribution of an initial portfolio of investments to our operatingpartnership and the other formation transactions entered into inconnection with our initial public offering. These results should bereviewed along with our prospectus, dated October 25, 2004, as filedpursuant to Rule 424(b) of the SEC's rules and regulations.

As a result of the timing and occurence of the contributiontransactions, the other formation transactions and our initial publicoffering, we do not believe that the results of operations of ourpredecessor contained herein are necessarily indicative of our futureoperating results as a publicly-held REIT. The information providedonly reflects the operations of our predecessor for the three andnine-month periods ended September 30, 2004 and 2003, and is notnecessarily indicative of our operations on a going forward basis.

General

Upon the consummation of our initial publicoffering on October 29, 2004, certain subsidiaries of NorthStarPartnership L.P. , the operating partnership through which NorthstarCapital Investment Corp. conducts its business, contributed our initialinvestments to our operating partnership in exchange for units oflimited partnership interest in our operating partnership andapproximately $36.1 million in cash. Our operating partnership, inturn, contributed all of the initial investments, other than the equityinterest in CDO I, to its wholly-owned subsidiary which is alsoorganized to qualify as a REIT. NorthStar Partnership, L.P. andNorthStar Capital Investment Corp. are collectively referred to belowas Northstar Capital.

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Through our operating partnership, we:

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| •  | acquire, originate and structuresubordinate and other high-yielding debt investments secured byincome-producing real estate properties; |

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| •  | create, manage and issue CDOs backed bycommercial real estate debt securities; and |

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| •  | acquire properties that are primarily netleased to corporate tenants. |

We conduct substantially all of ouroperations and make our investments through our operating partnership,of which we are the sole general partner. We operate so as to qualifyas a REIT under the Internal Revenue Code, commencing with our taxableyear ending December 31, 2004 and generally do not expect to be subjectto federal income taxes on our income to the extent we distribute ourincome to our stockholders and maintain our intended qualification as aREIT.

We were formed for the purpose of continuing and expandingthe subordinate debt, real estate securities and net lease businessesconducted by NorthStar Capital. Upon the consummation of our initialpublic offering, certain subsidiaries of NorthStar Capital contributedto our operating partnership 100% of their respective interestsin entities through which NorthStar Capital has engaged in thesebusinesses. Our management team consists of primarily the sameindividuals who managed these businesses for NorthStar Capital.

NorthStar Capital used $32 million of the $36.1 million cashdistribution to reduce the outstanding principal amount under itssenior secured credit facility with Allianz Risk Transfer in order torelease liens associated with our initial investments and $4.1 millionto reimburse Presidio Capital Investment Company LLC for a cash depositmade under the warehouse agreement for the acquisition of the realestate securities backing a prior CDO issuance.

Basis ofPresentation

The discussion below relates to the historicalfinancial condition and results of operations of the entities throughwhich NorthStar Capital owned and operated its subordinate real estatedebt, real estate securities and net lease properties businesses.

Our predecessor is an aggregation, on a combined and uncombinedbasis, of the entities engaged in these businesses and is not aseparate legal operating entity. The ultimate owners of the entitiescomprising our predecessor are NorthStar Capital and certain others whohave minority ownership interests in these entities. Our predecessorwas, and is, the managing member of the entities that directly orindirectly own the initial investments and our predecessor had, andhas, responsibility for the day-to-day operations of the entities thatare combined in our predecessor's historical financialstatements. Where our predecessor had, and will continue to have, anon-controlling interest, such entity is reflected as part of ourpredecessor on an uncombined basis. Because the discussion belowrelates to the historical financial condition and results of operationsof the entities comprising our predecessor, it reflects the historicalfinancing and operational strategies of these entities.

Theentities comprising our predecessor historically operated as separatebusinesses of NorthStar Capital utilizing certain NorthStar Capitalemployees, insurance and administrative services. General andadministrative costs incurred by NorthStar Capital on behalf of all ofits business units include employee salaries, rent, advertising,accounting, legal services and other general and administrativeexpenses. These expenses were allocated to our predecessor throughNorthStar Capital's specific identification of individual costitems, where practical, and otherwise through allocations based uponestimated levels of effort devoted by certain of its employees. In theopinion of management, the method utilized for allocating corporate,general and administrative expenses and other allocated costs isreasonable. With the consummation of the Offering, these businessesbecame more fully integrated, and certain general and administrativeservices provided by NorthStar Capital will now be reimbursed throughthe shared facilities and services agreement that we have entered intowith NorthStar Capital.

Sources of Operating Revenues

Our predecessor historically derived operating revenues primarilyfrom indirect interests in earnings of uncombined ventures and, morerecently, advisory fees related to both our real estate 

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securities and subordinate real estate debtbusinesses, and interest income on CDO investments. Earnings fromuncombined ventures include our proportionate share of the net incomefrom the rental operations related to the New York property portfolio,and our proportionate share of the net income from our subordinate realestate debt business. The discussion below reflects the historicalfinancing and operational strategies of our predecessor and, in someinstances, the performance of specific assets and investments no longerowned by it.

Subordinate Real Estate Debt

Oursubordinate real estate debt business invests in first lien mortgageloans, junior participations in first lien mortgage loans, second lienmortgage loans, mezzanine loans, preferred equity interests of realestate borrowers and other high-yielding real estate debt instruments.Our subordinate real estate debt business was initiated in 2001 and hasbeen operated through a joint venture, the NSF Venture, betweenNorthStar Capital and an institutional pension fund, the NSF VentureInvestor. The joint venture conducts its investment business throughNorthStar Funding LLC, which provides for each member to have approvalrights over the investments selected. Under the terms of the jointventure, NorthStar Funding Management LLC is responsible for theorigination, underwriting and structuring of all investments made bythe NSF Venture. NorthStar Funding Managing Member LLC, a NorthStarCapital affiliate, is the managing member of NorthStar FundingManagement LLC. NorthStar Funding Investor Member LLC held a 10%equity interest in the NSF Venture through July 10, 2003. OnJuly  10, 2003, NorthStar Funding Investor Member LLC negotiatedseveral modifications to the terms of the NSF Venture, including theNSF Venture Investor's increase in capital commitment to$190  million and a reduction of NorthStar Funding InvestorMember LLC's interest to 5%. Our predecessor'sequity in earnings of the NSF Venture includes interest income andorigination fees on investments. To date, the NSF Venture has notincurred any debt in connection with its investment activities.However, the NSF Venture has sold senior participation interests incertain of the subordinate debt investments which it has acquired,directly to the NSF Venture Investor outside of the NSF Venture,retaining the higher risk subordinate participation interests withcorrespondingly higher yields.

Our predecessor receives anadvisory fee equal to 1% per annum of the capital invested bythe NSF Venture as compensation for its management of theseinvestments. Additionally, NorthStar Funding Managing Member LLC isentitled to an incentive profit participation equal to 10% ofthe profit after a minimum required return on the NSF Venture'scapital and a return of and on capital based upon the operatingperformance of the NSF Venture's investments. Prior to thecontribution of the initial investments to our operating partnershipand the related formation transactions, Northstar Funding ManagingMember LLC received 75% of this incentive profit participationequal to 10% of the profit after minimum required return on NSFVenture's capital and a return of and on capital based on theoperating performance of the NSF Venture's investments. Ourpredecessor also earns an additional advisory fee from the NSF VentureInvestor for underwriting and placing the senior participation andsub-participation interests that are acquired by the NSF VentureInvestor directly from the NSF Venture. In the future, we expect toinvest directly in subordinate debt in addition to investing ourremaining commitment to the NSF Venture, which was approximately $3.3million at September 30, 2004. We will not earn advisory fees on theinvestments that we make directly.

Real Estate Securities

Our real estate securities business was initiated in 2002 to investin commercial mortgage-backed securities, or CMBS, and other realestate securities. These securities are primarily investment-grade andare financed with long-term debt through the issuance of CDOs, therebymatching the terms of the assets and the liabilities.

Prior to anew CDO issuance, there is a period during which real estate securitiesare identified and acquired for inclusion in a CDO, known as thewarehouse accumulation period. During this period, we direct theacquisition of securities under a warehouse facility from a bank thatwill be the lead manager of the CDO. The warehouse provider thenpurchases the securities and holds them on 

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its balance sheet. We direct the acquisitionof securities by the warehouse provider during this period, but we donot earn any fees for providing this service to either the warehouseprovider or the issuer of the CDO, which will receive such securitiesupon the closing of the CDO. We contribute cash and other collateral,which is held in escrow by the warehouse provider, to back ourcommitment to purchase equity in the CDO and to cover our share oflosses should securities need to be liquidated. Pursuant to thewarehouse agreement, we share gains, including the net interest earnedduring the warehouse period, and losses, if any, with the warehouseprovider. The investment parameters of this business reflect the riskmanagement strategies and the portfolio characteristics that we havejointly developed with the warehouse provider.

In August 2003,NS Advisors, LLC, ("NS Advisors") completedits first CDO issuance, through N-Star Real Estate CDO I Ltd., or CDOI, and retained an approximately 83% equity interest in CDO I.The 16.67% balance of the equity interest is owned by unrelatedthird party investors. We also earn ongoing management fees for ourmanagement and monitoring of the CDO collateral of CDO  I, whichfees equal 0.35% of the related CDO collateral.

OnNovember 11, 2003, NS Advisors entered into a second warehouseagreement with Citigroup Global Markets Inc., or Citigroup, wherebyCitigroup agreed to purchase up to $400 million of primarily CMBS andREIT debt, with the expectation of selling such securities to ourpredecessor's CDO II. Pursuant to the warehouse agreement for thesecond CDO issuance, our predecessor agreed to a $10 million limitedrecourse arrangement whereby it escrowed approximately $5.8 million incash and pledged its equity interest in CDO I to Citigroup to purchasefuture equity in CDO II upon formation by our predecessor. If eitherour predecessor, or we, caused an early termination, or unilaterallyrefused to proceed with the CDO issuance prior to the finaldetermination date, then any losses resulting from the disposition ofthe securities acquired by Citigroup would have been for the account ofour predecessor, or our account (if occurring after the consummation ofthe Offering), and any net gains arising from the disposition of thecollateral would have been allocated to Citigroup. If the second CDOissuance was not completed, the CDO II deposit of $10 million wouldhave been available to Citigroup for the purpose of covering a portionof any losses or costs associated with the liquidation of theaccumulated securities. This warehouse facility was terminated in July2004 when the Predecessor closed CDO II, through N-Star Real Estate CDOII Ltd., and acquired $35.0 million of subordinated securities of thissecond CDO issuance consisting of all of the"BB" rated junior classes of debt securitiesand unrated income securities. As part of any future CDO issuance, weintend to retain a significant portion of the equity and possibly someof the junior CDO debt securities in order to earn a spread between theyield on the assets and the yield on the CDO debt issued. Thepredecessor recognized unrealized losses of $0.1 million for the ninemonths ended September 30, 2004, related to the change in the fairvalue of the CDO II equity income and BB notes, which has been recordedas a component of other comprehensive income in owners'equity.

In September 2004, NS Advisors entered into a thirdwarehouse arrangement with Citigroup whereby Citigroup agreed topurchase up to $400 million of CMBS and other real estate debtsecurities at our direction for future sale to CDO III. We are requiredto pledge up to $10 million as security for the purpose of covering aportion of any losses or costs associated with the accumulation ofthese securities under this warehouse agreement. This security is inthe form of a pledge of our approximately 83% equity interest inCDO I for acquisitions of securities up to $150 million and cashdeposits of up to approximately $5.7 million to cover the accumulationof securities from $150 million to the maximum of $400 million. The CDOI preferred interest was pledged as security for the CDO  IIIwarehouse in October, 2004. The other terms of the CDO III warehouseagreement are substantially similar to those of the warehouse agreementfor CDO II. Approximately $100 million of the $400 million securitieshave been accumulated as of September 30, 2004 under the warehouseagreement. As of December 22, 2004, approximately $226 million of the$400 in securities have been accumulated. The predecessor recognized anunrealized gain on the warehouse agreement for CDO  III of $0.3million for the three months ended September 30, 2004.

Duringthe warehouse period, our participation under the warehouse agreementis reflected in our combined financial statements as a non-hedgederivative, which is reflected at fair value and any unrealized gain orloss is charged to operations. Based on an analysis of ourpredecessor's interest in 

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CDO I as a variable interest entity underFASB Interpretation No. 46R "Consolidation of VariableInterest Entities," the financial statements of CDO I werenot consolidated into our predecessor's financial statements asof December 31, 2003 and September 30, 2004 since our predecessor isnot the primary beneficiary of CDO I. Similarly, the financialstatements of CDO II were not consolidated into our predecessor'sfinancial statements as of September 30, 2004 since our predecessor isnot the primary beneficiary of CDO II. Accordingly, our predecessor hasdesignated these beneficial interests in preferred equity of CDO I andthe unrated income notes of CDO II as available for sale securities asthey meet the definition of a debt instrument due to their underlyingredemption provisions. We anticipate that CDO III will be treatedsimilarly for financial reporting purposes.

Short Sales

Our predecessor may sell securities that it does not own("short sales"). Short sales are typicallyentered into by our predecessor as a hedge to offset a future liabilityor changes in the market value of an asset resulting from changes ininterest rates. To complete a short sale, our Predecessor may arrangethrough a broker to borrow the securities to be delivered to the buyer.The proceeds received by our predecessor from the short sale areretained by the broker until our predecessor replaces the borrowedsecurities. In borrowing the securities to be delivered to the buyer,our predecessor becomes obligated to replace the securities borrowed attheir market price at the time of the replacement, whatever that pricemay be. A gain, limited to the price at which our predecessor sold thesecurity short, or a loss, unlimited as to dollar amount, will berealized upon the termination of a short sale if the market price isless than or greater than the proceeds originally received. Ourpredecessor's liability under the short sales is recorded at fairvalue, with unrealized gains or losses included in unrealized loss onshort sales of securities in the combined statement of operations. Ourpredecessor is exposed to credit loss in the event of nonperformance bythe broker that holds a deposit as collateral for securities borrowed.However, our predecessor does not anticipate nonperformance by thebroker. In connection with a short sale of a FNMA security used forhedging purposes in July 2004, our predecessor has recognized aliability of $12.9 million which is reflected on the combined balancesheet as securities sold, not yet purchased. In addition, there is anunrealized loss of $0.4  million on the sale of shortedsecurities for the three months ended September  30, 2004.

Net Lease Properties

We invest in office, industrial andretail properties net leased to corporate tenants. Tenants subject tonet leases generally pay for all or their pro rata portion of theoperating expenses of the property. A net lease property is oftenleased to a single tenant for an original term of ten years orlonger.

Our predecessor owns an indirect interest in a portfolioof well-located retail and commercial properties in the Times Squareand midtown Manhattan area of New York City. This New York propertyportfolio, consisting of two fee and six leasehold interests in retailand commercial properties, is owned by ALGM I Owners LLC, or ALGM, anentity in which our predecessor held a non-managing majority interest.This portfolio was acquired at a substantial discount due to a loandefault by the previous owner.

ALGM purchased the portfolio andproceeded to upgrade, reconfigure and reposition the assets, which atthe time of purchase were leased to tenants at below market rents. Theproperties have since attracted new, higher-paying tenants, increasingthe value of ALGM's interests in the properties.

As ofDecember 31, 2002, ALGM had interests in ten properties. Two ofALGM's leases expired in 2003, one in March and one in October.As of September 30, 2004 the remaining eight properties, which vary insize from 4,200 square feet to 21,140 square feet, had a total of96,114 net rentable square feet. Four of the properties are primarilyleased or subleased to single users and four are leased or subleased tomultiple tenants.

The results of operations for these propertiesare reflected in our predecessor's equity in earnings ofuncombined ventures because our predecessor currently owns a97.5% non-managing equity interest 

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in ALGM. Concurrently with the contributionof the initial investments to our operating partnership and theconsummation of our initial public offering, we purchased the remaining2.5% managing equity interest, which is also entitled to aspecial allocation of profits in ALGM, from ALGM I Equity LLC, arelated party, with $1.6 million of the proceeds of our initial publicoffering. Going forward, the results of these properties will bereflected on a consolidated basis.

In the future, we willoriginate net lease property investments through a variety of sources,which may include the purchase of office and industrial propertiesdeveloped by Koll Development Company. These properties are generallyleased to corporate tenants prior to or during the development process.Koll Development has developed 44 office and industrial propertiestotaling over 10 million square feet at a cost of approximately $1.1billion of invested capital. We believe that our affiliation with KollDevelopment will provide us with an ongoing source of valuable marketinformation and contacts in connection with our net lease investmentbusiness. No interest in Koll Development was contributed to us.

Application of Critical Accounting Policies

The preparationof financial statements in conformity with generally acceptedaccounting principles or GAAP, requires the use of estimates andassumptions that could affect the reported amounts of assets andliabilities, the disclosure of contingent assets and liabilities andthe reported amounts of revenue and expenses.

Management hasidentified certain critical accounting policies that affect the moresignificant judgments and estimates used by management in thepreparation of our predecessor's combined financial statements.Management evaluates on an ongoing basis estimates related to criticalaccounting policies, including those related to revenue recognition,allowances for doubtful accounts receivable and impairment ofinvestments in uncombined ventures and debt securities available forsale. The estimates are based on information that is currentlyavailable to management, as well as on various other assumptions thatmanagement believes are reasonable under the circumstances.

Debtsecurities available for sale are carried at estimated fair value withthe net unrealized gains or losses reported as a component ofaccumulated other comprehensive income (loss) in owners' equity.Our predecessor's equity investment in CDO I and CDO II arerelatively illiquid, and its value must be estimated by management.Fair value is based primarily upon broker quotes or management'sestimates. These estimated values are subject to significantvariability based on market conditions, such as interest rates andspreads. Changes in the valuations do not affect ourpredecessor's reported income or cash flows, but impactowners' equity. During the third quarter of 2004, based oncurrent year experience and secondary market data, our predecessorchanged its estimate of the call period for the CDO bonds of CDO I andthe expected default rate of the underlying securities collateralizingthese CDO bonds. The corresponding changes in estimated cash flowresulted in an increase in the estimated fair value of our investmentin CDO I and an increase in the average yield to maturity of ourresidual interest.

Management is required to make subjectiveassessments as to whether there are impairments in the values of ourinvestment in our predecessor's uncombined ventures accounted forusing the equity method. As no public market exists for theseinvestments, management estimates the recoverability of theseinvestments based on projections and cash flow analysis. Theseassessments have a direct impact on our net income, since recording animpairment loss results in an immediate negative adjustment to netincome.

The following is a summary of the accounting policiesfor our underlying uncombined ventures that are most affected byjudgments, estimates and assumptions.

Subordinate Real EstateDebt

The NSF Venture purchases subordinate real estate debt anddebt participations to be held for investment. As the managing memberof NSF Venture's managing member, we must periodically evaluateeach of these loans for possible impairment. Impairment is indicatedwhen it is deemed 

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probable that we will be unable to collectall amounts due according to the contractual terms of the loan. Upon adetermination of impairment, we would establish a specific valuationallowance with a corresponding charge to earnings. Significant judgmentis required both in determining impairment and in estimating theresulting loss allowance. Allowances for loan investment losses areestablished based upon a periodic review of the loan investments.Income recognition is generally suspended for loans at the earlier ofthe date at which payments become 90 days past due or when, in theopinion of management, a full recovery of income and principal becomesdoubtful. Income recognition is resumed when the loan becomescontractually current and performance is demonstrated to be resumed. Inperforming this review, management considers the estimated netrecoverable value of the loan as well as other factors, including thefair market value of any collateral, the amount and the status of anysenior debt, the prospects for the borrower and the economic conditionsin the region where the borrower does business. Because thisdetermination is based upon projections of future economic events,which are inherently subjective, the amounts ultimately realized fromthe loan investments may differ materially from the carrying value atthe balance sheet date. To date, all of the NSF Venture's debtinvestments are fully performing and we have determined that no lossallowances have been necessary with respect to the loans in our jointventure's portfolio.

The NSF Venture records the transferof a participation or sub-participation in a loan investment of the NSFVenture as a sale when the attributes of the transaction meet thecriteria for sale of SFAS  140, "Accounting forTransfers of Financial Assets and Extinguishments ofLiabilities," including transferring the financialinterest beyond the reach of its creditors and placing no substantiverestrictions on the resale of the participation or sub-participation bythe purchaser.

Net Lease Properties — ALGM

ALGM's rental revenue is recognized on a straight-line basisover the non-cancelable term of the respective leases. The excess ofstraight-line rents recognized over amounts contractually due pursuantto the underlying leases are included in straight-line (unbilled) rentsreceivable in the ALGM balance sheets. ALGM's management providesan allowance for doubtful accounts for estimated losses resulting fromthe inability of its tenants to make required rent and other paymentsas due. Additionally, ALGM establishes, on a current basis, anallowance for future tenant credit losses on unbilled rents receivablebased upon an evaluation of the collectibility of such amounts.ALGM's management is required to make subjective assessmentsabout the collectibility of the deferred rent receivable that in manycases will not be billed to tenants for many years from the balancesheet date. Management's determination is based upon anassessment of credit worthiness of private company tenants for whichfinancial information is not readily available and as such is notsubject to precise quantification.

Recent AccountingPronouncements

In January 2003, the Financial AccountingStandards Board, FASB, issued Interpretation No.  46,"Consolidation of Variable InterestEntities," or FIN  46. In general, a variableinterest entity is a corporation, partnership, trust or any other legalstructure used for business purposes that either (1)  does nothave equity investors with voting rights or (2)  has equityinvestors that do not provide sufficient financial resources for theentity to support its activities. Until adoption of FIN 46, ourpredecessor generally consolidated another entity in its financialstatements only if it controlled the entity through voting interests.FIN 46 will require a variable interest entity to be consolidated byour predecessor if it is subject to a majority of the risk of loss fromthe variable interest entity's activities or is entitled toreceive a majority of the entity's residual returns or both. FIN46's consolidation requirements apply immediately to variableinterest entities created or acquired after January  31, 2003.The consolidation requirements apply to older entities created prior toFebruary 1, 2003 in the first fiscal year or interim period beginningafter September 15, 2003. In December 2003, the FASB issued FIN 46R,deferring the effective date until the period ending March 31, 2004 forinterests held by public companies in variable interest entitiescreated before February 1, 2003, which were non-special purposeentities. Our predecessor has adopted FIN 46 and FIN 46R for variableinterest entities created prior to February 1, 2003 in the fourthquarter of 2003 and has applied the provisions 

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for all variable interest entities createdafter January 31, 2003. We do not anticipate that the adoption of FIN46 or FIN 46R will have a material impact on our combined financialstatements or results of operations taken as a whole. Based on ananalysis of our predecessor's interests in CDO I and CDOII as a variable interest entity under FIN 46 or FIN 46R, CDO I andII's financial statements were not consolidated into ourpredecessor's financial statements as of September 30, 2004 andDecember 31, 2003 as our predecessor is not the primary beneficiary.Accordingly, our predecessor's beneficial interest in preferredsecurities of CDO I and CDO II have been designated as available forsale securities as they meet the definition of a debt instrument due totheir redemption provisions. We anticipate that CDO III will be treatedsimilarly for financial reporting purposes.

Effective January 1,2003, our predecessor adopted the provisions of SFAS No. 123,"Accounting for Stock Based Compensation" (asamended by SFAS No. 148), which requires an estimate of the fair valueof equity based compensation at the time of grant rather than theintrinsic value method formerly followed by our predecessor. Ourpredecessor has elected to use the prospective method for thisadoption. All equity based awards or modifications of awards toemployees after January 1, 2003, will be amortized to compensationexpense over the award's vesting period based on the fair valueof the award at the date of grant. The adoption of these provisions didnot have a material effect on our predecessor's financialposition or results of operations**.**Please refer to theCompany's Registration Statement on Form S-11 dated October 25,2004 for a detailed discussion of our incentive compensation plan.

In May 2003, the FASB issued SFAS No. 150, "Accountingfor Certain Instruments with Characteristics of Both Liabilities andEquity." This standard requires that certain financialinstruments embodying an obligation to transfer assets or to issueequity securities be classified as liabilities. However, on October 29,2003, the FASB deferred the provisions of SFAS 150 as they apply tocertain mandatorily redeemable financial instruments. We do not expectthe adoption of this standard to have a significant effect on ourpredecessor's financial statements taken as a whole.

Results of Operations of Our Predecessor

Comparison of theThree Months Ended September 30, 2004 to the Three Months EndedSeptember  30, 2003

Revenues

Advisory andmanagement fee income from related parties increased by $0.7 million to$1.0 million for the three months ended September 30, 2004 from $0.3million for the three months ended September 30, 2003. This increase isthe result of increased asset advisory fees earned in 2004 by both thereal estate securities and subordinate real estate debt businesses. Thereal estate securities and subordinate real estate debt businesses bothhad minimal operating activity in 2003. See "Related PartyTransactions" for a description of our predecessor'sagreements with Related Parties pursuant to which our predecessorreceived these advisory fees.

Interest income from debtsecurities increased by $0.7 million to $0.9 million for the threemonths ended September 30, 2004 from $0.2 million for the three monthsended September 30, 2003. The CDO I issuer was newly formed in August2003 which resulted in minimal income being recognized for the threemonths ended September 30, 2003 as opposed to 2004 which had a fullquarter of activity. CDO II closed in July 2004 with interest incomeprimarily derived from the "BB" rated juniorclasses of debt securities and unrated income securities.

Expenses

General and administrative expenses increased by$0.7 million, or 47%, to $2.2 million for the three months endedSeptember 30, 2004 from $1.5 million for the three months endedSeptember 30, 2003. The increase in expenses related primarily to theaddition of new employees and an increase in allocated corporateoverhead and direct expenses related to the increased business activityin the 

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operations of the real estate securitiesbusiness and the subordinate real estate debt business from NorthStarCapital. The decrease in direct salaries is due to the decrease in theannual bonus paid to a key executive employee and the reversal of anoveraccrual due to a change in estimate.

Interest expense forthe three months ended September 30, 2004 totaled $0.2 million. Thisexpense relates to the Company's short term facility withCitigroup secured by the "BB" rated juniorclasses of debt securities and unrated income securities and its shortsale of a FNMA security in the third quarter of 2004.

Equity inEarnings

Equity in earnings of ALGM decreased by $0.2 million,or 40%, to $0.3 million for three months ended September 30,2004 from $0.5 million for the three months ended September 30, 2003primarily due to lower signage income in 2004 from one of the ALGMproperties.

Gains on Warehouse Agreements

Net gains onwarehouse agreements for the three months ended September 30, 2004 of$0.7  million consisted of a $0.2 million unrealized loss and a$0.6 million realized gain related to CDO  II. The unrealizedloss represents the change in the fair value of the warehousearrangement up until July 2004, when the CDO II warehouse terminated.CDO III also had an unrealized gain of $0.3  million at September30, 2004 related to the change in the fair value of that warehousearrangement.

Net gains on warehouse agreements for the threemonths ended September 30, 2003, consisted of a $0.9 million unrealizedloss and a $1.9 million realized gain relating to CDO I. The CDO Irealized gain represented the increase in fair value of the warehousearrangement from January 1, 2003 through August 21, 2003, the day thewarehouse was terminated and the underlying securities were transferredinto CDO I.

Other

An unrealized loss of approximately$0.4 million was recognized on a short sale of a FNMA security in thethird quarter of 2004. No short positions were taken in the thirdquarter of 2003.

Comparison of the Nine Months Ended September30, 2004 to the Nine Months Ended September 30, 2003

Revenues

Advisory and management fee income from relatedparties increased by approximately $1.6  million to approximately$2.1 million for the nine months ended September 30, 2004 from$0.5  million for the nine months ended September 30, 2003. Thisincrease is the result of additional asset advisory fees earned by boththe real estate securities business, due to the closing of CDOII in 2004 and higher loan balances in subordinate real estate debtbusinesses.

Interest income from CDO I and II increased by $1.3million to $1.5 million for the nine months ended September 30, 2004from $0.2 million for the nine months ended September 30, 2003. The CDOI issuer was newly formed in August 2003, resulting in minimal interestincome being recognized for the nine months ended September 30, 2003 asopposed to September 30, 2004, which had nine months of interestincome. In addition, CDO II closed in July 2004, and as a result hadinterest income generated primarily by the"BB" rated junior classes of debt securitiesand unrated income securities.

Expenses

General andadministrative expenses increased by $1.2 million, or 32%, from$3.7 million for the nine months ended September 30, 2003 to $4.9million for the nine months ended September 30, 2003. The increase inexpenses related primarily to the addition of new employees, as well asto the new 

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allocation of corporate overhead and directexpenses related to increased business activity in the operations ofthe real estate securities business and the subordinate real estatedebt businesses from Northstar Capital.

Interest expense for thenine months ended September 30, 2004 totaled $0.2 million. This expenserelates to the Company's short term facility with Citigroupsecured by the "BB" rated junior classes ofdebt securities and unrated income securities and its short sale of aFNMA security in the third quarter of 2004.

Equity inEarnings

Equity in earnings of the NSF venture increased by$0.1 million, or 33%, to $0.4 million for the nine months endedSeptember 30, 2004 from $0.3 million for the nine months endedSeptember 30, 2003. The net income of the NSF Venture increased in 2004due to increased income in 2004 from loan participations that closed inthe fourth quarter of 2003.

Equity in earnings of ALGM decreasedby $0.2 million, or 18%, to $0.9 million for the nine monthsended September 30, 2004 from $1.1 million for the nine months endedSeptember 30, 2003. This decrease is primarily due to lower signageincome in 2004 from one of the ALGM properties. In addition, there wasone leasehold termination in the first quarter of 2003 that waspartially offset by rent increases from other properties.

Gainson Warehouse Agreements

Net gains on warehouse agreements forthe nine months ended September 30, 2004 of $1.4 million consisted of a$0.5 million unrealized gain and a $0.6 million realized gain relatedto CDO II, with the unrealized portion of this gain representing thechange in the fair value of the warehouse arrangement up until July2004, when the CDO II warehouse terminated. CDO III also had anunrealized gain of $0.3 million at September 30, 2004 related to thechange in the fair value of that warehouse arrangement.

Netgains on warehouse agreements for the nine months ended September 30,2003, consisted of $2.9 million ($1.0 million unrealized and $1.9million realized) related to CDO I. The CDO I unrealized gainrepresented the increase in fair value of the warehouse arrangementfrom January 1, 2003 through August 21, 2003, the day the warehouse wasterminated and the underlying securities were transferred into CDOI.

Other

An unrealized loss of approximately $0.4million was recognized on a short sale of a FNMA security in the thirdquarter of 2004. No short positions were taken in the third quarter of2003.

Liquidity and Capital Resources

As of September30, 2004, we had an unrestricted cash balance of $2.1 million andaccrued expenses of $0.3 million. As a REIT, we will be required todistribute at least 90% of our taxable income to ourstockholders on an annual basis, and we intend to distribute all orsubstantially all of our REIT taxable income in order to comply withthe distribution requirements of the Internal Revenue Code and to avoidfederal income tax and the nondeductible excise tax. We believe thatwith the proceeds from the Offering, our working capital, secured andunsecured credit facilities that we may have or obtain in the future,and cash provided by operations will be sufficient to allow us to fundthe equity portion of our new investments, make distributions necessaryto enable us to continue to qualify as a REIT and fund operations forthe next 12 months. If our origination and investment activities overthe next 12 months are greater than currently anticipated, we may seekto finance these investments either through additional borrowings or byraising equity capital, or both. In the event that we are unable toenter into additional credit facilities, we believe that we will beable to meet our cash requirements for the next twelve months from cashflow from operations and the proceeds of the Offering.

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Our predecessor's debt position andliquidity as of September 30, 2004 should be reviewed in conjunctionwith the contribution transactions and the other formation transactionsentered into in connection with our initial public offering andliquidity position, each as discussed in our prospectus related to ourinitial public offering, dated October 25, 2004, as filed pursuant toRule 424(b) of the SEC's rules and regulations. As a result ofthe contribution transactions and our initial public offering, our debtand liquidity has changed significantly from that of our predecessor atSeptember 30, 2004.

The adjustment to the June 30, 2004financial statements, as disclosed in Footnote 2 of the September 30,2004 financial statements, primarily related to a mark to marketadjustment to the value of the CDO II warehouse, which is a non-cashitem that does not impact the cash flow of our investment in CDOII.

As of September 30, 2004, our predecessor hadthe following debt outstanding:

|                                 |  |                    |  |                                          |        |                                           |  |                 |         |              |  |                                       |  |             |  |        |      |        |  |  |  |  |  |  |  |  |
|---------------------------------|--|--------------------|--|------------------------------------------|--------|-------------------------------------------|--|-----------------|---------|--------------|--|---------------------------------------|--|-------------|--|--------|------|--------|--|--|--|--|--|--|--|--|
|                            |  | BusinessSegment    |  | Carrying Amount at 9/30/04 (inthousands) |        | Carrying Amount at 12/31/03 (inthousands) |  | Stated Maturity |         | InterestRate |  | Weighted Average Expected Life(years) |
| Mortgage notes payable(ALGM)(1) |  | Netleaseproperties |  | $                                        | 40,899 |                                      |  | $               | 41,881  |         |  | 01/01/2005                            |  | 5.60%       |  |   | 0.25 |   |
| Loanpayable                     |  | CDO                |  | $                                        | 17,517 |                                      |  |            | — |         |  | 07/21/05                              |  | LIBOR+1.25% |  |   | 0.83 |   |
|                                 |

|     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
|-----|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (1) | ALGMis uncombined as of September 30, 2004 and December 31, 2003. Weacquired the remaining 2.5% managing equity interest, which isalso entitled to a special allocation of profits, in ALGM with aportion of the proceeds of the Offering. ALGM will be consolidated inour financial statements subsequent to the Offering. The ALGM mortgagebears interest at the higher of the one-month LIBOR rate or 2%plus 3.60%, or 5.6%, and matures on January 1, 2005. TheALGM mortgage loan agreement includes the following financial covenantsand restrictions: (a) ALGM must maintain a debt service coverage ratioin excess of 1.15 to 1, computed using an annual interest rate of10.09%, and (b) ALGM must establish and maintain certain escrowreserve accounts for, among other things, payment of real estate taxes,capital expenditures and tenant rollover costs. |

Additionally, our predecessor has a residual interest in CDO I andII, which, under EITF 99-20, is accounted for by our predecessor as adebt security. The CDO entities are leveraged as follows:

|                |  |                       |  |                                         |         |                                          |  |                 |         |                              |  |                                       |  |        |     |         |  |        |     |        |  |  |  |  |  |  |
|----------------|--|-----------------------|--|-----------------------------------------|---------|------------------------------------------|--|-----------------|---------|------------------------------|--|---------------------------------------|--|--------|-----|---------|--|--------|-----|--------|--|--|--|--|--|--|
|           |  | BusinessSegment       |  | Carrying Amount at 9/30/04(inthousands) |         | Carrying Amount at 12/31/03(inthousands) |  | Stated Maturity |         | WeightedAverage InterestRate |  | Weighted AverageExpected Life (years) |
| CDO IBonds(1)  |  | Realestatesecurities  |  | $                                       | 340,280 |                                     |  | $               | 370,549 |                         |  | 08/01/2038                            |  |   | 6.5 | %  |  |   | 7.4 |   |
| CDOII Bonds(1) |  | Real estatesecurities |  | $                                       | 375,947 |                                     |  |            | — |                         |  | 06/01/2039                            |  |   | 6.0 | %  |  |   | 8.1 |   |
|                |

|     |                                                                                                          |
|-----|----------------------------------------------------------------------------------------------------------|
| (1) | CDOI is uncombined as of September 30, 2004 and December 31, 2003 and theventure will remain uncombined. |

|     |                                                                                     |
|-----|-------------------------------------------------------------------------------------|
| (2) | CDO II is uncombinedas of September 30, 2004 and the venture will remainuncombined. |

On July 21, 2004, NS CDO Holdings II, LLCentered into a financing arrangement with Citigroup Global Markets Inc.("Citigroup") and originally borrowed $17.4million, secured by the "BB" rated juniorclasses of debt securities and unrated income notes of CDO II. Theprincipal amount outstanding is $17.5 million at September 30, 2004.The financing matures on July 21, 2005 and bears interest at LIBOR plus125 basis points.  On November 3, 2004, the Company repaid $7.3million of the $17.5 million outstanding balance at September 30,2004.

The terms of CDO I and II's real estate securitiesare by their nature matched with the terms of its uncombinednon-recourse CDO liabilities. These CDO liabilities are repaid fromprincipal payments received on the real estate securities when thesepayments are actually received. There is no refinancing risk associatedwith the CDO liabilities, as principal is only due to the extent thatit has been collected on the underlying securities investments and thestated maturities are noted above.

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The real estate securities businessproduces a relatively predictable income stream based on the spreadbetween the interest earned on the securities and the interest paid onthe CDO liabilities. This spread may be reduced by credit losses on thesecurities or by hedging mismatches. CDO I and CDO  II have notincurred any losses on any of their securities investments from thedate of purchase through September 30, 2004. We receive quarterly cashdistributions from CDO I and monthly cash distributions from CDO II,representing our proportionate share of the cash flow from the CDOs, aswell as collateral advisory fees.

Our future net leased realestate investments will be financed on a long-term basis and are alsoexpected to produce stable cash flow. Debt securing these propertieswill be primarily non-recourse and will be repaid primarily from theproceeds of sales or refinancing of the properties. We intend tofinance approximately 70% to 80% of the value of thesenet lease assets. The properties currently held by ALGM are financedwith a floating rate loan. The ALGM properties currently produce stablecash flow after debt service. The impact of changes in interest ratesare mitigated through the use of interest rate cap agreements. Thesecontracts are entered into as part of our management of interest rateexposure and effectively limit the amount of interest rate risk onALGM's outstanding indebtedness.

The NSF Venture'ssubordinate real estate debt investments, as well as direct subordinatedebt investments, will typically have maturities of less than fiveyears and may be financed with moderate levels of debt. Theseinvestments are not presently subject to any financing, but we may useleverage in the future of approximately 50% to 75% of thevalue of these investments, on average. We receive monthly cashdistributions from the NSF Venture representing our proportionate shareof the interest income on the subordinate debt securities. In addition,we receive advisory fees from the NSF Venture and from the NSF VentureInvestor for the management of the NSF Venture and certain of the NSFVenture Investor's senior participation and sub-participationinterests, respectively. See "Related PartyTransactions."

We expect to meet our long-termliquidity requirements, specifically the repayment of debt, and ourinvestment funding needs, through additional borrowings, the issuanceof debt and/or equity securities and the liquidation or refinancing ofassets at maturity. We believe that the value of the New York propertyportfolio is, and will continue to be, sufficient to allow us torefinance its related debt at maturity.

On December 21, 2004, weentered into a $150 million master repurchase agreement with DeutscheBank AG, Cayman Islands Branch to finance our investment in firstmortgage loans, B notes, mezzanine loans and rated real estatesecurities. The agreement has a three-year term and one one-yearextension option. Advances under the agreement bear interest atone-month LIBOR plus a spread ranging from 0.75% to2.25%, which is reset monthly. The master repurchase agreementcontains certain covenants, the most restrictive of which, is arequirement that we maintain a minimum tangible net worth, includingthe minority interest in the operating partnership, of no less than$125 million. As of December 30, 2004 $27.8 million was outstandingunder this facility.

We have received a proposal by CitibankN.A. to provide us with a $150 million joint reverse repurchase andsecured loan facility, subject to conditions, includingCitibank's due diligence and credit and legal approval. We woulduse such a facility primarily to finance our subordinate real estatedebt investments. We would expect such a facility to have a one-yearterm and a two-year extension option and advance rates to range from50% to 85% of the collateral value, depending on thecharacteristics of the pledged assets.

We have committed tocontribute approximately $10 million, or 5%, of the total equitycommitment of $200 million of NSF Venture. The joint venture was formedto acquire and originate subordinate debt instruments on real estateassets. As of September 30, 2004 we had funded $6.7  million ofthe $10.0 million commitment.

With respect to our leased realestate assets owned through ALGM, we expect to incur costs ofapproximately $430,000 for tenant improvements in connection with newtenant leasing costs and capital expenditures during fiscal 2004. Weanticipate the sources of funds for such commitment to be 

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our working capital and lender reserves.With the contribution of the initial investments to us and the purchaseof the remaining 2.5% managing equity interest, which waspurchased by us with a portion of the proceeds of the IPO, we now bearthe costs, including all capital expenditures and tenant improvements,related to the assets owned by ALGM. 729 Seventh Avenue, one of theALGM fee properties, is currently in litigation with the net lessee ofthe property, a subsidiary of NRMI. If this claim is successful, itcould result in a total economic loss to us of up to approximately$700,000 in the first year, including damages and lost rent, inaddition to the cost of any legal proceedings or negotiations andapproximately $650,000 to $850,000 in lost rent annually thereafterunless re-rented on the same terms.

Cash Flow

The netcash flow provided by operating activities increased by $4.2 millionfor the nine months ended September 30, 2004 to $2.4 million from a useof ($1.8) million for the nine months ended September 30, 2003primarily due to the increased business activity in the operations ofthe real estate securities business and the subordinate real estatedebt business.

The net cash flow used in investing activitiesincreased by ($15.4) million for the nine months ended September 30,2004 to ($19.9) million from a use of ($4.5) million for the ninemonths ended September 30, 2003. Net cash used in investing activitiesin 2004 consisted primarily of funds used to purchase our interest inthe unrated income and the "BB" rated notesof CDO II.

The net cash flow provided by financing activitiesincreased by $11.6 million for the nine months ended September 30, 2004to $18.6 million from $7.0 million from financing activities for thenine months ended September 30, 2003. The primary sources of cash flowfrom financing activities in 2004 were loan proceeds to finance CDO IIand contributions by owners.

Recent Investment Activity

Subsequent to our initial public offering and NorthStarCapital's simultaneous contribution of our initial portfolio ofinvestments in subordinate real estate debt, real estate securities andnet lease properties, we have made the investments described below.

On November 12, 2004, we purchased a $24 million subordinate debtparticipation from a bank in an $82 million senior mortgage loansecured by a 417,922 square foot, 17 story, class-B office building inNew York City. The subordinate debt participation bears interest atLIBOR plus 375 basis points, with $6 million of the principal subjectto a LIBOR floor of 1.5% and matures on August 9, 2006. Inconnection with the purchase of this participation, we received a1% origination fee. In addition, the borrower has three one-yearextension options.

On November 16, 2004, we purchased a $22million mezzanine loan from a bank which is secured by an equityinterest in the borrower that is the owner of nine Embassy Suiteshotels with 2,150  rooms. The mezzanine loan bears interest atLIBOR plus 475 basis points and matures on June  9, 2006. Inaddition, the borrower has three one-year extension options.

OnNovember 19, 2004, we entered into a contract for $63.5 million topurchase a portfolio of three net-leased office properties totaling257,336 square feet of rentable space in Chatsworth, CA. The propertiesare net leased to a bank under leases that expire in June 2015. Inconnection with the contract, we made a deposit of $1.5 million whichis non-refundable unless the seller of the properties doesn'tmeet certain conditions prior to closing.

We have made temporaryinvestments in $1.32 billion of primarily AAA-rated, short-term,floating rate securities which are backed by commercial or residentialmortgage loans. These investments have been financed through repurchaseagreements with major banks and securities firms whereby we haveborrowed approximately $1.27 billion and funded the remaining balanceof $51  million in cash. In December 2004, the Company sold$431.9 million of these temporary investments and repaid the associatedrepurchase agreements with major banks. Our temporary investmentstrategy is designed to generate sufficient qualifying income duringthe two-month period before year-end so that it will be able to meetall of the REIT compliance requirements in advance of deploying capitalpursuant to our long-term business plan.

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On December 30, 2004, we purchased anapproximately $24.8 million subordinate participation interest in asenior mortgage loan secured by a 700,000 square foot hotel located inMiami, Florida that will be converted into residential condominiums. Inconnection with the purchase, we received a .50% originationfee. The subordinate debt participation initially bears interest atLIBOR plus 560 basis points, decreasing to LIBOR plus 440 basis pointsafter certain principal repayments are made by the borrower. Thesubordinate participation has an initial maturity of September 14, 2006and the borrower has the ability to extend the term for one additionalyear under certain conditions including the payment of a .25%fee.

NSF Venture

On December 11, 2004, the NSFVenture's $7.65 million subordinate loan participationcollateralized by a portfolio of multifamily properties in the PacificNorthwest was repaid in full. There were no additional fees associatedwith the repayment since the yield maintenance period for the loanexpired on October 11, 2004. The second extended maturity date for theloan was September  11, 2005.

On December 10, 2004, theborrower under the $9.48 million junior participation in a mezzanineloan collateralized by an office property in northern Florida held bythe NSF Venture notified the Company that they would repay the loan infull on January 11, 2005. There will be no additional fees associatedwith the repayment since the yield maintenance period expired onNovember 11, 2004. The initial extended maturity date for the loan wasAugust 11, 2005.

Related Party Transactions

Advisory Fee — NorthStar Funding LLC

In 2001,our predecessor entered into an advisory agreement with NorthStarFunding LLC, or the NSF Venture, whereby it receives as compensationfor its management of investments of the NSF Venture an advisory feeequal to 1% per annum of the capital invested by the NSFVenture. Additionally, NorthStar Funding Managing Member LLC isentitled to an incentive profit participation equal to 10% ofthe profit after a minimum required return on the NSF Venture'scapital and a return of and on capital based upon the operatingperformance of the NSF Venture's investments. Prior to thecontribution of the initial investments to our operating partnershipand the related formation transactions, NorthStar Funding ManagingMember LLC received 75% of this incentive profit participationequal to 10% of the profit after a minimum required return onNSF Venture's capital and a return of and on capital based on theoperating performance of the NSF Venture's investments. Ourpredecessor earned and recognized advisory fees from the NSF Venture ofapproximately $783,000 and $333,000 for the nine months ended September30, 2004 and 2003, respectively. Our predecessor received profitparticipation distributions of $120,000 during the nine months endedSeptember 30, 2004. Because such distributions may have to be refunded,no profit participation distributions were recognized as incomepursuant to Method 1 of Emerging Issues Task Force Topic D-96.

Advisory Fees — CDO I and II

In August, 2003and July, 2004, CDO I and II, respectively, entered into agreementswith our predecessor, through NS Advisors, to perform certain advisoryservices. Our predecessor earned total fees of approximately $1,390,000and $152,000 for the nine months ended September 30, 2004 and 2003,respectively, of which $100,000 and $117,000 is unpaid and included inour predecessor's balance sheets as of September 30, 2004 andDecember 31, 2003, respectively, as advisory and asset management feereceivable — related party. Our predecessor also earnedstructuring fees of $500,000 in connection with the closing of both CDOI and II for the nine months ended September 30, 2004 and 2003, whichwas used to reduce our predecessor's investments in debtsecurities available for sale.

ALGM

On December28, 2004, ALGM terminated its existing asset management agreement withEmmes Asset Management Co. LLC ("Emmes"), anaffiliate of Northstar Capital. Pursuant to the termination

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provisions of the agreement, ALGM paid Emmesa contractual termination payment of approximately $380,000, which isequal to two quarters of payments of the annual existing fee of$760,000. In addition, ALGM and Emmes entered into a new assetmanagement agreement which is cancelable on 30 days notice by ALGM. Theannual asset management fee under the new agreement is equal to3.5% of gross collections from tenants of the properties not toexceed $350,000 or be less than $300,000 per year, subject to certainprovisions.

Contractual Commitments

As of September 30,2004, our predecessor had the following contractual commitments andcommercial obligations:

|                                              |  |                      |            |                 |  |           |            |           |  |              |         |        |  |        |         |        |  |        |                                                               |        |  |  |
|----------------------------------------------|--|----------------------|------------|-----------------|--|-----------|------------|-----------|--|--------------|---------|--------|--|--------|---------|--------|--|--------|---------------------------------------------------------------|--------|--|--|
|                                         |  | PaymentsDue byPeriod |
| ContractualObligations —Combined Basis |  | Total                |            | Less than1 year |  | 1-3 years |            | 3-5 years |  | After 5years |
| Mortgage Debt –ALGM(1)                 |  | $                    | 40,899,000 |            |  | $         | 40,899,000 |      |  | $            | — |   |  | $      | — |   |  | $      |          — |   |
| Loanpayable                                  |  |                 | 17,517,000 |            |  |      | 17,517,000 |      |  |         | — |   |  |   | — |   |  |   | —                                                       |   |
| Securitiessold, not yetpurchased             |  |                 | 12,944,000 |            |  |      | 12,944,000 |      |  |         | — |   |  |   | — |   |  |   | —                                                       |   |
| Operatingleases                              |  |                 | 1,053,000  |            |  |      | 442,000    |      |  |         | 505,000 |   |  |   | 106,000 |   |  |   | —                                                       |   |
| Totalcontractualobligations                  |  | $                    | 72,413,000 |            |  | $         | 71,802,000 |      |  | $            | 505,000 |   |  | $      | 106,000 |   |  | $      | —                                                       |   |
|                                              |

|     |                                                                                                                                                                                                                                                                                     |
|-----|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (1) | ALGMis uncombined as of September 30, 2004. We have purchased the remaining2.5% managing equity interest, which is also entitled to aspecial allocation of profits, in ALGM with a portion of the proceedsof the Offering. Accordingly, ALGM will be consolidated in futureperiods. |

Off Balance Sheet Arrangements

As ofSeptember 30, 2004, our predecessor had the material off balance sheetarrangements described below:

|              |                                                                                                                                                                  |
|--------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| •  | As ofSeptember 30, 2004, we had an approximately $9.6 million equityinterest in CDO  I as described in Note 3 to ourpredecessor's combined financial statements. |

|              |                                                                                                                                                                                                 |
|--------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| •  | As of September 30, 2004, we had anapproximately $27.4  million equity interest in CDO  II,which closed in July 2004, as described in Note 3 to ourpredecessor's combined financial statements. |

|              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
|--------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| •  | In September 2004, NS Advisors enteredinto a warehouse arrangement with Citigroup in preparation for thesecuritization of CDO III. We were required to pledge up to $10 millionas security for the purpose of covering a portion of any losses orcosts associated with the accumulation of these securities under thewarehouse agreement. This security is in the form of a pledge of ourapproximately 83% equity interest in CDO I for acquisitions ofsecurities up to $150 million and cash deposits of up to approximately$5.7 million to cover the accumulation of securities from $150 millionto the maximum of $400 million. |

Our potential losses in CDO Iand II are limited to our predecessor's carrying value ofapproximately $37.0 million, at September 30, 2004, as reflected in ourcombined financial statements. At this time, we do not anticipate asubstantial risk of incurring a loss with respect to any of thesearrangements.

Inflation

Our leases for tenants of ALGMare either:

|              |                                                                                                                                                                                                                                             |
|--------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| •  | net leases where thetenants are responsible for all real estate taxes, insurance andoperating expenses and the leases provide for increases in rent eitherbased on changes in the Consumer Price Index (CPI) or pre-negotiatedincreases; or |

|              |                                                                                                                                                                                     |
|--------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| •  | operating leases whichprovide for separate escalations of real estate taxes and operatingexpenses over a base amount, and/or increases in the base rent based onchanges in the CPI. |

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We believe that inflationary increases inexpenses will generally be offset by the expense reimbursements andcontractual rent increases described above to the extent ofoccupancy.

We believe that the risk that the market interestrates on the floating rate debt of our investments in ALGM, CDO I andCDO II will increase as a result of inflation is largely offset by ourstrategy of matching the terms of our assets with the terms of ourliabilities and through our use of hedging instruments.

FundsFrom Operations

Management believes that funds from operations,or FFO, is an appropriate measure of performance of a REIT. AlthoughFFO is a non-GAAP measure, we believe it provides useful information toour stockholders, potential investors and management. We compute FFO inaccordance with the standards established by the National Associationof Real Estate Investment Trusts, or NAREIT, as net income or loss,excluding gains or losses from sales of depreciable properties plusreal estate depreciation and amortization, and after adjustments foruncombined partnerships and joint ventures. FFO does not represent cashgenerated from operating activities in accordance with GAAP and is notindicative of cash available to fund cash needs. FFO should not beconsidered as an alternative to net income as an indicator of ourpredecessor's operating performance or as an alternative to cashflow as a measure of liquidity.

Our predecessor's FFO forthe three and nine months ended September 30, 2004 and 2003 are asfollows:

|                                                              |  |                                 |         |                               |  |        |           |        |  |        |           |        |  |        |           |        |  |  |
|--------------------------------------------------------------|--|---------------------------------|---------|-------------------------------|--|--------|-----------|--------|--|--------|-----------|--------|--|--------|-----------|--------|--|--|
|                                                         |  | ThreeMonths Ended September 30, |         | Nine Months EndedSeptember30, |
|                                                         |  | 2004                            |         | 2003                          |  | 2004   |           | 2003   |
| Netincome                                                    |  | $                               | 350,000 |                          |  | $      | 651,000   |   |  | $      | 1,122,000 |   |  | $      | 1,296,000 |   |
| Realestate depreciation and amortization- uncombinedventures |  |                            | 489,000 |                          |  |   | 515,000   |   |  |   | 1,461,000 |   |  |   | 1,630,000 |   |
| Fundsfromoperations                                          |  | $                               | 839,000 |                          |  | $      | 1,166,000 |   |  | $      | 2,583,000 |   |  | $      | 2,926,000 |   |
|                                                              |

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ITEM3.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market risk is the exposure to loss resulting from changes ininterest rates and equity prices. We are subject to credit risk andinterest rate risk with respect to our investments in subordinate realestate debt and real estate securities. The primary market risk that weare exposed to is interest rate risk. Interest rates are highlysensitive to many factors, including governmental monetary and taxpolicies, domestic and international economic and politicalconsiderations and other factors beyond our control. Our interest raterisk sensitive assets, liabilities and related derivative positions aregenerally held for non-trading purposes.

Subordinate RealEstate Debt

We invest in subordinate real estate debtinstruments including mezzanine loans and junior participations inmortgage loans. We generally hold these instruments for investmentrather than trading purposes. These investments are either floating orfixed rate. The interest rates on our floating rate investmentstypically float at a fixed spread over an index such as LIBOR. Theseinstruments typically reprice every 30 days based upon LIBOR in effectat that time. Given the frequent and periodic repricing of our floatingrate investments, changes in interest rates are unlikely to affect thevalue of our floating rate portfolio. Changes in short term rates will,however, affect earnings from our investments. Increases in LIBOR willincrease the interest income received by us on our investments andtherefore increase our earnings. Decreases in LIBOR have the oppositeeffect. Over 50% of our subordinate real estate debt portfoliohas interest rate floors ranging from 2% to 3%.Therefore, decreases in LIBOR from the rate of 1.78% in effectat September 30, 2004 would have an immaterial effect on our earnings.Increases of 100 or 200 basis points, respectively, in the one monthLIBOR rate, above the September 30, 2004 LIBOR rate would haveincreased our annual income from the NSF Venture for the twelve monthperiod ending September 30, 2004, assuming the same portfolio of loans,by $39,000 and $88,000, respectively, because of the effect of theinterest rate floors.

We also make fixed rate investments. Thevalue of these investments may be affected by changes in long-terminterest rates. To the extent that long-term interest rates increase,the value of long-term fixed rate assets is diminished. Any fixed ratesubordinate debt investments which we hold would be similarly impacted.We do not generally seek to hedge this type of risk unless the asset isleveraged as the costs of such a hedging transaction over the term ofsuch an investment would generally outweigh the benefits. If fixed ratesubordinate debt is funded with floating rate liabilities, the fundingcost will be fixed through the use of interest rate caps or otherhedges. Because the interest rates on our fixed rate investments aregenerally fixed through maturity of the investment, changes in interestrates do not affect the income we earn from our fixed rateinvestments.

In our subordinate real estate debt business we arealso exposed to credit risk, which is the risk that the borrower underour loan documents cannot repay its obligations to us in a timelymanner. While we have never experienced a payment default or even alate payment to date, our subordinate position in the capital structuremay expose us to losses as a result of such default in the future. Ourrights to control the default or bankruptcy process following a defaultwill vary from transaction to transaction. The subordinate real estatedebt that we intend to invest in may not give us the right to demandforeclosure as a subordinate real estate debtholder. To the extent thevalue of our collateral exceeds the amount of our loan (including alldebt senior to us) and the expenses we incur in collecting on our loan,we would collect 100% of our loan amount. To the extent that theamount of our loan plus all debt senior to our position exceeds therealizable value of our collateral, then we would incur a loss. We alsoincur credit risk in our periodically scheduled interest payments,which may be interrupted as a result of the operating performance ofthe underlying collateral.

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

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

Real Estate Securities

In our real estate securitiesbusiness, we mitigate credit risk through credit analysis,subordination and diversification. The commercial mortgage-backedsecurities we invest in are generally junior in right of payment ofinterest and principal to one or more senior classes, but benefit fromthe support of one or more subordinate classes of securities or otherform of credit support within a securitization transaction. The seniorunsecured REIT debt securities we invest in reflect comparable creditrisk. Credit risk refers to each individual borrower's ability tomake required interest and principal payments on the scheduled duedates. We believe that these securities offer attractive risk-adjustedreturns with reasonable long-term principal protection under a varietyof default and loss scenarios. While the expected yield on thesesecurities is sensitive to the performance of the underlying assets,the more subordinated securities and certain other features of asecuritization, in the case of mortgage backed securities, and theissuer's underlying equity and subordinated debt, in the case ofREIT securities, are designed to bear the first risk of default andloss. CDO I's and CDO II's real estate securitiesportfolios are diversified by asset type, industry, location andissuer. We further minimize credit risk by actively monitoring CDOI's and CDO II's real estate securities portfolios and theunderlying credit quality of their holdings and, where appropriate,liquidating our investments to mitigate the risk of loss.

AtSeptember 30, 2004, the real estate securities that serve as collateralfor CDO I and CDO II each had an overall weighted average credit ratingof approximately BBB- and approximately 73.6% and 73.2%,respectively, of these securities had an investment grade rating (BBB-or higher).

The real estate securities underlying CDO I and CDOII are also subject to spread risk. The majority of these securitiesare fixed rate securities, which are valued based on a market creditspread over the rate payable on fixed rate U.S. Treasuries of likematurity. In other words, their value is dependent on the yielddemanded on such securities by the market, as based on their creditrelative to U.S. Treasuries. An excessive supply of these securitiescombined with reduced demand will generally cause the market to requirea higher yield on these securities, resulting in the use of a higher or"wider" spread over the benchmark rate(usually the applicable U.S. Treasury security yield) to value thesesecurities. Under these conditions, the value of our real estatesecurities portfolio would tend to decrease. Conversely, if the spreadused to value these securities were to decrease or"tighten," the value of our real estatesecurities would tend to increase. Such changes in the market value ofour real estate securities portfolio may affect our net equity or cashflow either directly through their impact on unrealized gains or losseson available-for-sale securities by diminishing our ability to realizegains on such securities, or indirectly through their impact on ourability to borrow and access capital.

Returns on our real estatesecurities are sensitive to interest rate volatility. If interest ratesincrease, the funding cost on liabilities that finance the securitiesportfolio will increase if these liabilities are at a floating rate orhave maturities shorter than the assets.

Our general financingstrategy focuses on the use of "match-funded"structures, which means that we seek to align the maturities of ourdebt obligations with the maturities of our investments in order tominimize the risk of being forced to refinance our liabilities prior tothe maturities of our assets, as well as to reduce the impact offluctuating interest rates on earnings. In addition, we generally matchinterest rates on our assets with like-kind debt, so that fixed rateassets are financed with fixed rate debt and floating rate assets arefinanced with floating rate debt, directly or through the use ofinterest rate swaps, caps or other financial instruments or through acombination of these strategies. CDO I and CDO II utilize interest rateswaps to minimize the mismatch between their fixed rate assets andfloating rate liabilities. An increase in LIBOR of 100 basis points or200 basis points over the September 30, 2004 LIBOR rate would havedecreased our income from CDO I by $11,000 and $22,000, respectively,on an annualized basis. With respect to CDO II, an increase in LIBOR of100 

40

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basis points or 200 basis points over theSeptember 30, 2004 LIBOR rate would have decreased our income by $3,000and $6,000, respectively, on an annualized basis. We expect to hedgethe interest rate risk in future CDOs in a similar manner.

Ourfinancing strategy is dependent on our ability to place thematch-funded debt we use to finance our real estate securities atspreads that provide a positive arbitrage. If spreads on the bondsissued by CDOs widen or if demand for these liabilities ceases toexist, then our ability to execute future CDO financings will beseverely restricted.

Interest rate changes may also impact ournet book value as our investments in debt securities aremarked-to-market each quarter with changes in fair value reflected inother comprehensive income (a separate component of owners'equity). Generally, as interest rates increase, the value of fixed ratesecurities within the CDO, such as CMBS, decreases and as interestrates decrease, the value of these securities will increase. Theseswings in value have a corresponding impact on the value of ourinvestment in the CDO. Within the CDO, we seek to hedge against changesin cash flows attributable to changes in interest rates by enteringinto interest rate swaps/caps and other derivative instruments asallowed by our predecessor's risk management policy. Suchderivatives are designated as cash flow hedge relationships accordingto SFAS No. 133.

During the warehouse period for CDOs, themarket value of the securities in the warehouse is hedged, typically byshort selling U.S. Agency (FNMA or FHLMC) debentures or U.S. Treasurysecurities in the warehouse. Movements in interest rates are expectedto result in a price movement for the hedge position that is oppositeto and offsets the price movement of the fixed rate securities in thewarehouse.

Net Lease Properties

Our ability to managethe interest rate risk and credit risk associated with the assets weacquire will be integral to the success of our net lease propertiesinvestment strategy. Although we may, in special situations, financeour purchase of net lease assets with floating rate debt, our generalpolicy will be to mitigate our exposure to rising interest rates byfinancing our purchases with fixed rate mortgages. We will seek tomatch the term of fixed rate mortgages to our expected holding periodfor the underlying asset. Factors we will consider to assess theexpected holding period will include, among other things, the primaryterm of the lease as well as any extension options that may exist.

We expect the credit profiles of our tenants will primarily beunrated and below investment grade. In order to ensure that we have ascomplete an understanding as possible of a tenant's ability tosatisfy its obligations under its lease, we expect to undertake arigorous credit evaluation of each tenant prior to executingsale/leaseback or net lease asset acquisitions. This analysis willinclude an extensive due diligence investigation of the tenant'sbusiness as well as an assessment of the strategic importance of theunderlying real estate to the tenant's core business operations.Where appropriate, we may seek to augment the tenant's commitmentto the facility by structuring various protection mechanisms into theunderlying leases. These mechanisms could include security depositrequirements or affiliate guarantees from entities we deem to becreditworthy.

ALGM's interest rate cap limits theone-month LIBOR rate applicable to its mortgage debt to no more than5%. Therefore, a 100 basis point increase in LIBOR would haveincreased the interest component of our predecessor's debtservice by approximately $0.4 million for the year ended December 31,2003 and $0.3 million for the nine months ended September 30, 2004.

ITEM 4.    CONTROLS AND PROCEDURES

The Company becamesubject to the periodic and other reporting requirements of theSecurities Exchange Act of 1934, as amended (the "ExchangeAct"), on October 25, 2004, the effective date of theCompany's registration statement relating to its initial publicoffering. On October 29, 2004, the date of the closing of theCompany's initial public offering, an initial portfolio of realestate related investments were contributed to the Company and theCompany began operations. The financial statements included in thisQuarterly Report on Form 10-Q are for NorthStar Realty Finance Corp.

41

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Predecessor (the"Predecessor"), a combination of certaincontrolling and non-controlling interests in real estate-relatedentities, which represent the initial portfolio of investments thatwere contributed to the Company subsequent to the quarter endedSeptember 30, 2004.

The Company formed a Disclosure Committee inNovember 2004 in order to have disclosure controls and procedures thatensure that information required to be disclosed in the Company'sfilings under the Exchange Act is recorded, processed, summarized andreported within the time periods specified in the SEC's rules andforms. The Disclosure Committee is currently comprised of all of theCompany's executive officers, as well as certain other employeeswith knowledge of information that may be considered material in theSEC reporting process. The Disclosure Committee has been given theresponsibility of developing and assessing the financial andnon-financial information to be included in the reports filed by theCompany with the SEC and assisting the Company's chief executiveofficer and chief financial officer in connection with theircertifications contained in the Company's SEC reports. TheDisclosure Committee will meet and report to the Audit Committee on aquarterly or more frequent basis.

During the course of theCompany's review in December 2004 of the Predecessor'sfinancial statements for the three and nine months ended September 30,2004 to be included in this Form 10-Q, management identified certaindeficiencies in the Predecessor's internal controls overfinancial reporting which include (i) the communication betweenbusiness unit personnel and financial reporting personnel with respectto the accounting for certain transactions associated with thePredecessor's CDO investments and other Company activity, (ii)the level of training of accounting and financial reporting personnel,and (iii) the level of detailed, quality control review of thePredecessor's financial statements. Taken together, thesedeficiencies rise to the level of a material weakness in internalcontrols over financial reporting. Based upon further investigation,the Company discovered certain errors in the accounting fortransactions entered into during June and the third quarter of 2004 inconnection with the Predecessor's CDO II and in the reporting ofallocated general and administrative expenses. These errors requiredthe Company to adjust the Predecessor's financial statements forthe six months ended June 30, 2004 as disclosed in Note 2 to thefinancial statements included in this Form 10-Q.

In addition,during the course of its review of this Form 10-Q and thePredecessor's financial statements to be included herein, theCompany's Disclosure Committee determined that thePredecessor's disclosure controls and procedures were noteffective at September 30, 2004 to ensure that financial informationrelated to such items was recorded, processed, summarized and reportedaccurately within the time periods specified in the SEC's rulesand forms. The Disclosure Committee reached this conclusion after theCompany was apprised by its independent auditors of a number ofadjustments to the Predecessor's financial statements for thethree and nine months ended September 30, 2004 with respect to theaccounting for (1) the reporting of allocated general andadministrative expenses and (2) certain transactions associated withthe Company's investment in CDO II. The Company's chiefexecutive officer and chief financial officer have evaluated thePredecessor's disclosure controls and procedures at September 30,2004, the end of the period covered by this Form 10-Q and, as a resultof the material weakness identified in the Predecessor's internalcontrols over financial reporting and the issues that arose during thecourse of the review in December 2004 of the third quarter 2004financial statements, have concluded that the Predecessor'sdisclosure controls and procedures at September 30, 2004 were noteffective.

In December 2004, the Company has undertaken a numberof initiatives to remedy the weakness discovered in thePredecessor's internal controls over financial reporting so thatthe Company's disclosure controls and procedures are effective inthe future. In this regard, the Company has hired a chief accountingofficer who has significant U.S. GAAP and SEC reporting experience,accelerated its search for additional accounting and financialreporting personnel, implemented policies to enhance communicationbetween business unit and financial reporting personnel in order toensure comprehensive review by management level business unit personnelof the recording of Company transactions, retained an outsideaccounting firm to review processes and procedures that the Company hasadopted in connection with its financial reporting and to assist in thepreparation and review of its financial reports and adopted a writtenpolicy for the accounting for CDO related 

42

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transactions. The Company is also in theprocess of reviewing its reporting standards for third party serviceproviders, including its CDO warehouse lender, with the objective ofoutlining clearer, more comprehensive periodic reporting standards. Inaddition, the Company will also provide for training of accounting andfinancial reporting personnel in the nature and type of transactionsentered into by each business segment of the Company and theappropriate accounting related thereto. The Company will continue toevaluate the effectiveness of its disclosure controls and proceduresand internal controls over financial reporting on an ongoing basis andwill take corrective action and implement improvements asappropriate.

Except as noted above, there were no changes in theCompany's internal control over financial reporting during thefiscal quarter ended September 30, 2004 that materially affected, orare reasonably likely to materially affect, the Company'sinternal control over financialreporting.

43

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PARTII - OTHER INFORMATION

ITEM 1.    LEGAL PROCEEDINGS

729 7th Avenue Realty Corp. v. 729 Demi-Tasse LLC

On August21, 2003, 729 7th Avenue Realty Corp., the net lessee of 729 SeventhAvenue and a subsidiary of National Restaurants Management Inc., filedan action against 729 Demi-Tasse LLC, the fee owner of 729 SeventhAvenue and one of our subsidiaries, in New York State Supreme Court,New York County to enforce certain rights it claims to have under itsnet lease with Demi-Tasse. 729 Seventh Avenue is one of the retailproperties in the New York property portfolio in which we have a feeinterest.

In its complaint, 729 7th Avenue Realty Corp. soughtspecific performance of its alleged right to require Demi-Tasse toprovide a subordination, non-disturbance and attornment agreement, oran SNDA, to a proposed subtenant so that in the event the net lease isterminated, the proposed sublease would remain in effect. The plaintiffalso sought a judgment in the amount of approximately $600,000 fordamages 729 7th Avenue Realty Corp. allegedly suffered by reason ofDemi-Tasse's refusal to provide the subtenant with SNDAprotection.

Demi-Tasse has refused to grant SNDA protection tothe subtenant on the grounds that the sublease is configured in such away so as to extract the most economically desirable portion of theproperty for the subtenant, an affiliate of 729 7th Realty Corp.,rendering the remaining space that would revert to Demi-Tasse upon atermination of the net lease unmarketable. Under the terms of the netlease, Demi-Tasse has no obligation to provide SNDA protection to aproposed sublease where, in Demi-Tasse's discretion, theremaining space would be rendered unmarketable.

On September 18,2003, Demi-Tasse moved to dismiss the claim for $600,000 in damages onthe grounds that the net lease prohibits the recovery of monetarydamages that may result from Demi-Tasse's refusal to provide aproposed subtenant with SNDA protection. Demi-Tasse's time toanswer the first cause of action was stayed until a decision wasrendered on the motion. Demi-Tasse's motion to dismiss the claimfor monetary damages was granted on March 29, 2004. Demi-Tasse intendsto vigorously oppose 729 7th Realty Corp.'s claim that it has theright to obtain SNDA protection for its subtenant under the currentcircumstances.

If the claim for SNDA protection is successful,it would result in a total economic loss to us of up to approximately$700,000, including lost rent, leasing commissions and concessions inthe first year following the litigation, in addition to the cost of anylegal proceedings or negotiations, and up to approximately $650,000 to$850,000 in lost rent annually thereafter unless re-rented on the sameterms. ALGM has established a collectibility reserve totaling$2,323,000 as of September 30, 2004 in its financial statements,related to straight-line (unbilled) rents receivable under this lease.However, this reserve may not be adequate to protect ALGM against anyloss.

ITEM 2.    UNREGISTERED SALES OF EQUITY SECURITIES ANDUSE OF PROCEEDS

(a)    None.

(b)    Pursuantto a registration statement that was declared effective on October 25,2004 (File No. 333-114675), we registered (i) 20,000,000 shares of ourcommon stock to be sold in an initial public offering through Friedman,Billings, Ramsey & Co., Inc, Deutsche Bank Securities Inc., CreditSuisse First Boston LLC, and JMP Securities LLC, as managingunderwriters, and (ii) up to an additional 3,000,000 shares of ourcommon stock to be sold upon the exercise of the underwriters'over-allotment option. The offering price per share was $9.00. Weissued 20,000,000 shares of our common stock upon the closing of ourinitial public offering on October 29, 2004. On November 19, 2004, theunderwriters exercised their over-allotment option and we issued anadditional 1,160,750 shares of common stock. 21,160,750 shares ofcommon stock were sold before the termination of the offering. Theaggregate offering price of our initial public offering wasapproximately $190.5 million. The underwriters received a discount ofapproximately $0.63 per share on 20,636,528 of the 21,160,750

44

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shares issued in our initial public offering,for a total underwriting discount of $13.0 million. On October 29,2004, we granted 50,000 shares of our common stock to Friedman,Billings, Ramsey & Co., Inc. as partial compensation for itsservices as an underwriter of our initial public offering. The issuanceof these 50,000 shares was exempt from the registration requirements ofthe Securities Act pursuant to Section 4(2) thereof.

We haveincurred offering expenses of approximately $7.3 million. The netoffering proceeds of the offering to us, after deducting theunderwriting discount and expenses were approximately $170.1 million.The net proceeds were used to pay NorthStar Partnership, L.P. $36.1million, of which it used approximately $32 million to repay debtassociated with our initial investments, repay $7.3 million of anapproximately $17.4 million short-term loan payable which was securedby our interest in the unrated income notes of CDO II, purchase the2.5% minority interest in ALGM for approximately $1.6 million,pay approximately $0.9 million in transfer taxes due in connection withthe acquisition of membership interests in ALGM which owns fee andleasehold interests in eight commercial properties located in New YorkCity, use $46 million to make investments in subordinate debt andposted approximately $51 million as collateral for temporaryinvestments of $1.32 billion of primarily AAA-rated, short-term,floating rate securities.

(c)    None.

ITEM3.    DEFAULTS UPON SENIOR SECURITIES.

None.

ITEM4.    SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS.

None.

ITEM 5.    OTHER INFORMATION

a)    None

b)    There have been no material changes tothe procedures by which stockholders may recommend nominees to ourboard of directors.

ITEM 6.    EXHIBITS AND REPORTS ON FORM8-K

a)    Exhibits

|             |  |                                                                                                                                                                                                                                                                                           |  |  |  |  |
|-------------|--|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--|--|--|--|
| Exhibit No. |  | Description                                                                                                                                                                                                                                                                               |
| 2.1         |  | Contribution Agreement, dated as of October 29,2004, by and among NS Advisors Holdings LLC, Presidio CapitalInvestment Company, LLC and NorthStar Realty Finance LimitedPartnership                                                                                                       |
| 2.2         |  | Contribution Agreement,dated as of October 29, 2004, by and among NorthStar Partnership, L.P.,NorthStar Funding Managing Member Holdings LLC and NorthStar RealtyFinance Limited Partnership                                                                                              |
| 2.3         |  | Purchaseand Sale Agreement, dated as of October 29, 2004, between NorthStarRealty Finance Limited Partnership and ALGM I Equity, LLC                                                                                                                                                      |
| 3.1         |  | Articles of Amendment and Restatement of NorthStarRealty Finance Corp., as filed with the State Department of Assessmentsand Taxation of Maryland on October 20, 2004 (incorporated by referenceto Exhibit 3.1 to the Company's Registration Statement on FormS-11 (File No. 333-114675)) |
| 3.2         |  | Bylaws ofNorthStar Realty Finance Corp. (incorporated by reference to Exhibit3.2 to the Company's Registration Statement on Form S-11 (FileNo. 333-114675))                                                                                                                               |
|             |

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|             |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |  |  |  |  |
|-------------|--|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--|--|--|--|
| Exhibit No. |  | Description                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 4.1         |  | Registration RightsAgreement, dated as of October 29, 2004, by and among NorthStar RealtyFinance Corp., NorthStar Partnership, L.P., NorthStar Funding ManagingMember Holdings LLC and NS Advisors Holdings LLC                                                                                                                                                                                                                                                                                                                          |
| 10.1        |  | Agreement of Limited Partnership of NorthStarRealty Finance Limited Partnership, dated as of October 19, 2004, byand among NorthStar Realty Finance Corp., as sole general partner andinitial limited partner and the other limited partners a party theretofrom time to time                                                                                                                                                                                                                                                            |
| 10.2        |  | Non-CompetitionAgreement, dated as of October 29, 2004, by and among NorthStar RealtyFinance Corp., NorthStar Realty Finance Limited Partnership, NorthStarCapital Investment Corp. and NorthStar Partnership, L.P.                                                                                                                                                                                                                                                                                                                      |
| 10.3        |  | Shared Facilities and Services Agreement, datedas of October 29, 2004, by and between NorthStar Realty Finance Corp.and NorthStar Capital Investment Corp.                                                                                                                                                                                                                                                                                                                                                                               |
| 10.4        |  | Amended, Restated and Consolidated Fee andLeasehold Mortgage, Assignment of Leases and Rents and SecurityAgreement, dated as of December 4, 2002, by and among 729 Demi-TasseLLC, 1552 Lonsdale LLC, ALGM Leasehold II LLC, ALGM Leasehold III LLC,ALGM Leasehold VI LLC, ALGM Leasehold VIII LLC, ALGM Leasehold IX LLC,ALGM Leasehold X LLC, ALGM Leasehold XII LLC and Greenwich CapitalFinancial Products, Inc. (incorporated by reference to Exhibit 10.1 tothe Company's Registration Statement on Form S-11 (File No.333-114675)) |
| 10.5        |  | Executive EmploymentAgreement, dated as of October 22, 2004, between David T. Hamamoto andNorthStar Realty Finance Corp.                                                                                                                                                                                                                                                                                                                                                                                                                 |
| 10.6        |  | Executive Employment Agreement, dated as ofOctober 22, 2004, between Mark E. Chertok and NorthStar Realty FinanceCorp.                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.7        |  | Executive Employment Agreement,dated as of October 22, 2004, between Jean-Michel Wasterlain andNorthStar Realty Finance Corp.                                                                                                                                                                                                                                                                                                                                                                                                            |
| 10.8        |  | Executive Employment Agreement, dated as ofOctober 22, 2004, between Daniel R. Gilbert and NorthStar RealtyFinance Corp.                                                                                                                                                                                                                                                                                                                                                                                                                 |
| 10.9        |  | NorthStar Realty FinanceCorp. 2004 Omnibus Stock Incentive Plan                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.10       |  | LTIP Unit Vesting Agreement under the NorthStar Realty FinanceCorp. 2004 Omnibus Stock Incentive Plan among NorthStar Realty FinanceCorp., NorthStar Realty Finance Limited Partnership and NRF Employee,LLC                                                                                                                                                                                                                                                                                                                             |
| 10.11       |  | Form of Vesting Agreement forUnits of NRF Employee, LLC, each dated as of October 29, 2004, betweenNRF Employee, LLC and certain employees and co-employees of NorthStarRealty Finance Corp.                                                                                                                                                                                                                                                                                                                                             |
| 10.12       |  | Form ofRestricted Stock Agreement (incorporated by reference to Exhibit10.7(a) to the Company's Registration Statement on Form S-11(File No. 333-114675))                                                                                                                                                                                                                                                                                                                                                                                |
| 10.13       |  | NorthStarRealty Finance Corp. 2004 Long-Term Incentive Bonus Plan                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10.14       |  | Form of Notification under NorthStar RealtyFinance Corp. 2004 Long-Term Incentive Bonus Plan                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.15       |  | Form of Indemnification Agreement for directorsand officers of NorthStar Realty Finance Corp. (incorporated byreference to Exhibit 10.15 to the Company's RegistrationStatement on Form S-11 (File No. 333-114675))                                                                                                                                                                                                                                                                                                                      |
|             |

46

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|             |  |                                                                                                                                        |  |  |  |  |
|-------------|--|----------------------------------------------------------------------------------------------------------------------------------------|--|--|--|--|
| Exhibit No. |  | Description                                                                                                                            |
| 10.16       |  | Master RepurchaseAgreement, dated as of December 21, 2004 between NRFC DB Holdings, LLCand Deutsche Bank AG, Cayman Islands Branch     |
| 31.1        |  | Certification of David T. Hamamoto, ChiefExecutive Officer pursuant to Rule 13a - 14(a)                                                |
| 31.2        |  | Certification of Mark E. Chertok, Chief FinancialOfficer pursuant to Rule 13a - 14(a)                                                  |
| 32.1        |  | Certification of David T. Hamamoto, ChiefExecutive Officer pursuant to Section 1350 of Chapter 63 of Title 18 ofthe United States Code |
| 32.2        |  | Certificationof Mark E. Chertok, Chief Financial Officer pursuant to Section 1350 ofChapter 63 of Title 18 of the United StatesCode    |
|             |

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SIGNATURES

Pursuant to therequirements of the Securities Exchange Act of 1934, the Registrant hasduly caused this report to be signed on its behalf by the undersignedhereunto duly authorized.

|  | NORTHSTAR REALTYFINANCE CORP. |
|--|-------------------------------|

Date:    December 30, 2004

|  | By:    /s/ David T.Hamamoto   Name: David T. Hamamoto Title:Chief Executive Officer |
|--|-------------------------------------------------------------------------------------------------------------------|

|  | By:    /s/ Mark E.Chertok   Name: Mark E. Chertok Title: ChiefFinancial Officer |
|--|---------------------------------------------------------------------------------------------------------------|

48

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EXHIBITINDEX

|            |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |  |  |  |  |
|------------|--|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--|--|--|--|
| ExhibitNo. |  | Description                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 2.1        |  | Contribution Agreement, dated as of October 29,2004, by and among NS Advisors Holdings LLC, Presidio CapitalInvestment Company, LLC and NorthStar Realty Finance LimitedPartnership                                                                                                                                                                                                                                                                                                                                                      |
| 2.2        |  | Contribution Agreement,dated as of October 29, 2004, by and among NorthStar Partnership, L.P.,NorthStar Funding Managing Member Holdings LLC and NorthStar RealtyFinance Limited Partnership                                                                                                                                                                                                                                                                                                                                             |
| 2.3        |  | Purchaseand Sale Agreement, dated as of October 29, 2004, between NorthStarRealty Finance Limited Partnership and ALGM I Equity, LLC                                                                                                                                                                                                                                                                                                                                                                                                     |
| 3.1        |  | Articles of Amendment and Restatement of NorthStarRealty Finance Corp., as filed with the State Department of Assessmentsand Taxation of Maryland on October 20, 2004 (incorporated by referenceto Exhibit 3.1 to the Company's Registration Statement on FormS-11 (File No. 333-114675))                                                                                                                                                                                                                                                |
| 3.2        |  | Bylaws ofNorthStar Realty Finance Corp. (incorporated by reference to Exhibit3.2 to the Company's Registration Statement on Form S-11 (FileNo. 333-114675))                                                                                                                                                                                                                                                                                                                                                                              |
| 4.1        |  | Registration RightsAgreement, dated as of October 29, 2004, by and among NorthStar RealtyFinance Corp., NorthStar Partnership, L.P., NorthStar Funding ManagingMember Holdings LLC and NS Advisors Holdings LLC                                                                                                                                                                                                                                                                                                                          |
| 10.1       |  | Agreement of Limited Partnership of NorthStarRealty Finance Limited Partnership, dated as of October 19, 2004, byand among NorthStar Realty Finance Corp., as sole general partner andinitial limited partner and the other limited partners a party theretofrom time to time                                                                                                                                                                                                                                                            |
| 10.2       |  | Non-CompetitionAgreement, dated as of October 29, 2004, by and among NorthStar RealtyFinance Corp., NorthStar Realty Finance Limited Partnership, NorthStarCapital Investment Corp. and NorthStar Partnership, L.P.                                                                                                                                                                                                                                                                                                                      |
| 10.3       |  | Shared Facilities and Services Agreement, datedas of October 29, 2004, by and between NorthStar Realty Finance Corp.and NorthStar Capital InvestmentCorp.                                                                                                                                                                                                                                                                                                                                                                                |
| 10.4       |  | Amended, Restated andConsolidated Fee and Leasehold Mortgage, Assignment of Leases and Rentsand Security Agreement, dated as of December 4, 2002, by and among 729Demi-Tasse LLC, 1552 Lonsdale LLC, ALGM Leasehold II LLC, ALGMLeasehold III LLC, ALGM Leasehold VI LLC, ALGM Leasehold VIII LLC, ALGMLeasehold IX LLC, ALGM Leasehold X LLC, ALGM Leasehold XII LLC andGreenwich Capital Financial Products, Inc. (incorporated by referenceto Exhibit 10.1 to the Company's Registration Statement on FormS-11 (File No. 333-114675)) |
| 10.5       |  | ExecutiveEmployment Agreement, dated as of October 22, 2004, between David T.Hamamoto and NorthStar Realty Finance Corp.                                                                                                                                                                                                                                                                                                                                                                                                                 |
| 10.6       |  | Executive Employment Agreement, dated as ofOctober 22, 2004, between Mark E. Chertok and NorthStar Realty FinanceCorp.                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.7       |  | Executive Employment Agreement,dated as of October 22, 2004, between Jean-Michel Wasterlain andNorthStar Realty Finance Corp.                                                                                                                                                                                                                                                                                                                                                                                                            |
|       |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
|            |

----

|            |  |                                                                                                                                                                                                                     |  |  |  |  |
|------------|--|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--|--|--|--|
| ExhibitNo. |  | Description                                                                                                                                                                                                         |
| 10.8       |  | Executive EmploymentAgreement, dated as of October 22, 2004, between Daniel R. Gilbert andNorthStar Realty Finance Corp.                                                                                            |
| 10.9       |  | NorthStar Realty Finance Corp. 2004 Omnibus StockIncentive Plan                                                                                                                                                     |
| 10.10      |  | LTIP Unit VestingAgreement under the NorthStar Realty Finance Corp. 2004 Omnibus StockIncentive Plan among NorthStar Realty Finance Corp., NorthStar RealtyFinance Limited Partnership and NRF Employee, LLC        |
| 10.11      |  | Form of Vesting Agreement for Units of NRFEmployee, LLC, each dated as of October 29, 2004, between NRF Employee,LLC and certain employees and co-employees of NorthStar Realty FinanceCorp.                        |
| 10.12      |  | Form of Restricted StockAgreement (incorporated by reference to Exhibit 10.7(a) to theCompany's Registration Statement on Form S-11 (File No.333-114675))                                                           |
| 10.13      |  | NorthStar Realty FinanceCorp. 2004 Long-Term Incentive Bonus Plan                                                                                                                                                   |
| 10.14      |  | Form of Notification under NorthStar RealtyFinance Corp. 2004 Long-Term Incentive Bonus Plan                                                                                                                        |
| 10.15      |  | Form of Indemnification Agreement for directorsand officers of NorthStar Realty Finance Corp. (incorporated byreference to Exhibit 10.15 to the Company's RegistrationStatement on Form S-11 (File No. 333-114675)) |
| 10.16      |  | Master Repurchase Agreement, dated as ofDecember 21, 2004 between NRFC DB Holdings, LLC and Deutsche Bank AG,Cayman Islands Branch                                                                                  |
| 31.1       |  | Certification ofDavid T. Hamamoto, Chief Executive Officer pursuant to Rule 13a -14(a)                                                                                                                              |
| 31.2       |  | Certification of Mark E.Chertok, Chief Financial Officer pursuant to Rule 13a -14(a)                                                                                                                                |
| 32.1       |  | Certification of David T.Hamamoto, Chief Executive Officer pursuant to Section 1350 of Chapter63 of Title 18 of the United StatesCode                                                                               |
| 32.2       |  | Certification of Mark E. Chertok,Chief Financial Officer pursuant to Section 1350 of Chapter 63 of Title18 of the United StatesCode                                                                                 |
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