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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 March 31, 2004 Commission File Number: 0-25074 PARAGON REAL ESTATE EQUITY AND INVESTMENT TRUST  Maryland
(State or other jurisdiction of incorporation)1240 Huron Road, Suite 301, Cleveland, OH
(Address of principal executive offices)
    
    39-6594066
(I.R.S. Employer Identification Number)44115
(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 May 10, 2004, 32,740,615 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March 31, 2004 (unaudited)
    
    Page 2Consolidated Statements of OperationsThree months ended March 31, 2004 and March 31, 2003 (unaudited)
    
    Page 3Consolidated Statements of Cash FlowsThree months ended March 31, 2004 and March 31, 2003 (unaudited)
    
    Page 4Notes to Consolidated Financial Statements
    
    Page 5Item 2. Managements Discussion and Analysis or Plan of Operation
    
    Page 13Item 3. Controls and Procedures
    
    Page 19Part II. Other InformationItem 1. Legal Proceedings
    
    Page 19Item 2. Changes in Securities
    
    Page 19Item 3. Defaults upon Senior Securities
    
    Page 19Item 4. Submission of Matters to a Vote of Security Holders.
    
    Page 19Item 5. Other Information
    
    Page 19Item 6. Exhibits and Reports on Form 8-K
    
    Page 20Signatures
    
    Page 20EX-31.1 Sect. 302 Cert of Chief Executive OfficerEX-31.2 Sect. 302 Cert of Chief Financial OfficerEX-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
 March 31, 2004
 (unaudited)
 AssetsInvestments in real estate:Land
    
    $
    797,682Buildings and improvements
    
    
    3,188,727Furniture, fixtures and equipment
    
    
    7,8283,994,237Accumulated depreciation and amortization
    
    
    (60,254
    )Net investments in real estate
    
    
    3,933,983Cash and cash equivalents
    
    
    2,312,074Marketable securities
    
    
    74,700Restricted cash
    
    
    81,412Accounts receivable, net
    
    
    6,340Other assets, net
    
    
    125,455Total Assets
    
    $
    6,533,964Liabilities and Shareholders EquityLiabilities:Mortgage loan payable
    
    $
    2,799,965Accounts payable and accrued expenses
    
    
    162,890Rents received in advance and security deposits
    
    
    60,495Total liabilities
    
    
    3,023,350Minority interest in consolidated subsidiary
    
    
    2,162,600Commitments 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; 32,740,615 shares issued and
outstanding
    
    
    327,406Additional paid-in capital
    
    
    28,275,536Accumulated other comprehensive income, net
unrealized gain on marketable securities
    
    
    37,200Accumulated deficit
    
    
    (23,878,740
    )Treasury stock, at cost, 2,859,765 shares
    
    
    (800,735
    )Unearned compensation and trustees fees
    
    
    (2,615,438
    )Total shareholders equity
    
    
    1,348,014Total Liabilities and Shareholders Equity
    
    $
    6,533,964
 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 three months ended March 31,2004
    
    2003RevenuesRental revenue
    
    $
    150,602
    
    
    $
    Interest and other
    
    
    18,157
    
    
    
    2,429Total revenues
    
    
    168,759
    
    
    
    2,429ExpensesProperty, operating and maintenance
    
    
    56,353
    
    
    
    Property taxes and insurance
    
    
    23,215
    
    
    
    Depreciation and amortization
    
    
    21,431
    
    
    
    5,438Interest
    
    
    41,667
    
    
    
    General and administrative
    
    
    239,593
    
    
    
    199,591Management fees
    
    
    6,866
    
    
    
    Total expenses
    
    
    389,125
    
    
    
    205,029Loss from operations before loss allocated to
minority interest
    
    
    (220,366
    )
    
    
    (202,600
    )Loss allocated to minority interest
    
    
    86,896
    
    
    
    9,858Loss from continuing operations
    
    
    (133,470
    )
    
    
    (192,742
    )Discontinued operations:Loss from discontinued operations
    
    
    
    
    
    
    (52,456
    )Net loss available to Common Shareholders
    
    $
    (133,470
    )
    
    $
    (245,198
    )Net loss available to Common Shareholders per
Common Share: Basic and Diluted
    
    $
    (0.00
    )
    
    $
    (0.05
    )Weighted average number of Common Shares
outstanding: Basic and Diluted
    
    
    32,580,976
    
    
    
    4,517,524Comprehensive loss:Net loss
    
    $
    (133,470
    )
    
    $
    (245,198
    )Other comprehensive loss:Unrealized loss on marketable securities
    
    
    (24,500
    )
    
    
    (8,400
    )Comprehensive loss
    
    $
    (157,970
    )
    
    $
    (253,598
    )
 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 Cash Flows
 (unaudited)
 For the three months ended March 31,2004
    
    2003Cash flows from operating activities:Net loss
    
    $
    (133,470
    )
    
    $
    (245,198
    )Adjustments to reconcile net loss to net cash used
in continuing operations:Discontinued operations, net of tax
    
    
    
    
    
    
    52,456Compensation costs and trustees fees incurred
through the issuance of restricted shares
    
    
    31,533
    
    
    
    Rent expense incurred through the issuance of
restricted shares
    
    
    51,500
    
    
    
    Depreciation and amortization
    
    
    21,431
    
    
    
    5,438Loss allocated to minority interest
    
    
    (86,896
    )
    
    
    (9,858
    )Net change in assets and liabilities:Accounts receivable, net
    
    
    3,471
    
    
    
    Restricted cash
    
    
    15,670
    
    
    
    Other assets, net
    
    
    242,165
    
    
    
    (968
    )Accounts payable and accrued expenses
    
    
    (37,627
    )
    
    
    69,285Rents received in advance and security deposits
    
    
    790
    
    
    
    Net cash provided by (used in) continuing
operations
    
    
    108,567
    
    
    
    (128,845
    )Cash flows from investing activities:Additions to real estate properties
    
    
    (2,996
    )
    
    
    Net cash used in investing activities
    
    
    (2,996
    )
    
    
    Cash flows from financing activities:Payments on mortgage loan
    
    
    (12,171
    )
    
    
    Net cash used in financing activities
    
    
    (12,171
    )
    
    
    Net cash used in discontinued operationsDiscontinued operations of technology segment
    
    
    
    
    
    
    (27,249
    )Discontinued operations of commercial properties
    
    
    
    
    
    
    (96,742
    )Net cash used in discontinued operations
    
    
    
    
    
    
    (123,991
    )Net increase (decrease) in cash and cash equivalents
    
    
    93,400
    
    
    
    (252,836
    )Cash and cash equivalentsBeginning of period
    
    
    2,218,674
    
    
    
    1,029,265End of period
    
    $
    2,312,074
    
    
    $
    776,429Supplemental information to Consolidated Statements of Cash FlowsInterest paid
    
    $
    41,667
    
    
    $
    83,713
 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 
 Notes to Consolidated Financial Statements 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 March 31,
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. 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 March 31, 2004, the results of our operations for the three month
periods ended March 31, 2004 and 2003, and of our cash flows for the three
month periods ended March 31, 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 March 31,
2004, and the reported amounts of revenues and expenses for the three month
periods ended March 31, 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. 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 -5-




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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 three months ended March
31, 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 $19,000 at March 31, 2004 in a money market
account that was not federally insured. Cash of approximately $81,000 is
classified as restricted at March 31, 2004 because it is held in an escrow
account of the mortgage lender for the payment of property taxes and insurance
and security deposits held on behalf of our residential tenants. Accounts Receivable Our accounts receivable are reported net of an allowance for bad debts of
$4,000 at March 31, 2004 for Richton Trail. Other Assets As of March 31, 2004, other assets include deferred financing costs incurred to
obtain and secure mortgage debt financing. Other assets are carried at cost,
less accumulated amortization. The deferred financing costs of approximately $55,000 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 March 31, 2004 was
approximately $2,000. Revenue Recognition Revenues from rental property are recognized when due from tenants. Leases are
generally for terms of one year or less. -6-




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Stock Based Compensation At March 31, 2004, we had one stock-based employee compensation plan. During
the three month period ended March 31, 2004, we issued 450,000 common share
options and further issued 900,000 restricted share grants. In connection with
the resignation of an employee we cancelled 50,000 restricted share grants
under this plan. During the three month period ended March 31, 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 three month periods endedMarch 31,2004
    
    2003Net loss attributable to Common Shareholders
    
    $
    (133,470
    )
    
    $
    (245,198
    )Add: Stock-based employee compensation
expense included in reported net loss, net
of related tax effects
    
    
    31,533
    
    
    
    Deduct: Total stock-based employee
compensation expense determined under fair
value based method for all awards, net of
related tax effects
    
    
    (39,408
    )
    
    
    Pro forma net loss attributable to Common
Shareholders
    
    $
    (141,345
    )
    
    $
    (245,198
    )Net loss attributable to Common
Shareholders per Common Share:Basic and Diluted  as reported
    
    $
    (0.00
    )
    
    $
    (0.05
    )Basic and Diluted  pro forma
    
    $
    (0.00
    )
    
    $
    (0.05
    )
 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 March 31, 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 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. -7-




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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 March
31, 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 three month period ended March 31, 2003. Reclassification As a result of the sale of our commercial properties on October 1, 2003,
certain amounts in the March 31, 2003 financial statements have been
reclassified to conform to the March 31, 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 March
31, 2004, and represent 10,000 common shares of Stellent, Inc. (Stellent).
The shares were acquired in connection with the sale of certain assets of
Stonehaven Technologies on July 10, 2001. As of March 31, 2004, the 10,000 shares of Stellent had a fair market value of
approximately $75,000 (based upon the NASDAQ closing quote of $7.47 per share
on March 31, 2004). We recorded an unrealized loss on marketable securities
during 2003 of $24,500, resulting in a balance of $37,200 in shareholders
equity for unrealized gain on marketable securities. The NASDAQ closing quote on May 6, 2004 was $6.98 per common share of Stellent. -8-




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Note 5  Pro Forma Consolidated Financial Information (Unaudited) 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 March
31, 2003, all revenues and expenses associated with the commercial properties
have been recorded as discontinued operations. For the threemonths endedMarch 31, 2003Pro forma total revenue
    
    $
    160,000Pro forma loss from continuing operations
    
    $
    (187,000
    )Pro forma loss attributable to Common Shareholders
    
    $
    (239,000
    )Pro forma loss per Common Share: Basic and Diluted
    
    $
    (0.01
    )
 Note 6Mortgage Loan Payable The mortgage loan payable secured by our residential real estate property has a
balance at March 31, 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. 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 issued 250,000 restricted common shares to our
landlord in connection with office space and related services for the twelve
months ended March 4, 2004. 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
Income/Loss from discontinued operations. -9-




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The following is a summary of the income from discontinued operations of our
commercial properties. For the threemonths endedMarch 31, 2003Revenues
    
    $
    328,548Operating expenses
    
    
    (158,453
    )Depreciation and amortization
    
    
    (50,554
    )Interest expense
    
    
    (83,713
    )General and administrative
    
    
    (88,284
    )Loss from discontinued operations
    
    $
    (52,456
    )
 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 three month periods ended
March 31, 2004 and March 31, 2003 were 32,580,976 and 4,517,524, respectively.
Common share equivalents of approximately 23.6 million and 3.1 million as of
March 31, 2004 and March 31, 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 three months ended March 31,2004
    
    2003NumeratorNet Loss from continuing operations
    
    $
    (133,470
    )
    
    $
    (192,742
    )Discontinued operations:Discontinued operations, net of tax
    
    
    
    
    
    
    (52,456
    )Net loss available to Common Shareholders
    
    $
    (133,470
    )
    
    $
    (245,198
    )DenominatorWeighted average Common Shares
outstanding at March 31, 2004 and March
31, 2003, respectively:Basic and Diluted
    
    
    32,580,976
    
    
    
    4,517,524Basic and Diluted EPSNet Loss from continuing operations
    
    $
    (0.00
    )
    
    $
    (0.04
    )Discontinued operations:Discontinued operations, net of tax
    
    
    
    
    
    
    (0.01
    )Net loss available to Common
Shareholders   Basic and Diluted
    
    $
    (0.00
    )
    
    $
    (0.05
    )
 -10-




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Note 10  Commitments and Contingencies Liquidity As of March 31, 2004, our unrestricted cash resources were approximately
$2,312,000 and our marketable securities available for sale were approximately
$75,000. Our marketable securities represented 10,000 shares of common stock
of Stellent. The NASDAQ closing quote on May 6, 2004 was $6.98 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 three 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. 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. -11-




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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 $16,000 for the three months ended March 31, 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 in three month period ended March 31, 2004 were
approximately $7,000. Reimbursement, at cost, for the payroll related costs
paid and accrued for the three month period ended March 31, 2004 was
approximately $15,000. 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 three month period ended March 31, 2003, we recognized rental
expense of approximately $4,900 related to office space leased from Hoyt
Properties. Medical Reimbursement Paragon reimburses MDC Realty Corp. for medical insurance, at cost, for one of
its executive officers. The amount paid or accrued for the three month period
ended March 31, 2004 was approximately $1,400. -12-




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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 March 31, 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, but continued marketing the software product. In
2002, we discontinued the operations of our technology segment. 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 three month
periods ended March 31, 2004 and 2003 and financial condition, including  
    
    Explanation of changes in the results of operations in the
Consolidated Statements
of Operations for the three month period ended March 31, 2004 compared to
the three month period ended March 31, 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 three month period
ended March 31, 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
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 -13-




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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, our failure to lease
unoccupied units or to re-lease occupied units upon expiration of leases in
accordance with the 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, our
ability to obtain 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 Three-Month Period Ended March 31, 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 March 31, 2003. Richton Trail, which we acquired on July 1, 2003,
is included in continuing operations. Rental revenue of approximately $151,000 for the three month period ended March
31, 2004 was comprised entirely of Richton Trail, acquired on July 1, 2003,
compared to $0 the three month period ended March 31, 2003 when it was not part
of our portfolio. Interest and other revenue increased by approximately $16,000 to approximately
$18,000 for the three month period ended March 31, 2004 compared to the three
month period ended March 31, 2003. The increase is primarily due to the
increase in cash and cash equivalents, coupled with the acquisition of the
Richton Trail in July 2003. Cash and cash equivalents increased as a result of
the sale of our Minnesota properties on October 1, 2003, coupled with the
refinance of the Richton Trail on October 30, 2003. Expenses from Continuing Operations Total expenses increased from approximately $205,000 for the three month period
ended March 31, 2003 to $389,000 for the three month period ended March 31,
2004, a net increase of $184,000 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  $56,000
    
    Property taxes and insurance   $23,000
    
    Depreciation and amortization  $21,000
    
    Interest  $42,000
    
    Management fees  $7,000 -14-




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General and administrative expenses increased from approximately $200,000 for
the three month period ended March 31, 2003 to approximately $240,000 for the
three month period ended March 31, 2004. The increase was primarily the result
of the amortization of unearned compensation and trustee fees in the amount of
approximately $32,000 paid through the issuance of restricted shares. The
officers and trustees were issued these restricted shares for their services as
a means to preserve cash. Loss from operations before minority interest As a result of the above, loss from operations before loss allocated to
minority interest increased from approximately $203,000 for the three month
period ended March 31, 2003 to approximately $220,000 for the three month
period ended March 31, 2004. Loss allocated to minority interest Loss allocated to minority interests increased from approximately $10,000 for
the three month period ended March 31, 2003 to approximately $87,000 for the
three month period ended March 31, 2004 primarily as a result of the July 2003
acquisition of our partnership interest in Richton Apartments 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 $193,000 for the
three month period ended March 31, 2003 to approximately $133,000 for the three
month period ended March 31, 2004. Discontinued operations Loss from discontinued operations of approximately $0 and $52,000 for the
three month periods ended March 31, 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 $245,000 for the three month period ended March 31, 2003 to
$133,000 for the three month period ended March 31, 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 -15-




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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 March 31, 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. 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 March 31, 2004, our unrestricted cash resources were approximately
$2,312,000 and our marketable securities available for sale were approximately
$75,000, comprised solely of 10,000 common shares of Stellent. The NASDAQ
closing quote on May 6, 2004 was $6.98 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 three month period ended March 31, 2004, we generated cash of
approximately $108,000 from our continuing operations, which included the
refund of a deposit of $250,000 on a development site in February 2004. Cash
was used primarily for (i) additions to real estate properties of approximately
$3,000; and (ii) payments on the mortgage loan payable of approximately
$12,000. As a result, our cash balance increased by approximately $93,000 from
approximately $2,219,000 at December 31, 2003 to approximately $2,312,000 at
March 31, 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
March 31, 2004 compared to March 31, -16-




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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.
    
    Each of the three 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
three 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. 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 in order to make acquisitions. Current Tax Status At March 31, 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 -17-




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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 are expected 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 will continue 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. -18-




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ITEM 3. CONTROLS AND PROCEDURES As of March 31, 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 March 31, 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 March 31, 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 January 2, 2004, we issued a total of 900,000 restricted common
shares to three of our officers and a total of 450,000 common share options
exercisable at a price of $0.27 per share to three of our officers for services
rendered. 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. Effective March 4, 2004, we issued 250,000 restricted common shares to our
landlord in connection with office space we occupy in Cleveland, Ohio and
related services for the twelve months ended March 4, 2004. We believe this
issuance of common shares to be exempt from registration under Section 4(2) of
the Securities Act. During the first quarter of 2004, a shareholder converted 935 preferred shares
into 3,224 common shares at a conversion rate of 3.448 common for each
preferred share pursuant to the terms of the preferred shares. We believe this
issuance of common shares to be exempt from registration under Section 3(a)(9)
of the Securities Act. 
 ITEM 3. DEFAULTS UPON SENIOR SECURITIES None 
 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None 
 ITEM 5. OTHER INFORMATION None -19-




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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (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.
 (b) Reports On Form 8-K During the three month period ended March 31, 2004 and through May 10, 2004, we
filed no current reports on Form 8-K. 
 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: May 10, 2004
    
    
    
    James C. MastandreaChief Executive OfficerPARAGON REAL ESTATE EQUITY AND INVESTMENT TRUSTDate: May 10, 2004
    
    By:
    
    /s/ John J. Dee

John J. DeeChief Financial Officer
 -20-