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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION     Form 10-QSB QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 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 x    No o As of November 4, 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 x




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PARAGON REAL ESTATE EQUITY AND INVESTMENT TRUST AND SUBSIDIARIES
FORM 10-QSB
INDEX PART I. Financial InformationItem 1. Financial StatementsConsolidated Balance Sheet  September 30, 2004 (unaudited)
    
    Page - 2 -Consolidated Statements of Operations  Nine months ended
September 30, 2004 and September 30, 2003 (unaudited)
    
    Page - 3 -Consolidated Statements of Operations  Three months ended
September 30, 2004 and September 30, 2003 (unaudited)
    
    Page - 4 -Consolidated Statements of Cash Flows  Nine months ended
September 30, 2004 and September 30, 2003 (unaudited)
    
    Page - 5 -Notes to Consolidated Financial Statements (unaudited)
    
    Page - 7 -Item 2. Managements Discussion and Analysis or
Plan of Operation
    
    Page - 15 -Item 3. Controls and Procedures
    
    Page - 23 -Part II. Other InformationItem 1. Legal Proceedings
    
    Page - 24 -Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    Page - 24 -Item 3. Defaults upon Senior Securities
    
    Page - 24 -Item 4. Submission of Matters to a Vote of Security Holders
    
    Page - 24 -Item 5. Other Information
    
    Page - 24 -Item 6. Exhibits
    
    Page - 24 -Signatures
    
    Page - 25 -EX-31.1 CertificationEX-31.2 CertificationEX-32.1 Certification
  EX - 31.1 Section 302 Certification of Chief Executive Officer
EX - 31.2 Section 302 Certification of Chief Financial Officer
EX - 32.1 CEO/CFO Under 906 of Sarbanes-Oxley Act - 1 -




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Paragon Real Estate Equity and Investment Trust and Subsidiaries 
 Consolidated Balance Sheet
 September 30, 2004
(unaudited)
 AssetsInvestments in real estate:Land
    
    $
    797,682Buildings and improvements
    
    
    3,197,409Furniture, fixtures and equipment
    
    
    16,4064,011,497Accumulated depreciation and amortization
    
    
    (101,101
    )Net investments in real estate
    
    
    3,910,396Cash and cash equivalents
    
    
    1,946,913Marketable securities
    
    
    78,328Restricted cash
    
    
    123,052Accounts receivable, net
    
    
    10,392Other assets, net
    
    
    84,193Total Assets
    
    $
    6,153,274Liabilities and Shareholders EquityLiabilities:Mortgage loan payable
    
    $
    2,775,535Accounts payable and accrued expenses
    
    
    190,522Security deposits
    
    
    56,524Total liabilities
    
    
    3,022,581Minority interest in consolidated subsidiary
    
    
    2,174,339Commitments 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; 33,440,615 shares
issued and outstanding
    
    
    334,406Additional paid-in capital
    
    
    28,369,536Accumulated other comprehensive income, net
unrealized gain on marketable securities
    
    
    39,652Accumulated deficit
    
    
    (24,332,690
    )Treasury stock, at cost, 2,859,765 shares
    
    
    (800,735
    )Unearned compensation and trustees fees
    
    
    (2,656,600
    )Total shareholders equity
    
    
    956,354Total Liabilities and Shareholders Equity
    
    $
    6,153,274
 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 nine months ended September 30,2004
    
    2003RevenuesRental revenue
    
    $
    455,741
    
    
    $
    144,408Interest and other
    
    
    38,511
    
    
    
    7,570Total revenues
    
    
    494,252
    
    
    
    151,978ExpensesProperty, operating and maintenance
    
    
    158,694
    
    
    
    33,014Property taxes and insurance
    
    
    70,738
    
    
    
    23,195Depreciation and amortization
    
    
    65,006
    
    
    
    35,812Interest
    
    
    124,912
    
    
    
    27,975General and administrative
    
    
    717,386
    
    
    
    754,027Management fees
    
    
    20,094
    
    
    
    6,175Total expenses
    
    
    1,156,830
    
    
    
    880,198Loss from operations before loss allocated to minority
interest
    
    
    (662,578
    )
    
    
    (728,220
    )Loss allocated to minority interest
    
    
    75,158
    
    
    
    41,445Loss from operations
    
    
    (587,420
    )
    
    
    (686,775
    )Gain on sale of marketable securities
    
    
    
    
    
    
    105,421Loss from continuing operations
    
    
    (587,420
    )
    
    
    (581,354
    )Discontinued operations:Loss from discontinued operations
    
    
    
    
    
    
    (495,158
    )Net loss available to Common Shareholders
    
    $
    (587,420
    )
    
    $
    (1,076,512
    )Net loss available to Common Shareholders per Common
Share: Basic and Diluted
    
    $
    (0.02
    )
    
    $
    (0.08
    )Weighted
average number of Common Shares outstanding: Basic and Diluted
    
    
    32,899,490
    
    
    
    13,669,351Comprehensive loss:Net loss
    
    $
    (587,420
    )
    
    $
    (1,076,512
    )Other comprehensive loss:Unrealized (loss) gain on marketable securities
    
    
    (22,048
    )
    
    
    32,800Comprehensive loss
    
    $
    (609,468
    )
    
    $
    (1,043,712
    )
 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 September 30,2004
    
    2003RevenuesRental revenue
    
    $
    160,130
    
    
    $
    144,408Interest and other
    
    
    11,054
    
    
    
    4,347Total revenues
    
    
    171,184
    
    
    
    148,755ExpensesProperty, operating and maintenance
    
    
    58,511
    
    
    
    33,014Property taxes and insurance
    
    
    24,033
    
    
    
    23,195Depreciation and amortization
    
    
    21,997
    
    
    
    26,743Interest
    
    
    41,760
    
    
    
    27,975General and administrative
    
    
    253,024
    
    
    
    155,277Management fees
    
    
    6,537
    
    
    
    6,175Total expenses
    
    
    405,862
    
    
    
    272,379Loss from operations before loss allocated to
minority interest
    
    
    (234,678
    )
    
    
    (123,624
    )Income allocated to minority interest
    
    
    (5,859
    )
    
    
    (1,125
    )Loss from operations
    
    
    (240,537
    )
    
    
    (124,749
    )Gain on sale of marketable securities
    
    
    
    
    
    
    105,421Loss from continuing operations:
    
    
    (240,537
    )
    
    
    (19,328
    )Discontinued operations:Income from discontinued operations of
commercial properties
    
    
    
    
    
    
    54,811Net (loss) income available to Common Shareholders
    
    $
    (240,537
    )
    
    $
    35,483Net loss available to Common Shareholders per
Common Share: Basic and Diluted
    
    $
    (0.01
    )
    
    $
    (0.00
    )Weighted average number of Common Shares
outstanding: Basic and Diluted
    
    
    33,342,790
    
    
    
    31,382,566Comprehensive income (loss):Net (loss) income
    
    $
    (240,537
    )
    
    $
    35,483Other comprehensive loss:Unrealized loss on marketable securities
    
    
    (8,316
    )
    
    
    (6,000
    )Comprehensive (loss) income
    
    $
    (248,853
    )
    
    $
    29,483
 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 nine months ended September 30,2004
    
    2003Cash flows from operating activities:Net loss
    
    $
    (587,420
    )
    
    $
    (1,076,512
    )Adjustments to reconcile net loss to net cash used
in continuing operations:Discontinued operations of commercial properties,
net of tax
    
    
    
    
    
    
    495,158Compensation costs and trustees fees incurred
through the issuance of shares
    
    
    91,371
    
    
    
    300,000Rent expense incurred through the issuance of
restricted shares
    
    
    51,500
    
    
    
    Depreciation and amortization
    
    
    65,006
    
    
    
    35,812Loss allocated to minority interest
    
    
    (75,158
    )
    
    
    (41,445
    )Gain on sale of marketable securities
    
    
    
    
    
    
    (105,421
    )Net change in assets and liabilities:Accounts receivable, net
    
    
    (581
    )
    
    
    (7,528
    )Restricted cash
    
    
    (25,970
    )
    
    
    (42,682
    )Other assets, net
    
    
    280,700
    
    
    
    12,591Accounts payable and accrued expenses
    
    
    (15,491
    )
    
    
    216,768Rents received in advance and security deposits
    
    
    2,316
    
    
    
    55,289Net cash used in continuing operations
    
    
    (213,727
    )
    
    
    (157,970
    )Cash flows from investing activities:Acquisition and additions to real estate properties
    
    
    (20,258
    )
    
    
    (86,818
    )Sale (purchase) of marketable securities
    
    
    (1,175
    )
    
    
    199,171Net cash (used in) from investing activities
    
    
    (21,433
    )
    
    
    112,353Cash flows from financing activities:Payments on mortgage loans and notes payable
    
    
    (36,601
    )
    
    
    (7,059
    )Deferred financing costs paid
    
    
    
    
    
    
    (23,970
    )Net cash used in financing activities
    
    
    (36,601
    )
    
    
    (31,029
    )Net cash used in discontinued operations
    
    
    
    
    
    
    (469,405
    )Net decrease in cash and cash equivalents
    
    
    (271,761
    )
    
    
    (546,051

    )Cash and cash equivalentsBeginning of period
    
    
    2,218,674
    
    
    
    1,029,265End of period
    
    $
    1,946,913
    
    
    $
    483,214
 Consolidated Statements of Cash Flows is continued on the next page. - 5 -




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Paragon Real Estate Equity and Investment Trust and Subsidiaries
Consolidated Statements of Cash Flows
(unaudited) Supplemental information to Consolidated Statements of Cash Flows For the nine months ended September 30,2004
    
    2003Interest paid
    
    $
    124,912
    
    
    $
    251,900Supplemental schedule of non-cash investing and
financing activities:The following assets and liabilities were assumed
in connection with the acquisition of Richton
Trail Apartments:Acquisition of residential real estate
    
    $
    
    
    
    $
    (3,986,409
    )Additions to real estate
    
    
    
    
    
    
    (1,277
    )Mortgage note payable
    
    
    
    
    
    
    1,544,258Minority interest
    
    
    
    
    
    
    2,356,610Acquisition and additions to real estate properties
    
    $
    
    
    
    $
    (86,818
    )
 The accompanying notes are an integral part of the consolidated financial statements. - 6 -




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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 September
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. Because we are the
sole general partner of Paragon Real Estate, LP, we consolidate Richton Trail
in our financial statements and show separately amounts for minority interest
for Hampton Court, which is the only 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 September 30, 2004, the results of our operations for the nine
month periods ended September 30, 2004 and 2003, the results of our operations
for the three month periods ended September 30, 2004 and 2003, and of our cash
flows for the nine month periods ended September 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 September
30, 2004, and the reported amounts of revenues and expenses for the nine month
and three month periods ended September 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 - 7 -




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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. 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 nine months and three months ended September
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 September 30, 2004 in a money
market account that was not federally insured. Cash of approximately $123,000
is classified as restricted at September 30, 2004 because approximately $66,000
is held in an escrow account of the mortgage lender for the payment of property
taxes and insurance and approximately $57,000 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 $23,000 at September 30, 2004 for Richton Trail. Other Assets As of September 30, 2004, other assets include prepaid expenses of
approximately $35,000 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 September 30, 2004 was approximately $5,000. - 8 -




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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 September 30, 2004, we had one stock-based employee compensation plan.
During the nine months ended September 30, 2004, we issued 550,000 common share
options and further issued 1,600,000 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 nine months ended September 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 nine month periods endedSeptember 30,2004
    
    2003Net loss attributable to Common Shareholders
    
    $
    (587,420
    )
    
    $
    (1,076,512
    )Add: Stock-based employee compensation
expense included in reported net loss, net
of related tax effects
    
    
    91,371
    
    
    
    Deduct: Total stock-based employee
compensation expense determined under fair
value based method for all awards, net of
related tax effects
    
    
    (119,496
    )
    
    
    32,000Pro forma net loss attributable to Common
Shareholders
    
    $
    (615,545
    )
    
    $
    (1,044,512
    )Net loss attributable to Common
Shareholders per Common Share:Basic and Diluted  as reported
    
    $
    (0.02
    )
    
    $
    (0.08
    )Basic and Diluted  pro forma
    
    $
    (0.02
    )
    
    $
    (0.08
    )
 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. While we would be eligible to re-elect REIT status on January
1, 2005, we are continuing to evaluate our tax status to take advantage of our
tax loss carryforwards. At September 30, 2004, we have net operating losses, and at December 31, 2003,
we had net operating losses totaling approximately $10.2 million and capital
losses of approximately $0.7 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. - 9 -




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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
September 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 nine months and three months ended September 30, 2003. Reclassification As a result of the sale of our commercial properties on October 1, 2003,
certain amounts in the September 30, 2003 financial statements have been
reclassified to conform to the September 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
September 30, 2004, and represent 10,000 common shares of Stellent, Inc.
(Stellent) and 100 common shares of Century Realty Trust (Century). As of September 30, 2004, our marketable securities had a fair market value of
approximately $78,000 (based upon the NASDAQ closing quote of $7.71 per share
for Stellent and $12.28 per share for Century on September 30, 2004). We
recorded an unrealized loss on marketable securities during 2004 of
approximately $22,000, resulting in a balance of approximately $40,000 in
shareholders equity for unrealized gain on marketable securities. The NASDAQ closing quote on November 4, 2004 was $6.99 per common share of
Stellent and $15.02 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
September 30, 2003, all revenues and expenses associated with the commercial
properties have been recorded as discontinued operations. - 10 -




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For the nine months endedSeptember 30, 2003Pro forma total revenue
    
    $
    453,000Pro forma loss from continuing operations
    
    $
    (612,000
    )Pro forma loss attributable to Common Shareholders
    
    $
    (612,000
    )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 September 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 September 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, 250,000 restricted common shares are issuable 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 one year after issuance and expire 90 days after leaving Paragons
board. Effective July 19, 2004, we committed to issue 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. The following is a summary of the (loss) income from discontinued operations of
our commercial properties. - 11 -




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For the
    
    For thenine months ended
    
    three months endedSeptember 30, 2003
    
    September 30, 2003Revenues
    
    $
    1,004,632
    
    
    $
    336,873Operating expenses
    
    
    (435,068
    )
    
    
    (125,296
    )Depreciation and amortization
    
    
    (157,735
    )
    
    
    (55,894
    )Interest expense
    
    
    (251,900
    )
    
    
    (83,618
    )General and administrative
    
    
    (305,087
    )
    
    
    (17,254
    )Non-recurring real estate expense
    
    
    (350,000
    )
    
    
    (Loss) income from discontinued
operations
    
    $
    (495,158
    )
    
    $
    54,811
 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 nine months ended September
30, 2004 and September 30, 2003 were 32,899,490 and 13,669,351, respectively.
Common share equivalents of approximately 23.7 million and 23.3 million as of
September 30, 2004 and September 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 nine months ended September 30,2004
    
    2003NumeratorNet loss from continuing operations
    
    $
    (587,420
    )
    
    $
    (581,354
    )Discontinued operations:Discontinued operations, net of tax
    
    
    
    
    
    
    (495,158
    )Net loss available to Common Shareholders
    
    $
    (587,420
    )
    
    $
    (1,076,512
    )DenominatorWeighted average Common Shares
outstanding at September 30, 2004 and
September 30, 2003, respectively: Basic
and Diluted
    
    
    32,899,490
    
    
    
    13,669,351Basis and Diluted EPSNet loss from continuing operations
    
    $
    (0.02
    )
    
    $
    (0.04
    )Discontinued operations:Discontinued operations, net of tax
    
    
    
    
    
    
    (0.04
    )Net loss available to Common
Shareholders - Basic and Diluted
    
    $
    (0.02
    )
    
    $
    (0.08
    )
 For the quarter ended September 30, 2003, Net income per weighted Common Share
outstanding  diluted would have included common share equivalents of 23.3
million, which would not have had a material effect on reported Net income
available to Common Shareholders  diluted of $0.00 per share. - 12 -




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Note 10  Commitments and Contingencies Liquidity As of September 30, 2004, our unrestricted cash resources were approximately
$1,947,000 and our marketable securities available for sale were approximately
$78,000. Our marketable securities primarily represented 10,000 common shares
of Stellent. The NASDAQ closing quote on
November 4, 2004 was $6.99 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 is $60,000. As a material inducement for
Mr. Kuhn, the independent Management, Organization and Compensation Committee
approved a restricted share grant of up to 1.0 million 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, our former chief executive officer (the Plaintiffs),
filed a complaint in the United States District Court - 13 -




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##### Table of Contents



for the District of Minnesota, Fourth Division, against Paragon and our stock
transfer agent. Plaintiffs alleged 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. In
October 2004, we and the Plaintiffs signed an agreement allowing the Plaintiffs
to sell their Paragon shares without restrictive legends being attached to the
shares and without a limit on the number of shares to be sold. Shares owned by
the Plaintiffs are required to be voted for proxy proposals presented by the
Company through June 30, 2005. 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 $49,000 for the nine months ended September 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 Court), 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 Court 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 nine months ended September 30, 2004 were
approximately $20,000. Reimbursement, at cost, for the payroll related costs
paid and accrued for the nine months ended September 30, 2004 was approximately
$49,000. 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 nine months ended September 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 nine months ended
September 30, 2004 was approximately $4,000. - 14 -




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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 September 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. Because we are the sole
general partner of Paragon Real Estate, LP, we consolidate Richton Trail in our
financial statements and show separately amounts for the minority interest for
Hampton Court, which is the only 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. We are continuing to evaluate our tax status to take
advantage of our tax loss carryforwards. Forward-Looking Information The following is a discussion of our results of operations for the nine month
and three month periods ended September 30, 2004 and 2003 and financial
condition, including  
    
    Explanation of changes in the results of operations in the
Consolidated Statements of Operations for the nine month period ended
September 30, 2004 compared to the nine month period ended September
30, 2003.  
    
    Explanation of changes in the results of operations in the
Consolidated Statements of Operations for the three month period ended
September 30, 2004 compared to the three month period ended September
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 nine month period
ended September 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, - 15 -




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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 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),
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, identifying and acquiring properties at acceptable prices,
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 Nine Month Periods Ended September 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 nine month
period ended September 30, 2003. Continuing operations include Richton Trail,
acquired on July 1, 2003, for only three months of the nine month period ending
September 30, 2003, and for all nine months in the nine month period ended
September 30, 2004. Rental revenue of approximately $456,000 and $144,000 for the nine month
periods ended September 30, 2004 and September 30, 2003, respectively, was
comprised entirely of Richton Trail revenue. Acquired on July 1, 2003, Richton
Trail revenue is included for only three months of the nine months ended
September 30, 2003. Interest and other revenue increased by approximately $31,000 to approximately
$39,000 for the nine month period ended September 30, 2004 compared to the nine
month period ended September 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 the four commercial 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 $880,000 for the nine month period
ended September 30, 2003 to $1,157,000 for the nine month period ended
September 30, 2004, a net increase of $277,000 described below. As a result of the October 1, 2003 sale of our 92.9% general partnership
interest in the four commercial properties costs representing property taxes
and insurance, depreciation and amortization, interest and management fees
related to these properties were reclassified to discontinued operations for
the nine month period ended September 30, 2003. - 16 -




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Richton Trail, which we acquired on July 1, 2003, is included in continuing
operations for the entire nine month period ended September 30, 2004 and for
three months of the nine month period ended
September 30, 2003. The related expenses are as follows: Nine months ended September 30,2004
    
    2003
    
    Increase (decrease)Richton TrailProperty, operating and
maintenance
    
    $
    159,000
    
    
    $
    33,000
    
    
    $
    126,000Property taxes and insurance
    
    
    71,000
    
    
    
    23,000
    
    
    
    48,000Depreciation and amortization
    
    
    65,000
    
    
    
    36,000
    
    
    
    29,000Interest
    
    
    125,000
    
    
    
    28,000
    
    
    
    97,000Management fees
    
    
    20,000
    
    
    
    6,000
    
    
    
    14,000Totals for Richton Trail
    
    
    440,000
    
    
    
    126,000
    
    
    
    314,000General and administrative
    
    
    717,000
    
    
    
    754,000
    
    
    
    (37,000
    )Total expenses
    
    $
    1,157,000
    
    
    $
    880,000
    
    
    $
    277,000
 The increases in expenses shown above, except for general and administrative
explained in the following paragraph, are mainly due to nine months of Richton
Trail operations in 2004 compared to only three months in 2003. General and administrative expenses decreased from approximately $754,000 for
the nine month period ended September 30, 2003 to approximately $717,000 for
the nine month period ended September 30, 2004. The decrease of approximately
$37,000 was primarily the result of reduced compensation and related costs of
approximately $119,000 representing non-cash severance costs incurred in 2003,
net of increased costs in 2004 including approximately $91,000 of non-cash
costs paid through the issuance of restricted shares. These reduced
compensation costs were offset, in part, by an increase of approximately
$71,000 in legal costs related to litigation with former management. Loss from operations before minority interest As a result of the above, the loss from operations before loss allocated to
minority interest decreased from approximately $728,000 for the nine month
period ended September 30, 2003 to approximately $663,000 for the nine month
period ended September 30, 2004. Loss allocated to minority interest Loss allocated to minority interests increased from approximately $41,000 for
the nine month period ended September 30, 2003 to approximately $75,000 for the
nine month period ended September 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 $687,000 for the
nine month period ended September 30, 2003 to approximately $587,000 for the
nine month period ended September 30, 2004. Gain on sale of marketable securities The gain on sale of marketable securities of approximately $105,000 for the
nine month period ended September 30, 2003 was the result of our sale of 25,000
shares of Stellent common stock at an average price of $7.97 per share. - 17 -




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Discontinued operations As a result of the October 2003 sale of our partnership interest in our
commercial properties, the loss from discontinued operations for the nine month
period ended September 30, 2003 was $495,000 and $0 for the nine month period
ended September 30, 2004. Net loss available to Common Shareholders Based on the above, the Net loss available to Common Shareholders decreased
from approximately $1,077,000 for the nine month period ended September 30,
2003 to $587,000 for the nine month period ended September 30, 2004. Comparison of the Three Month Periods Ended September 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 September 30, 2003. Richton Trail, which we acquired on July 1,
2003, is included in continuing operations for the three month periods ended
September 30, 2003 and September 30, 2004. Rental revenue of approximately $160,000 for the three month period ended
September 30, 2004 was comprised entirely of Richton Trail, acquired on July 1,
2003. This is compared to approximately $144,000 for the three month period
ended September 30, 2003. Interest and other revenue increased by approximately $7,000 to approximately
$11,000 for the three month period ended September 30, 2004 compared to the
three month period ended September 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 the four commercial 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 $272,000 for the three month period
ended September 30, 2003 to $406,000 for the three month period ended September
30, 2004, a net increase of $134,000. As a result of the October 1, 2003 sale of our 92.9% general partnership
interest in the four commercial 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: Three months ended September 30,2004
    
    2003
    
    Increase (decrease)Richton TrailProperty, operating and
maintenance
    
    $
    59,000
    
    
    $
    33,000
    
    
    $
    26,000Property taxes and insurance
    
    
    24,000
    
    
    
    23,000
    
    
    
    1,000Depreciation and amortization
    
    
    22,000
    
    
    
    27,000
    
    
    
    (5,000
    )Interest
    
    
    42,000
    
    
    
    28,000
    
    
    
    14,000Management fees
    
    
    6,000
    
    
    
    6,000
    
    
    
    Totals for Richton Trail
    
    
    153,000
    
    
    
    117,000
    
    
    
    36,000General and administrative
    
    
    253,000
    
    
    
    155,000
    
    
    
    98,000Total expenses
    
    $
    406,000
    
    
    $
    272,000
    
    
    $
    134,000
 - 18 -




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Property operating and maintenance expenses increased by approximately $26,000
from the three months of September 30, 2003 compared to the same period of
2004. Increased utility expenses and bad debt expense were the majority of the
higher property expenses. Interest expense increased by approximately $14,000 from the three months ended
September, 2003 compared to the same period of 2004 due to the refinance of the
Richton Trail mortgage on October 31, 2003. The mortgage loan increased from
approximately $1.5 million to $2.8 million and was offset, in part, by a lower
interest rate of 5.87% compared to the prior rate of 7.25%. General and administrative expenses increased from approximately $155,000 for
the three month period ended September 30, 2003 to approximately $253,000 for
the three month period ended September 30, 2004. The increase of approximately
$98,000 was the result of increased compensation and related costs of
approximately $29,000, including approximately $36,000 of non-cash costs paid
through the issuance of restricted shares, and an increase of approximately
$40,000 in legal and other professional costs of which the majority was related
to litigation with former management. Loss from operations before minority interest As a result of the above, loss from operations before loss allocated to
minority interest increased from approximately $124,000 for the three month
period ended September 30, 2003 to approximately $235,000 for the three month
period ended September 30, 2004. Loss (income) allocated to minority interest Loss (income) allocated to minority interests changed from approximately $1,000
of income allocated for the three month period ended September 30, 2003 to
approximately $6,000 of income allocated for the three month period ended
September 30, 2004 primarily as a result of the different allocation methods
for the July 2003 acquisition of our partnership interest in Richton Trail
compared to our partnership interest in our commercial properties that were
sold October 1, 2003. Gain on sale of marketable securities The gain on sale of marketable securities of approximately $105,000 for the
three month period ended September 30, 2003 was the result of our sale of
25,000 shares of Stellent common stock at an average price of $7.97 per share. Loss from continuing operations Loss from continuing operations increased from approximately $19,000 for the
three month period ended September 30, 2003 to approximately $241,000 for the
three month period ended September 30, 2004. Income (loss) from discontinued operations Income from discontinued operations of approximately $55,000 for the three
month period ended September 30, 2003, was the result of the October 2003 sale
of our partnership interest in our commercial properties. There was no activity
in discontinued operations for the three month period ended
September 30, 2004. Net (loss) income available to Common Shareholders Based on the above, the net amount available to Common Shareholders changed
from income of approximately $35,000 for the three month period ended September
30, 2003 to loss of approximately
$241,000 for the three month period ended September 30, 2004. - 19 -




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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 September 30, 2004, we have net operating losses and at
December 31, 2003, we had net operating losses totaling approximately $10.2
million and capital losses of approximately $0.7 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. 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 September 30, 2004, our unrestricted cash resources were approximately
$1,947,000 and our - 20 -




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marketable securities available for sale were approximately
$78,000, comprised primarily of 10,000 common shares of Stellent. The NASDAQ
closing quote on November 4, 2004 was $6.99 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 is not sufficient to meet our
operating requirements. During the nine month period ended September 30, 2004, we utilized cash for (i)
our continuing operations of approximately $214,000, 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 $20,000; (iii) purchase of marketable
securities of approximately $1,000; and (iv) payments on the mortgage loan
payable of approximately $37,000. As a result, our cash balance decreased by
approximately $272,000 from approximately $2,219,000 at December 31, 2003 to
approximately $1,947,000 at September 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
September 30, 2004 compared to September 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 85%
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 September 30, 2004, we had four executive officers. 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 executive officers, in an effort to
conserve cash. The Company has the benefit of 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 independent Management,
Organization and Compensation Committee approved a restricted share grant of up
to 1.0 million 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. - 21 -




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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 September 30, 2004, we have a net operating loss, and at December 31, 2003,
we had net operating losses totaling approximately $10.2 million and capital
losses of approximately $0.7 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 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. - 22 -




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ITEM 3. CONTROLS AND PROCEDURES As of September 30, 2004, the date of this report, James M. Mastandrea, our
Chairman of the Board, Chief Executive Officer and President and John J. Dee,
our Chief Financial Officer and Senior Vice President, 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 September 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 September 30, 2004. - 23 -




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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 alleged 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. In October 2004, we and
the Plaintiffs signed an agreement allowing the Plaintiffs to sell their
Paragon shares without restrictive legends being attached to the shares and
without a limit on the number of shares to be sold. Shares owned by the
Plaintiffs are required to be voted for proxy proposals presented by the
Company through June 30, 2005. 
 ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS None 
 ITEM 3. DEFAULTS UPON SENIOR SECURITIES None 
 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None 
 ITEM 5. OTHER INFORMATION None 
 ITEM 6. EXHIBITS (a) Exhibits ExhibitNumber
    
    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.
 - 24 -




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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: November 8, 2004
    
    
    
    James C. MastandreaChief Executive OfficerParagon real estate equity and investment trustBy:
    
    /s/ John J. DeeDate: November 8, 2004
    
    
    
    John J. DeeChief Financial Officer
 - 25 -