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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
   Form 10-QSB QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2004 Commission File Number: 0-25074 PARAGON REAL ESTATE EQUITY AND INVESTMENT TRUST  Maryland
    
    39-6594066(State or other jurisdiction of incorporation)
    
    (I.R.S. Employer Identification Number)1240 Huron Road, Suite 301, Cleveland, OH
    
    44115(Address of principal executive offices)
    
    (Zip code)
 Issuers telephone number: 216-430-2700   Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to the filing requirements for the past 90 days. Yes þ No o As of August 3,2004, 33,440,615 shares of the issuers common shares were
outstanding, including 2,859,765 common shares held in treasury. Transitional Small Business Disclosure Format (Check one): Yes o No þ




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PARAGON REAL ESTATE EQUITY AND INVESTMENT TRUST AND SUBSIDIARIES
FORM 10-QSB INDEX
 PART I. Financial InformationItem 1. Financial Statements
Consolidated Balance Sheet  June 30, 2004 (unaudited).
    
    Page 2Consolidated Statements of Operations  Six months ended
June 30, 2004 and June 30, 2003 (unaudited).
    
    Page 3Consolidated Statements of Operations  Three months ended
June 30, 2004 and June 30, 2003 (unaudited).
    
    Page 4Consolidated Statements of Cash Flows  Six months ended
June 30, 2004 and June 30, 2003 (unaudited).
    
    Page 5Notes to Consolidated Financial Statements (unaudited).
    
    Page 6Item 2. Managements Discussion and Analysis or
Plan of Operation.
    
    Page 14Item 3. Controls and Procedures.
    
    Page 22Part II. Other InformationItem 1. Legal Proceedings.
    
    Page 22Item 2. Changes in Securities.
    
    Page 22Item 3. Defaults upon Senior Securities.
    
    Page 22Item 4. Submission of Matters to a Vote of Security Holders
    
    Page 22Item 5. Other Information.
    
    Page 23Item 6. Exhibits and Reports on Form 8-K.
    
    Page 23Signatures.
    
    Page 24EX-31.1 CertificationEX-31.2 CertificationEX-32.1 Certification
  1




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Paragon Real Estate Equity and Investment Trust and Subsidiaries
Consolidated Balance Sheet
June 30, 2004
(unaudited) AssetsInvestments in real estate:Land
    
    $
    797,682Buildings and improvements
    
    
    3,188,727Furniture, fixtures and equipment
    
    
    13,1513,999,560Accumulated depreciation and amortization
    
    
    (80,469
    )Net investments in real estate
    
    
    3,919,091Cash and cash equivalents
    
    
    2,132,368Marketable securities
    
    
    86,643Restricted cash
    
    
    106,917Accounts receivable, net
    
    
    15,575Other assets, net
    
    
    101,090Total Assets
    
    $
    6,361,684Liabilities and Shareholders EquityLiabilities:Mortgage loan payable
    
    $
    2,787,613Accounts payable and accrued expenses
    
    
    175,023Security deposits
    
    
    60,999Total liabilities
    
    
    3,023,635Minority interest in consolidated subsidiary
    
    
    2,168,480Commitments and ContingenciesShareholders equity:Preferred Shares  $0.01 par value,
10,000,000 authorized: 278,455 Class A
cumulative convertible shares issued and
outstanding, $10.00 per share liquidation
preference
    
    
    2,785Common Shares  $0.01 par value,
100,000,000 authorized; 32,940,615 shares
issued and outstanding
    
    
    329,406Additional paid-in capital
    
    
    28,309,536Accumulated other comprehensive income, net
unrealized gain on marketable securities
    
    
    47,968Accumulated deficit
    
    
    (24,092,153
    )Treasury stock, at cost, 2,859,765 shares
    
    
    (800,735
    )Unearned compensation and trustees fees
    
    
    (2,627,238
    )Total shareholders equity
    
    
    1,169,569Total Liabilities and Shareholders Equity
    
    $
    6,361,684
 The accompanying notes are an integral part of the consolidated financial statements. 2




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Paragon Real Estate Equity and Investment Trust and Subsidiaries
Consolidated Statements of Operations
(unaudited) For the six months ended June 30,2004
    
    2003RevenuesRental revenue
    
    $
    295,611
    
    
    $
    Interest and other
    
    
    27,457
    
    
    
    3,223Total revenues
    
    
    323,068
    
    
    
    3,223ExpensesProperty, operating and maintenance
    
    
    100,183
    
    
    
    Property taxes and insurance
    
    
    46,705
    
    
    
    Depreciation and amortization
    
    
    43,009
    
    
    
    9,069Interest
    
    
    83,152
    
    
    
    General and administrative
    
    
    464,362
    
    
    
    598,750Management fees
    
    
    13,557
    
    
    
    Total expenses
    
    
    750,968
    
    
    
    607,819Loss from operations before loss allocated to minority
interest
    
    
    (427,900
    )
    
    
    (604,596
    )Loss allocated to minority interest
    
    
    81,017
    
    
    
    42,570Loss from continuing operations
    
    
    (346,883
    )
    
    
    (562,026
    )Discontinued operations:Loss from discontinued operations
    
    
    
    
    
    
    (549,969
    )Net loss available to Common Shareholders
    
    $
    (346,883
    )
    
    $
    (1,111,995
    )Net loss available to Common Shareholders per Common
Share: Basic and Diluted
    
    $
    (0.01
    )
    
    $
    (0.24
    )Weighted average number of Common Shares outstanding: Basic and Diluted
    
    
    32,678,378
    
    
    
    4,665,950Comprehensive loss:Net loss
    
    $
    (346,883
    )
    
    $
    (1,111,995
    )Other comprehensive loss:Unrealized gain (loss) on marketable securities
    
    
    (13,732
    )
    
    
    38,800Comprehensive loss
    
    $
    (360,615
    )
    
    $
    (1,073,195
    )
 The accompanying notes are an integral part of the consolidated financial
statements. 3




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Paragon Real Estate Equity and Investment Trust and Subsidiaries
Consolidated Statements of Operations
(unaudited) For the three months ended June 30,2004
    
    2003RevenuesRental revenue
    
    $
    145,009
    
    
    $
    Interest and other
    
    
    9,300
    
    
    
    794Total revenues
    
    
    154,309
    
    
    
    794ExpensesProperty, operating and maintenance
    
    
    43,830
    
    
    
    Property taxes and insurance
    
    
    23,490
    
    
    
    Depreciation and amortization
    
    
    21,578
    
    
    
    3,631Interest
    
    
    41,485
    
    
    
    General and administrative
    
    
    224,769
    
    
    
    399,159Management fees
    
    
    6,691
    
    
    
    Total expenses
    
    
    361,843
    
    
    
    402,790Loss from operations before loss allocated to
minority interest
    
    
    (207,534
    )
    
    
    (401,996
    )(Income) loss allocated to minority interest
    
    
    (5,879
    )
    
    
    32,712Loss from continuing operations
    
    
    (213,413
    )
    
    
    (369,284
    )Discontinued operations:Loss from discontinued operations
    
    
    
    
    
    
    (497,513
    )Net loss available to Common Shareholders
    
    $
    (213,413
    )
    
    $
    (866,797
    )Net loss available to Common Shareholders per
Common Share: Basic and Diluted
    
    $
    (0.01
    )
    
    $
    (0.18
    )Weighted average number of Common Shares
outstanding: Basic and Diluted
    
    
    32,775,781
    
    
    
    4,812,744Comprehensive loss:Net loss
    
    $
    (213,413
    )
    
    $
    (866,797
    )Other comprehensive loss:Unrealized gain on marketable securities
    
    
    10,768
    
    
    
    47,200Comprehensive loss
    
    $
    (202,645
    )
    
    $
    (819,597
    )
 The accompanying notes are an integral part of the consolidated financial
statements. 4




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Paragon Real Estate Equity and Investment Trust and Subsidiaries
Consolidated Statements of Cash Flows
(unaudited) For the six months ended June 30,2004
    
    2003Cash flows from operating activities:Net loss
    
    $
    (346,883
    )
    
    $
    (1,111,995
    )Adjustments to reconcile net loss to net cash used in
continuing operations:Discontinued operations, net of tax
    
    
    
    
    
    
    549,969Compensation costs and trustees fees incurred
through the issuance of shares
    
    
    55,733
    
    
    
    300,000Rent expense incurred through the issuance of
restricted shares
    
    
    51,500
    
    
    
    Depreciation and amortization
    
    
    43,009
    
    
    
    9,069Loss allocated to minority interest
    
    
    (81,017
    )
    
    
    (42,570
    )Net change in assets and liabilities:Accounts receivable, net
    
    
    (5,764
    )
    
    
    Restricted cash
    
    
    (9,835
    )
    
    
    Other assets, net
    
    
    265,168
    
    
    
    (64,428
    )Accounts payable and accrued expenses
    
    
    (27,185
    )
    
    
    288,282Security deposits
    
    
    2,985
    
    
    
    Net cash used in continuing operations
    
    
    (52,289
    )
    
    
    (71,673
    )Cash flows from investing activities:Additions to real estate properties
    
    
    (8,319
    )
    
    
    Purchase of marketable securities
    
    
    (1,175
    )
    
    
    Net cash used in investing activities
    
    
    (9,494
    )
    
    
    Cash flows from financing activities:Payments on mortgage loan
    
    
    (24,523
    )
    
    
    Net cash used in financing activities
    
    
    (24,523
    )
    
    
    Net cash used in discontinued operationsDiscontinued operations of technology segment
    
    
    
    
    
    
    (27,249
    )Discontinued operations of commercial properties
    
    
    
    
    
    
    (558,713
    )Net cash used in discontinued operations
    
    
    
    
    
    
    (585,962
    )Net decrease in cash and cash equivalents
    
    
    (86,306
    )
    
    
    (657,635
    )Cash and cash equivalentsBeginning of period
    
    
    2,218,674
    
    
    
    1,029,265End of period
    
    $
    2,132,368
    
    
    $
    371,630Supplemental information to Consolidated Statements of Cash FlowsInterest paid
    
    $
    83,152
    
    
    $
    168,282Accrued financing costs
    
    $
    
    
    
    $
    23,465
 The accompanying notes are an integral part of the consolidated financial
statements. 5




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Paragon Real Estate Equity and Investment Trust and Subsidiaries 
 Notes to Consolidated Financial Statements
(unaudited) Note 1  Organization Paragon Real Estate Equity and Investment Trust (the Company, Paragon,
we, our, or us) is a real estate company which primarily acquires, owns
and operates multi-family residential real estate properties. As of June 30,
2004, we owned a 1.0% interest in Paragon Real Estate, LP, the operating
partnership that owns Richton Trail Apartments (Richton Trail), an apartment
complex containing 72 units. Hampton Court Associates (Hampton Court) owns
the remaining 99.0% interest in Paragon Real Estate, LP. We are the sole
general partner of Paragon Real Estate, LP and Hampton Court is the limited
partner. Hampton Courts ownership interest in Paragon Real Estate, LP is
813,938 restricted limited partnership units, each unit redeemable after July
1, 2007 for cash, or, at our option, 22.881 of our common shares. Note 2  Basis of Presentation We have prepared the consolidated financial statements without audit pursuant
to the rules and regulations of the Securities and Exchange Commission. Certain
information and footnote disclosures normally included in the financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted pursuant to such rules and regulations.
However, we believe that the included disclosures are adequate to make the
information presented not misleading. In our opinion, all adjustments
(consisting solely of normal recurring items, except for discontinued
operations of our technology segment and the discontinued operations of our
commercial properties) necessary for a fair presentation of our financial
position as June 30, 2004, the results of our operations for the six month
periods ended June 30, 2004 and 2003, the results of our operations for the
three month periods ended June 30, 2004 and 2003, and of our cash flows for the
six month periods ended June 30, 2004 and 2003 have been included. The results
of operations for such interim periods are not necessarily indicative of the
results for a full year. For further information, refer to our consolidated
financial statements and footnotes included in the Annual Report on Form 10-KSB
for the year ended December 31, 2003. Note 3  Summary of Significant Accounting Policies Use of Estimates in the Preparation of Financial Statements In order to conform with generally accepted accounting principles, management,
in preparation of our consolidated financial statements, is required to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities as of June 30,
2004, and the reported amounts of revenues and expenses for the six month and
three month periods ended June 30, 2004 and 2003. Actual results could differ
from those estimates. Significant estimates include the valuation of
investments in real estate, marketable securities and deferred taxes, and these
significant estimates, as well as other estimates and assumptions, which may
change in the near term. Investments in Real Estate Our investments in real estate assets are reported at the lower of cost or
estimated net realizable value. We periodically review our properties for impairment and provide for a
provision if impairments are determined. First, to determine if impairment may
exist, we review our properties and identify those, if any, which have had
either an event of change or event of circumstances warranting further
assessment of recoverability. Then, we estimate the fair value of those
properties on an individual basis based on an independent appraisal,
capitalizing the expected net operating income, or applying various other
valuation factors. Such amounts are then compared to the propertys
depreciated cost to determine whether an impairment exists. 6




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In accordance with Financial Accounting Standard No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets (FAS 144), impairment of
investments in real estate exists when the carrying amount of the investments
exceeds its fair value and is non-recoverable. Fair value of these assets is
the amount an asset could be bought or sold in a current transaction between
willing parties. Further, FAS 144 defines a component of a company to be the
operations that can be clearly distinguished from the rest of the company, and
then requires elimination from its continuing operations for those assets held
for sale or disposed of. Accordingly, one of the impacts of our adoption of
this standard is that revenues and expenses associated with our properties sold
on October 1, 2003, are classified as discontinued operations on our
Consolidated Statements of Operations for the six months and three months ended
June 30, 2003. Depreciation expense is computed using the straight-line method based on the
following useful lives: YearsBuilding and improvements
    
    
    40Furniture, fixtures and equipment
    
    
    3-7
 Expenditures for ordinary maintenance and repairs are expensed to operations as
incurred and significant renovations and improvements that improve or extend
the useful life of the asset are capitalized and depreciated over their
estimated useful life. When a property is sold or retired, the costs and related accumulated
depreciation are removed from the accounts and the resulting gain or loss,
together with the related historical operating results, are included in
discontinued operations. Cash and cash equivalents Cash and cash equivalents include all cash and liquid investments that mature
three months or less from when they are purchased. Cash equivalents are
reported at cost, which approximates fair value. We maintain our cash in bank
accounts in amounts that may exceed federally insured limits at times. We also
maintained cash of approximately $18,000 at June 30, 2004 in a money market
account that was not federally insured. Cash of approximately $107,000 is
classified as restricted at June 30, 2004 because approximately $51,000 is held
in an escrow account of the mortgage lender for the payment of property taxes
and insurance and approximately $56,000 is in a separate bank account for
security deposits of our residential tenants. Accounts Receivable Our accounts receivable are reported net of an allowance for bad debts of
approximately $6,000 at June 30, 2004 for Richton Trail. Other Assets As of June 30, 2004, other assets include prepaid expenses of approximately
$50,000 and deferred financing costs incurred to obtain and secure mortgage
debt financing of approximately $55,000. Other assets are carried at cost,
less accumulated amortization. The deferred financing costs are being amortized over the life of the mortgage
loan payable on a straight-line basis. Accumulated amortization related to
deferred financing costs as of June 30, 2004 was approximately $4,000. 7




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Revenue Recognition Revenues from rental property are recognized when due from tenants. Leases are
generally for terms of one year or less. Stock Based Compensation At June 30, 2004, we had one stock-based employee compensation plan. During
the six months ended June 30, 2004, we issued 550,000 common share options and
further issued 1,100,000 restricted share grants. In connection with the
resignation of an employee in 2004, we cancelled 50,000 restricted share grants
under this plan. During the six months ended June 30, 2003, no options or
restricted share grants were issued under this plan. We account for the plan
under the recognition and measurement principles of APB Opinion No. 25,
Accounting for Stock Issued to Employees, and related interpretations. In
accordance with APB Opinion No. 25, no stock-based employee compensation cost
would be reflected in net loss, as all options granted under the plan would
have an exercise price equal to the market value of the underlying common
shares on the date of grant. The following table illustrates the effect on net
loss and loss per share if the Company had applied the fair value recognition
provisions of FASB Statement No. 123, Accounting for Stock-Based
Compensation, as amended, to stock-based employee compensation. For the six month periods endedJune 30,2004
    
    2003Net loss attributable to Common Shareholders
    
    $
    (346,883
    )
    
    $
    (1,111,995
    )Add: Stock-based employee compensation
expense included in reported net loss, net
of related tax effects
    
    
    55,733
    
    
    
    Deduct: Total stock-based employee
compensation expense determined under fair
value based method for all awards, net of
related tax effects
    
    
    (71,483
    )
    
    
    Pro forma net loss attributable to Common
Shareholders
    
    $
    (362,633
    )
    
    $
    (1,111,995
    )Net loss attributable to Common
Shareholders per Common Share:Basic and
Diluted  as reported
    
    $
    (0.01
    )
    
    $
    (0.24
    )Basic and
Diluted  pro forma
    
    $
    (0.01
    )
    
    $
    (0.24
    )
 Income Taxes Because the Company is no longer a Real Estate Investment Trust (REIT) for
federal income tax purposes, we now account for income taxes using the
liability method under which deferred tax assets and liabilities are determined
based on differences between the financial reporting and tax bases of assets
and liabilities using enacted tax rates in effect for the period in which the
differences are expected to affect taxable income. Valuation allowances are
established when necessary to reduce deferred tax assets to the amount expected
to be realized. We will be eligible to re-elect REIT status on January 1,
2005. At June 30, 2004, we have net operating losses, and at December 31, 2003, we
had net operating losses totaling approximately $11.0 million and capital
losses of approximately $0.8 million. While these losses created a deferred
tax asset, a valuation allowance was applied against the asset because of the
uncertainty of whether we will be able to use these loss carry forwards, which
will expire in varying amounts through the year 2023. 8




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We are also subject to certain state and local income, excise and franchise
taxes. The provision for
state and local taxes has been reflected in general and administrative expense
in the consolidated statements of operations and has not been separately stated
due to its insignificance. Fair Value of Financial Instruments Our financial instruments include cash and cash equivalents, marketable
securities and a mortgage loan. The fair values of the financial instruments
were not materially different from their carrying or contract values at June
30, 2004. Segment Disclosure Statement of Financial Accounting Standards No. 131, Disclosures about
Segments of an Enterprise and Related Information requires that a public
company report financial and descriptive information about its reportable
operating segments. Generally, financial information is required to be
reported on the basis that it is used internally for evaluating segment
performance and deciding how to allocate resources to segments. Management
views the Company as a single segment, which acquires, owns and operates rental
real estate. During 2003 we sold our commercial real estate resulting in the
revenues and expenses of these properties being classified as discontinued
operations for the six months and three months ended June 30, 2003. Reclassification As a result of the sale of our commercial properties on October 1, 2003,
certain amounts in the June 30, 2003 financial statements have been
reclassified to conform to the June 30, 2004 presentation. These
reclassifications had no effect on net loss or shareholders equity as
previously reported. Note 4  Marketable Securities Our investments in marketable securities are available-for-sale, as of June 30,
2004, and represent 10,000 common shares of Stellent, Inc. (Stellent) and 100
common shares of Century Realty Trust (Century). The Stellent shares were
acquired in connection with the sale of certain assets of Stonehaven
Technologies on July 10, 2001. As of June 30, 2004, our marketable securities had a fair market value of
approximately $87,000 (based upon the NASDAQ closing quote of $8.54 per share
for Stellent and $12.44 per share for Century on June 30, 2004). We recorded
an unrealized loss on marketable securities during 2004 of approximately
$14,000, resulting in a balance of approximately $48,000 in shareholders
equity for unrealized gain on marketable securities. The NASDAQ closing quote on August 2, 2004 was $7.15 per common share of
Stellent and $12.75 per common share of Century. Note 5  Pro Forma Consolidated Financial Information The following pro forma condensed consolidated financial information presented
below is as if the disposition of our 92.9% general partnership interest in our
commercial properties (closed October 1, 2003) and the acquisition of the
Richton Trail Apartments (closed July 1, 2003) had occurred on January 1, 2003.
The pro forma financial information is not necessarily indicative of the
results, which actually would have occurred if the disposition and acquisition
had been consummated on January 1, 2003, nor does the pro forma information
purport to represent the results of operations for future periods. As of June
30, 2003, all revenues and expenses associated with the commercial properties
have been recorded as discontinued operations. 9




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For the six months endedJune 30, 2003Pro forma total revenue
    
    $
    305,000Pro forma loss from continuing operations
    
    $
    (605,000
    )Pro forma loss attributable to Common Shareholders
    
    $
    (605,000
    )Pro forma loss per Common Share: Basic and Diluted
    
    $
    (0.02
    )
 Note 6  Mortgage Loan Payable The mortgage loan payable secured by our residential real estate property has a
balance at June 30, 2004 of approximately $2.8 million at a fixed interest rate
of 5.87% for a term of 10 years with monthly principal and interest payments of
approximately $18,000 based on a 25-year amortization schedule. Note 7  Equity During the first quarter of 2004, 935 preferred shares were converted to 3,224
common shares, at a conversion rate of 3.448 common shares for each preferred
share. No other preferred shares were converted through June 30, 2004. Effective January 2, 2004, we issued a total of 900,000 restricted common
shares to three of our officers and 450,000 common share options at a price of
$0.27 per share to three of our officers. The market value of the restricted
common shares on the date of grant was $198,000. The options vest ratably over
three years after issuance and expire after five years from the date of
issuance. Effective February 16, 2004, 50,000 restricted common shares (issued during
2003) were cancelled in connection with one employees resignation. Effective March 4, 2004, we agreed to issue 250,000 restricted common shares to
our landlord in connection with office space and related services for the
twelve months ended March 4, 2004. Effective June 15, 2004, we issued a total of 200,000 restricted common shares
and 100,000 common share options at a price of $0.18 per share to our four
independent trustees, who are not executive officers of Paragon, as part of
their compensation for serving on Paragons board and committees. The market
value of the restricted common shares on the date of grant was $36,000. The
options vest ratably over three years after issuance and expire after five
years from the date of issuance. Subsequent to June 30, 2004, effective July 19, 2004, we issued a total of 1.0
million restricted common shares to a new officer of the Company. The initial
grant of 500,000 restricted shares will vest half of the shares in four years
and the second half in five years. Additional grants of 125,000 restricted
common shares will be made annually for the next four years beginning on the
anniversary date of his employment with vesting effective four years after each
grant date. Note 8  Discontinued Operations On October 1, 2003 we sold our 92.9% general partnership interest in our
commercial properties. The results of operations for these properties are
presented in the accompanying Consolidated Statement of Operations as Loss
from discontinued operations. 10




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The following is a summary of the loss from discontinued operations of our
commercial properties. For the six
    
    For the threemonths ended
    
    months endedJune 30, 2003
    
    June 30, 2003Revenues
    
    $
    667,759
    
    
    $
    339,211Operating expenses
    
    
    (309,772
    )
    
    
    (151,319
    )Depreciation and amortization
    
    
    (101,841
    )
    
    
    (51,287
    )Interest expense
    
    
    (168,282
    )
    
    
    (84,569
    )General and administrative
    
    
    (287,833
    )
    
    
    (199,549
    )Non-recurring real estate expense
    
    
    (350,000
    )
    
    
    (350,000
    )Loss from discontinued operations
    
    $
    (549,969
    )
    
    $
    (497,513
    )
 Note 9  Loss Per Share The Company has adopted the Statement of Financial Accounting Standards No.
128, Earnings Per Share (EPS) for all periods presented herein. Net loss
per weighted average Common Share outstandingbasic and net loss per weighted
average Common Share outstandingdiluted are computed based on the weighted
average number of Common Shares outstanding for the period. The weighted
average number of Common Shares outstanding for the six months ended June 30,
2004 and June 30, 2003 were 32,678,378 and 4,665,950, respectively. Common
share equivalents of approximately 23.7 million and 31.8 million as of June 30,
2004 and June 30, 2003, respectively, include outstanding convertible preferred
shares, warrants, stock options and limited partnership units, and are not
included in net loss per weighted average common share outstandingdiluted as
they would be anti-dilutive. For the six months ended June 30,2004
    
    2003NumeratorNet Loss from continuing operations
    
    $
    (346,883
    )
    
    $
    (562,026
    )Discontinued operations:Discontinued operations, net of tax
    
    
    
    
    
    
    (549,969
    )Net loss available to Common Shareholders
    
    $
    (346,883
    )
    
    $
    (1,111,995
    )DenominatorWeighted average Common Shares
outstanding at June 30, 2004 and June
30, 2003, respectively: Basic and
Diluted
    
    
    32,678,378
    
    
    
    4,665,950Basis and Diluted EPSNet Loss from continuing operations
    
    $
    (0.01
    )
    
    $
    (0.12
    )Discontinued operations:Discontinued operations, net of tax
    
    
    
    
    
    
    (0.12
    )Net loss available to Common
Shareholders   Basic and Diluted
    
    $
    (0.01
    )
    
    $
    (0.24
    )
 11




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Note 10  Commitments and Contingencies Liquidity As of June 30, 2004, our unrestricted cash resources were approximately
$2,132,000 and our marketable securities available for sale were approximately
$87,000. Our marketable securities primarily represented 10,000 common shares
of Stellent. The NASDAQ closing quote on August 2, 2004 was $7.15 per common
share of Stellent. During the first half of 2003, we put into place a new management team and
shareholders elected five new Trustees. Paragon has developed a value-added
business plan that is primarily focused on acquiring well located,
under-performing multi-family residential properties and repositioning them
through renovation, leasing, improved management, and branding. This strategy,
while unique to public companies, is common among private companies on both a
local and limited regional basis. Paragons investments will be in properties,
portfolios and companies with value-added programs. Paragon intends to raise
equity through joint venture structures to be used for property and portfolio
acquisitions, and use tax-deferred operating partnership units, convertible
into a separate class of common shares, for acquisitions of companies. Failure
to obtain external sources of capital or to find sellers willing to exchange
their properties for tax-deferred partnership units will materially and
adversely affect our strategy and will materially and adversely affect our
operations, liquidity and financial results. We are dependent on our existing cash and Stellent shares to meet our liquidity
needs because cash from operations is not sufficient to meet our operating
requirements. Because the cash flow from our properties is not expected to
fully fund our future liquidity requirements, we have reduced our material
future obligations, which include a mortgage on the apartment complex and the
employment contracts for our executive officers. The debt service payment is
being funded from the cash flow of the property secured by the mortgage, and
the current salary requirements of the employment contracts is only $5,000 per
month for each executive officer. We historically have financed our long-term capital needs, including
acquisitions, as follows:  
    
    Borrowings from new loans;
    
    Additional equity issuances of our common and preferred shares; and
    
    Proceeds from the sales of our real estate and technology segment. There can be no assurance that any of the alternatives will be adopted, or if
adopted, will be successful. Employment Agreements On July 19, 2004, Jack R. Kuhn joined our executive management team as Sr. Vice
President  Chief Property Management & Development Officer responsible for
overseeing, managing and directing all property management and development
activities. Mr. Kuhns annual salary will be $60,000. As a material
inducement for Mr. Kuhn, the independent Management, Organization and
Compensation Committee approved a restricted share grant of up to 1,000,000
shares. The initial grant of 500,000 restricted shares will vest half of the
shares in four years and the second half in five years. Additional grants of
125,000 restricted common shares will be made annually for the next four years
beginning on the anniversary date of his employment with vesting effective four
years after each grant date. Legal Proceedings On April 1, 2004, Steven B. Hoyt, our former chairman, his wife Michelle L.
Hoyt, and Duane H. Lund, 12




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our former chief executive officer (the Plaintiffs),
filed a complaint in the United States District Court for the District of
Minnesota, Fourth Division, against Paragon and our stock transfer agent.
Plaintiffs allege that we have breached the terms of the voting and stock
restriction agreement that Messrs. Hoyt and Lund signed in March 2003, by
hindering the sale of the Plaintiffs Paragon shares. Plaintiffs seek a ruling
entitling them to sell their shares in the open market and more than $75,000 in
damages. Although we cannot predict the outcome of the suit, we believe that
the Plaintiffs claims are without merit and intend to vigorously defend
ourselves. Note 11  Related Party Transactions Management Fees of Commercial Properties We maintained a property management agreement with Hoyt Properties, Inc. (Hoyt
Properties), an entity controlled by Steven B. Hoyt, our former Chairman of
the Board, which served as property manager of the commercial properties
previously owned by us. In connection with the agreement, Hoyt Properties
managed the day-to-day operations of properties owned by us and received a
management fee for this service. Management fees paid to Hoyt Properties were
approximately $32,000 for the six months ended June 30, 2003. On October 1,
2003 we sold our four commercial properties managed by Hoyt Properties. As a
result, these management fees are included in discontinued operations. Richton Trail Acquisition and Management Fees Effective July 1, 2003, we closed the acquisition of our residential apartment
complex, Richton Trail, following approval by our shareholders of the
transaction on June 30, 2003. Our operating partnership, Paragon Real Estate,
LP, acquired the residential complex along with the associated mortgage from
Hampton Court Associates, LP (Hampton), a partnership controlled by James C.
Mastandrea, its general partner and our Chairman, Chief Executive Officer and
President. In consideration for transferring Richton Trail, Hampton received
813,938 restricted limited partnership units of Paragon Real Estate, LP. Each
unit is redeemable after four years for cash, or, at our option, 22.881 of our
common shares. Mr. Mastandrea also owns two companies that provide services to Richton Trail.
Mid Illinois Realty Corp. manages Richton Trail and MDC Realty Corp. is
reimbursed, at cost, for Richton Trails payroll related costs. The related
management fees included for the six months ended June 30, 2004 were
approximately $14,000. Reimbursement, at cost, for the payroll related costs
paid and accrued for the six months ended June 30, 2004 was approximately
$33,000. As Paragon acquires more properties, we intend to use local third
party management companies until we are able to provide management services
internally for our properties. Rental Expense During the six months ended June 30, 2003, we recognized rental expense of
approximately $8,000 related to office space leased from Hoyt Properties. Medical Insurance Reimbursement Paragon reimburses MDC Realty Corp. for medical insurance, at cost, for one of
its executive officers. The amount paid or accrued for the six months ended
June 30, 2004 was approximately $3,000. 13




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ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OR PLAN OF OPERATION Overview Paragon Real Estate Equity and Investment Trust (the Company, Paragon,
we, our, or us) is a real estate company that primarily acquires, owns
and operates multi-family residential properties. As of June 30, 2004, we
owned a 1.0% interest in Paragon Real Estate, LP, the operating partnership
that owns Richton Trail Apartments (Richton Trail), an apartment complex
containing 72 units. Hampton Court Associates (Hampton Court) owns the
remaining 99.0% interest in Paragon Real Estate, LP. We are the sole general
partner of Paragon Real Estate, LP and Hampton Court is the limited partner.
Hampton Courts ownership interest in Paragon Real Estate, LP is 813,938
restricted limited partnership units, each unit redeemable after July 1, 2007
for cash, or, at our option, 22.881 of our common shares. Our current management has developed a value-added business plan that is
primarily focused on acquiring well located, under-performing multi-family
residential properties, and then repositioning them through renovation,
leasing, improved management and branding. Besides identifying acquisitions,
it is equally important to locate sources of capital to fund the acquisitions,
or find sellers interested in exchanging their properties for tax deferred
partnership units. Brief History Paragon was formed on March 15, 1994 as a Maryland real estate investment trust
(REIT). We operated as a traditional REIT by buying, selling, owning and
operating commercial and residential properties through December 31, 1999. In February 2000, former management of Paragon purchased a software technology
company. As a result of the operations of the technology company commencing in
2000, Paragon did not meet the Internal Revenue Code qualifications to be a
REIT for federal tax purposes. In July 2001, former management sold the
software technology company, and continued marketing the software product until
2002, when operations of our technology segment were discontinued. Although
Paragon is no longer a REIT for federal tax purposes, we can elect REIT status
effective for 2005. Forward-Looking Information The following is a discussion of our results of operations for the six month
and three month periods ended June 30, 2004 and 2003 and financial condition,
including  
    
    Explanation of changes in the results of operations in the
Consolidated Statements of Operations for the six month period ended
June 30, 2004 compared to the six month period ended June 30, 2003.
    
    Explanation of changes in the results of operations in the
Consolidated Statements of Operations for the three month period ended
June 30, 2004 compared to the three month period ended June 30, 2003.
    
    Our critical accounting policies and estimates that require our
subjective judgment and are important to the presentation of our
financial condition and results of operations.
    
    Our primary sources and uses of cash for the six month period ended
June 30, 2004, and how we intend to generate cash for long-term capital
needs.
    
    Our current income tax status. This report on Form 10-QSB contains forward-looking statements for the
purposes of the Securities Act of 1933 and the Securities Exchange Act of 1934
and may involve known and unknown risks, uncertainties and other factors that
may cause the actual results, performance, and achievements of the Company to
be materially different from results, performance or achievements expressed or 14




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implied by such forward-looking statements. Although the Company believes that
the expectations
reflected in such forward-looking statements are based upon reasonable
assumptions, there can be no assurance that these expectations will be
realized. The Company assumes no obligation to update or supplement
forward-looking statements that become untrue because of subsequent events.
Factors that could cause actual results to differ materially from managements
current expectations include, but are not limited to, changes in general
economic conditions, changes in local real estate conditions (including rental
rates and competing properties), identifying and acquiring properties at
acceptable prices, changes in the economic conditions affecting industries
which employ tenants residing in our property, leasing unoccupied units or
re-leasing occupied units upon expiration of leases in accordance with our
projections, changes in prevailing interest rates, the cost or general
availability of equity and debt financing, unanticipated costs associated with
the acquisition and integration of our acquisitions, obtaining adequate
insurance for terrorist acts, demand for tenant services beyond those
traditionally provided by landlords, and potential liability under
environmental or other laws. For further information, refer to our
consolidated financial statements and footnotes included in the Annual Report
on Form 10-KSB for the year ended December 31, 2003. The following discussion and analysis should be read in conjunction with the
financial statements and notes thereto appearing elsewhere herein. Results of Operations Comparison of the Six Month Period Ended June 30, 2004 and 2003 Revenues from Continuing Operations As a result of the October 1, 2003 sale of our 92.9% general partnership
interest in the operating partnership that held our four commercial real estate
properties, rental revenues and interest and other revenue related to these
properties were reclassified to discontinued operations for the six month
period ended June 30, 2003. Richton Trail, which we acquired on July 1, 2003,
is included in continuing operations. Rental revenue of approximately $296,000 for the six month period ended June
30, 2004 was comprised entirely of Richton Trail, acquired on July 1, 2003,
compared to $0 for the six month period ended
June 30, 2003 when it was not part of our portfolio. Interest and other revenue increased by approximately $24,000 to approximately
$27,000 for the six month period ended June 30, 2004 compared to the six month
period ended June 30, 2003. The increase is primarily due to the increase in
cash and cash equivalents between the periods, as a result of the sale of our
Minnesota properties on October 1, 2003 and the refinance of the Richton Trail
mortgage on October 31, 2003. Expenses from Continuing Operations Total expenses increased from approximately $608,000 for the six month period
ended June 30, 2003 to $751,000 for the six month period ended June 30, 2004, a
net increase of $143,000 described below. As a result of the October 1, 2003 sale of our 92.9% general partnership
interest in the four commercial Minnesota properties, property taxes and
insurance, depreciation and amortization, interest and management fees related
to these properties were reclassified to discontinued operations. Richton
Trail, which we acquired on July 1, 2003, is included in continuing operations,
as follows:  
    
    Property, operating and maintenance  $100,000
    
    Property taxes and insurance   $47,000
    
    Depreciation and amortization  $43,000
    
    Interest  $83,000
    
    Management fees  $14,000 15




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General and administrative expenses decreased from approximately $599,000 for
the six month period
ended June 30, 2003 to approximately $464,000 for the six month period ended
June 30, 2004. The decrease was primarily the result of reduced compensation
and related costs of approximately $172,000 representing non-cash severance
costs incurred in 2003, net of increased costs in 2004 including approximately
$56,000 of non-cash costs paid through the issuance of restricted shares.
These reduced compensation costs were offset, in part, by increased travel and
other costs of approximately $19,000 related to the pursuit of new deals and
increased rent costs of approximately $24,000 representing non-cash costs paid
through the issuance of restricted shares. Loss from operations before minority interest As a result of the above, loss from operations before loss allocated to
minority interest decreased from approximately $605,000 for the six month
period ended June 30, 2003 to approximately $428,000 for the six month period
ended June 30, 2004. Loss allocated to minority interest Loss allocated to minority interests increased from approximately $43,000 for
the six month period ended June 30, 2003 to approximately $81,000 for the six
month period ended June 30, 2004 primarily as a result of the July 2003
acquisition of our partnership interest in Richton Trail offset, in part, by
the October 2003 sale of our partnership interest in our commercial properties. Loss from continuing operations Loss from continuing operations decreased from approximately $562,000 for the
six month period ended June 30, 2003 to approximately $347,000 for the six
month period ended June 31, 2004. Discontinued operations Loss from discontinued operations of approximately $0 and $550,000 for the
six month periods ended June 30, 2004 and 2003, respectively, were a result of
the October 2003 sale of our partnership interest in our commercial properties. Net loss available to Common Shareholders Based on the above, the net loss available to Common Shareholders decreased
from approximately $1,112,000 for the six month period ended June 30, 2003 to
$347,000 for the six month period ended June 30, 2004. Comparison of the Three Month Period Ended June 30, 2004 and 2003 Revenues from Continuing Operations As a result of the October 1, 2003 sale of our 92.9% general partnership
interest in the operating partnership that held our four commercial real estate
properties, rental revenues and interest and other revenue related to these
properties were reclassified to discontinued operations for the three month
period ended June 30, 2003. Richton Trail, which we acquired on July 1, 2003,
is included in continuing operations for 2004. Rental revenue of approximately $145,000 for the three month period ended June
30, 2004 was comprised entirely of Richton Trail, acquired on July 1, 2003,
compared to $0 for the three month period ended June 30, 2003 when it was not
part of our portfolio. 16




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Interest and other revenue increased by approximately $8,000 to approximately
$9,000 for the three month period ended June 30, 2004 compared to the three
month period ended June 30, 2003. The increase is primarily due to the
increase in cash and cash equivalents between the periods, as a result of the
sale of our Minnesota properties on October 1, 2003 and the refinance of the
Richton Trail
mortgage on October 31, 2003. Expenses from Continuing Operations Total expenses decreased from approximately $403,000 for the three month period
ended June 30, 2003 to $362,000 for the three month period ended June 30, 2004,
a net decrease of $41,000 described below. As a result of the October 1, 2003 sale of our 92.9% general partnership
interest in the four commercial Minnesota properties, property taxes and
insurance, depreciation and amortization, interest and management fees related
to these properties were reclassified to discontinued operations. Richton
Trail, which we acquired on July 1, 2003, is included in continuing operations,
as follows:  
    
    Property, operating and maintenance  $44,000
    
    Property taxes and insurance   $23,000
    
    Depreciation and amortization  $22,000
    
    Interest  $41,000
    
    Management fees  $7,000 General and administrative expenses decreased from approximately $399,000 for
the three month period ended June 30, 2003 to approximately $225,000 for the
three month period ended June 30, 2004. The decrease was primarily the result
of reduced compensation and related costs of approximately $188,000
representing non-cash severance costs incurred in 2003, net of increased costs
in 2004 including approximately $24,000 of non-cash costs paid through the
issuance of restricted shares. These reduced compensation costs were offset,
in part, by increased travel and other costs of approximately $3,000 related to
the pursuit of new deals and increased rent costs of approximately $10,000
representing non-cash costs paid through the issuance of restricted shares. Loss from operations before minority interest As a result of the above, loss from operations before income (loss) allocated
to minority interest decreased from approximately $402,000 for the three month
period ended June 30, 2003 to approximately $208,000 for the three month period
ended June 30, 2004. Income (loss) allocated to minority interest Income (loss) allocated to minority interests changed from approximately
$33,000 of loss allocated for the three month period ended June 30, 2003 to
approximately $6,000 of income allocated for the three month period ended June
30, 2004 primarily as a result of the July 2003 acquisition of our partnership
interest in Richton Trail offset, in part, by the October 2003 sale of our
partnership interest in our commercial properties. Loss from continuing operations Loss from continuing operations decreased from approximately $369,000 for the
three month period ended June 30, 2003 to approximately $213,000 for the three
month period ended June 30, 2004. 17




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Discontinued operations Loss from discontinued operations of approximately $0 and $498,000 for the
three month periods ended June 30, 2004 and 2003, respectively, were a result
of the October 2003 sale of our partnership interest
in our commercial properties. Net loss available to Common Shareholders Based on the above, the net loss available to Common Shareholders decreased
from approximately $867,000 for the three month period ended June 30, 2003 to
$213,000 for the three month period ended June 30, 2004. Critical Accounting Policies and Estimates Our Consolidated Financial Statements are prepared in accordance with generally
accepted accounting principles, which require us to make certain estimates and
assumptions. A summary of our significant accounting policies is provided in
Note 3 to our Consolidated Financial Statements. The following section is a
summary of certain aspects of those accounting policies that both require our
most subjective judgment and are most important to the presentation of our
financial condition and results of operations. It is possible that the use of
different estimates or assumptions in making these judgments could result in
materially different amounts being reported in our Consolidated Financial
Statements. Impairment of Long-Lived Assets We recognize an impairment loss on a real estate asset if the assets carrying
amount exceeds its fair value and is non-recoverable. First, to determine if
impairment may exist, we review our properties and identify those, if any,
which have had either an event of change or event of circumstances warranting
further assessment of recoverability. Next, we estimate the fair value of
those properties on an individual basis through either independent appraisals
or by capitalizing the expected net operating income, among various other
factors. These amounts are then compared to the propertys depreciated cost to
determine whether an impairment exists. We compute the expected net operating
income using certain estimates and assumptions for revenues and expenses. As a
result, these estimates and assumptions impact the amount of impairment loss
that we recognize. Real Estate Investments When we acquire real estate properties, we allocate the components of these
acquisitions using relative fair values computed using our estimates and
assumptions. These estimates and assumptions affect the amount of costs
allocated between land and different categories of building improvements. The
allocations impact depreciation expense and gain or loss recorded on sale of
real estate. When we acquired Richton Trail, we allocated 80% of the
acquisition price to building and 20% to land, based on our judgment of the
relative values of the two components and as supported by standard industry
practice. The acquisition price was from a market appraisal. Valuation Allowance of Deferred Tax Asset We account for income taxes using the liability method under which deferred tax
assets and liabilities are determined based on differences between the
financial reporting and tax bases of assets and liabilities using enacted tax
rates in effect for the period in which the differences are expected to affect
taxable income. As of June 30, 2004, we have net operating losses and at
December 31, 2003, we had net operating losses totaling approximately $11.0
million and capital losses of approximately $0.8 million. While these losses
created a deferred tax asset of approximately $4.9 million, a valuation
allowance of $4.9 million was applied against this asset because of the
uncertainty of whether we will be able to use these loss carryforwards, which
will expire in varying amounts through the year 2023. 18




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Liquidity and Capital Resources Cash provided by operations, equity transactions, and borrowings from
affiliates and lending institutions have generally provided the primary sources
of liquidity to Paragon. Historically, we have used these sources to fund
operating expenses, satisfy our debt service obligations and fund distributions
to shareholders. In 2003, as part of the one-time incentive exchange offer for
holders of preferred shares
to convert to common shares, our shareholders approved eliminating the
preferred dividend, which allows us to use that cash for current operations and
future growth of the Company. Cash Flows As of June 30, 2004, our unrestricted cash resources were approximately
$2,132,000 and our marketable securities available for sale were approximately
$87,000, comprised primarily of 10,000 common shares of Stellent. The NASDAQ
closing quote on August 2, 2004 was $7.15 per common share of Stellent. We are
dependent on our existing cash resources and Stellent shares to meet our
liquidity needs because cash from operations are not sufficient to meet our
operating requirements. During the six month period ended June 30, 2004, we utilized cash for (i) our
continuing operations of approximately $52,000, net of the refund of a deposit
of $250,000 on a development site in February 2004; (ii) additions to real
estate properties of approximately $8,000; (iii) purchase of marketable
securities of approximately $1,000; and (iv) payments on the mortgage loan
payable of approximately $25,000. As a result, our cash balance decreased by
approximately $86,000 from approximately $2,219,000 at December 31, 2003 to
approximately $2,132,000 at June 30, 2004. Future Obligations Because the cash flow from our properties is not expected to fully fund our
future liquidity requirements, we reduced our material future obligations at
June 30, 2004 compared to June 30, 2003, which include the mortgage on the
apartment complex and the employment contracts for our executive officers.  
    
    The mortgage is being paid by the cash flow from Richton Trail.
The property has been well maintained and managed, and has had
historical occupancy in the range of 95% to 100% even prior to our
ownership. So long as Richton Trail maintains approximately 84%
occupancy, it will generate the cash flow needed to pay its current
expenses and the mortgage debt service. We intend to keep the property
as close to 100% occupancy as possible and do not foresee any market
conditions that would show a decline in occupancy or rents during the
coming year. Also, no major improvements are planned at the property
through December 31, 2004.
    
    As of June 30, 2004, we had three executive officers, and a fourth
executive officer joined our management team on July 19th. Each of the
four employment contracts for our executive officers has a salary
requirement of only $60,000 per year, plus medical benefits which are
being paid for only one of the three executive officers, in an effort
to conserve cash. The Company has the benefit of four highly qualified
executives in the real estate industry, each with previous experience
with a publicly traded company, for salaries that are well below market
levels. As the Company grows and appreciates in value, our executive
officers expect to share in the growth of the Company, along with our
other shareholders, because each executive has a significant number of
common shares, and to earn higher levels of compensation. Employment Agreement On July 19, 2004, Jack R. Kuhn joined our executive management team as Sr. Vice
President  Chief Property Management & Development Officer responsible for
overseeing, managing and directing all property management and development
activities. As a material inducement for Mr. Kuhn, the 19




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independent Management,
Organization and Compensation Committee approved a restricted share grant of up
to 1,000,000 shares. The initial grant of 500,000 restricted shares will vest
half of the shares in four years and the second half in five years. Additional
grants of 125,000 restricted common shares will be made annually for the next
four years beginning on the anniversary date of his employment with vesting
effective four years after each grant date. Long Term Liquidity and Operating Strategies We historically have financed our long-term capital needs, including
acquisitions, as follows:  
    
    Borrowings from new loans:
    
    Additional equity issuances of our common and preferred shares; and
    
    Proceeds from the sales of our real estate and technology segment. During the first half of 2003, we put into place a new management team and
shareholders elected five new Trustees. Paragon has developed a value-added
business plan that is primarily focused on acquiring well located,
under-performing multi-family residential properties and repositioning them
through renovation, leasing, improved management, and branding. This strategy,
while unique to public companies, is common among private companies on both a
local and limited regional basis. Paragons investments will be in properties,
portfolios and companies with value-added programs. Paragon intends to raise
equity through joint venture structures to be used for property and portfolio
acquisitions, and use tax-deferred operating partnership units, convertible
into a separate class of common shares, for acquisitions of companies. Failure
to obtain external sources of capital or to find sellers willing to exchange
their properties for tax-deferred partnership units will materially and
adversely affect our strategy and will materially and adversely affect our
operations, liquidity and financial results. Paragons investment advantages,
compared to private companies, include our potential ability to access capital
and to offer sellers a tax-deferred exit alternative to exchange their
properties for partnership units with opportunities for both liquidity and
share appreciation. Our cash resources are sufficient to meet our current
overhead for approximately two years while identifying and reviewing potential
acquisitions. Current Tax Status At June 30, 2004, we have net operating losses, and at December 31, 2003, we
had net operating losses totaling approximately $11.0 million and capital
losses of approximately $0.8 million. While these losses created a deferred
tax asset, a valuation allowance was applied against the asset because of the
uncertainty of whether we will be able to use these loss carry forwards, which
will expire in varying amounts through the year 2023. We will be eligible to
re-elect REIT status on January 1, 2005. We, and certain of our subsidiaries, are also subject to certain state and
local income, excise and franchise taxes. The provision for state and local
taxes has been reflected in general and administrative expense in the
consolidated statements of operations and has not been separately stated due to
its insignificance. Interest Rates and Inflation For the past several years, interest rates have declined, and many financial
experts and economists have predicted that interest rates reached bottom in
2003. Lower interest rates have led to higher selling prices for established
real estate properties, the type that we intend to buy. Purchasers of
properties have been able to place a larger amount of debt on their
acquisitions because the lower interest rates have lowered the monthly mortgage
payments. Interest rates have started to increase during 2004, which should
lead to slightly lower prices for real estate properties and to higher
borrowing rates. The interactions between an increase in interest rates and a
decrease in selling prices of properties cannot be measured with any certainty.
Paragon continues to pursue its value-added 20




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business plan during 2004. The
economics of transactions, including price, current cash flow, existing debt,
cost of new funds for acquiring the properties, and potential for increased
value, will be reviewed very closely prior to making any acquisitions. We were not significantly affected by inflation during the periods presented in
this report due primarily to the relative low nationwide inflation rates. Off-Balance Sheet Arrangements We have no off-balance sheet arrangements that have, or are likely to have, a
current or future material effect on our financial condition, changes in
financial condition, revenues or expenses, results of operations, liquidity,
capital expenditures or capital resources. 21




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ITEM 3. CONTROLS AND PROCEDURES As of June 30, 2004, the date of this report, James M. Mastandrea, our Chief
Executive Officer and John J. Dee, our Chief Financial Officer, evaluated the
effectiveness of the design and operation of the Companys disclosure controls
and procedures pursuant to Rule 13a-15(b) under the Securities Exchange Act of
1934. Based upon this evaluation, Messrs. Mastandrea and Dee concluded that, as
of June 30, 2004, our disclosure controls and procedures are effective to
ensure that material information relating to the Company and our consolidated
subsidiaries is recorded, processed, summarized and reported in a timely
manner. Further, there were no significant changes in the internal controls or, to our
knowledge, in other factors that could significantly affect such controls
subsequent to June 30, 2004. 
 PART II. OTHER INFORMATION 
 ITEM 1. LEGAL PROCEEDINGS On April 1, 2004, Steven B. Hoyt, our former chairman, his wife Michelle L.
Hoyt, and Duane H. Lund, our former chief executive officer (the Plaintiffs),
filed a complaint in the United States District Court for the District of
Minnesota, Fourth Division, against Paragon and our stock transfer agent.
Plaintiffs allege that we have breached the terms of the voting and stock
restriction agreement that Messrs. Hoyt and Lund signed in March 2003, by
hindering the sale of the Plaintiffs Paragon shares. Plaintiffs seek a ruling
entitling them to sell their shares in the open market and more than $75,000 in
damages. Although we cannot predict the outcome of the suit, we believe that
the Plaintiffs claims are without merit and intend to vigorously defend
ourselves. 
 ITEM 2. CHANGES IN SECURITIES AND ISSUER PURCHASES OF EQUITY SECURITIES Effective June 15, 2004, we issued a total of 200,000 restricted common shares
and a total of 100,000 common share options exercisable at a price of $0.18 per
share to our four independent trustees, who are not executive officers of
Paragon, as part of their compensation for serving on Paragons board and
committees. We believe these issuances of restricted common shares and common
share options to be exempt from registration under Section 4(2) of the
Securities Act. 
 ITEM 3. DEFAULTS UPON SENIOR SECURITIES None 
 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS The following matters were submitted to a vote of our shareholders at our
annual meeting on June 14, 2004: Description of each mattervoted on at meeting:Proposal 1
    
    Election of the following Trustees:John J. Dee and Paul T. LambertProposal 2
    
    Restatement of 1998 Share Option Plan
 22




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Results of vote(1): Proposal 1:
    
    John J. Dee
    
    CombinedFor
    
    
    32,163,340Withheld
    
    
    371,854Individual shareholder non-votes
    
    
    1,442,449Proposal 1:
    
    Paul T. Lambert
    
    CombinedFor
    
    
    32,161,083Withheld
    
    
    374,111Individual shareholder non-votes
    
    
    1,442,449Proposal 2
    
    
    
    CombinedFor
    
    
    24,979,940Against and Abstentions
    
    
    1,119,741Broker non-votes
    
    
    6,435,513Individual shareholder non-votes
    
    
    1,442,449
 (1)Results of vote are based on combined basis of Common and
Preferred Shares. 
 ITEM 5. OTHER INFORMATION None 
 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits Exhibit Number
    
    Exhibit Description31.1
    
    Section 302 Certification pursuant to the Sarbanes-Oxley Act of 2002
 Chief Executive Officer31.2
    
    Section 302 Certification pursuant to the Sarbanes-Oxley Act of 2002
 Chief Financial Officer32.1
    
    CEO/CFO Certification under Section 906 of Sarbanes-Oxley Act of 2002.
 (b) Reports On Form 8-K During the three month period ended June 30, 2004 and through August 3, 2004 we
filed one current report on Form 8-K dated July 22, 2004. The Form 8-K
reported that we had filed Articles Supplementary to the Declaration of Trust
with the State of Maryland, electing to become subject to Sections 3-804(c) and
3-805 of Maryland General Corporation Law. Section 3-804(c) provides for the
Board of Trustees to fill any vacancies on the board resulting from an increase
in its size or from the death, resignation, or removal of a trustee for the
remaining term of the trustee. Section 3-805 specifies that a written request
of a majority of votes entitled to be cast at a meeting is required for a
special meeting of the shareholders. 23




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SIGNATURES In accordance with the requirements of the Exchange Act of 1934, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized. PARAGON REAL ESTATE EQUITY AND INVESTMENT TRUSTBy:
    /s/ James C. MastandreaDate: August 3, 2004
    
    James C. MastandreaChief Executive OfficerPARAGON REAL ESTATE EQUITY AND INVESTMENT TRUSTBy:
    /s/ John J. DeeDate: August 3, 2004
    
    John J. DeeChief Financial Officer 24