** **

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

** **

**FORM 10-Q**

** **
| **x**      | ** ** | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR  15(d) OF  THE SECURITIES EXCHANGE ACT OF 1934**                                                                                                                                                            |
|------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** ** | ** ** | ** **                                                                                                                                                                                                                                                         |
| ** ** | ** ** | **For the  quarterly period ended March 31, 2006**                                                                                                                                                                                                            |
| ** ** | ** ** | ** **                                                                                                                                                                                                                                                         |
| ** ** | ** ** | **or**                                                                                                                                                                                                                                                             |
| ** ** | ** ** | ** **                                                                                                                                                                                                                                                         |
| **o**      | ** ** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF  THE SECURITIES EXCHANGE ACT OF 1934**                                                                                                                                                           |
| ** ** | ** ** | ** **                                                                                                                                                                                                                                                         |
| ** ** | ** ** | **For the  transition period from                     to                   .** |
| ** ** | ** ** | ** **                                                                                                                                                                                                                                                         |
| ** ** | ** ** | **Commission  File No. 001-32248**                                                                                                                                                                                                                            |
| ** ** | ** ** | ** **                                                                                                                                                                                                                                                         |

** **

**GRAMERCY CAPITAL CORP.**

(Exact name ofregistrant as specified in its charter)

 
| **Maryland**                                                                                                    |   | **06-1722127**       |
|-----------------------------------------------------------------------------------------------------------------|--------|----------------------|
| (State or other  jurisdiction                                                                                   |   | (I.R.S. Employer     |
| of incorporation  or organization)                                                                              |   | Identification  No.) |
| * *                                                                                                        |   | * *             |
| **420  Lexington Avenue, New York, New York   10170**  (Address of principal executive offices - zip code) |
| * *                                                                                                        |   | * *             |
| **(212)  297-1000**(Registrant’s telephone number, including area code)                                    |

 

Indicate by checkmark whether the registrant (1) has filed all reports required to be filedby Section 13 or 15(d) of the Securities Exchange Act of 1934 duringthe preceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days. Yes x   No o

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer or a non-accelerated filer. Seedefinition of “accelerated filer” and “non-accelerated filer” in Rule 12b-2 ofthe Exchange Act.

Large accelerated filer o    Accelerated Filer x    Non-accelerated filer o

Indicate by check mark whether the registrant is a shell company (asdefined in Rule 12b-2 of the Exchange Act). Yes  o No x.

The number ofshares outstanding of the registrant’s common stock, $0.001 par value, was22,817,642 at May 10, 2006.

 

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**GRAMERCYCAPITAL CORP.**

**INDEX**
| **PART I.**    | **FINANCIAL  INFORMATION**                                                                                       |   |   |
|----------------|------------------------------------------------------------------------------------------------------------------|--------|--------|
|           |                                                                                                             |   |   |
| **ITEM  1.**   | **FINANCIAL  STATEMENTS**                                                                                        |   |   |
|           |                                                                                                             |   |   |
|                | Consolidated  Balance Sheets as of March 31, 2006 (unaudited) and December 31,  2005                   |   |   |
|           |                                                                                                             |   |   |
|           | Consolidated  Statements of Income for the three months ended March 31, 2006 and 2005  (unaudited)          |   |   |
|           |                                                                                                             |   |   |
|           | Consolidated  Statement of Stockholders’ Equity for the three months ended March 31,  2006 (unaudited) |   |   |
|           |                                                                                                             |   |   |
|           | Consolidated  Statements of Cash Flows for the three months ended March 31, 2006 and  2005 (unaudited)      |   |   |
|           |                                                                                                             |   |   |
|           | Notes  to Consolidated Financial Statements (unaudited)                                                          |   |   |
|           |                                                                                                             |   |   |
| **ITEM 2.**    | **MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION **                                      |   |   |
|           | **AND RESULTS OF OPERATIONS**                                                                                    |   |   |
|           |                                                                                                             |   |   |
| **ITEM 3.**    | **QUANTITATIVE  AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**                                                  |   |   |
|           |                                                                                                             |   |   |
| **ITEM 4.**    | **CONTROLS AND  PROCEDURES**                                                                                     |   |   |
|           |                                                                                                             |   |   |
| **PART II.**   | **OTHER INFORMATION**                                                                                            |   |   |
|           |                                                                                                             |   |   |
| **ITEM 1.**    | **LEGAL PROCEEDINGS**                                                                                            |   |   |
|           |                                                                                                             |   |   |
| **ITEM  1A.**  | **RISK  FACTORS**                                                                                                |   |   |
|           |                                                                                                             |   |   |
| **ITEM 2.**    | **UNREGISTERED  SALES OF EQUITY SECURITIES AND USE OF PROCEEDS**                                                 |   |   |
|           |                                                                                                             |   |   |
| **ITEM 3.**    | **DEFAULTS UPON  SENIOR SECURITIES**                                                                             |   |   |
|           |                                                                                                             |   |   |
| **ITEM 4.**    | **SUBMISSION OF  MATTERS TO A VOTE OF SECURITY HOLDERS**                                                         |   |   |
|           |                                                                                                             |   |   |
| **ITEM 5.**    | **OTHER INFORMATION**                                                                                            |   |   |
|           |                                                                                                             |   |   |
| **ITEM  6.**   | **EXHIBITS**                                                                                                     |   |   |
|           |                                                                                                             |   |   |
| **Signatures** |                                                                                                             |   |

 

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**PART I.****    FINANCIAL INFORMATION**

**ITEM 1.****     Financial Statements**

**GramercyCapital Corp.Consolidated Balance Sheets(Amounts in thousands, except share and per share data)**

 
| ** **                                                                                                                                                                                    | ** ** | **March 31,  2006  (Unaudited)** | ** ** | **December 31,  2005** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|-----------------------------|------------|
| **Assets:**                                                                                                                                                                                   |       |                                  |       |                        |       |
| Cash and cash  equivalents                                                                                                                                                                    |       | $                                     | 46,001     |                        | $          | 70,576 |   |
| Restricted cash                                                                                                                                                                               |       | 65,187                                |       | 53,833                      |       |
| Loans and other  lending investments, net                                                                                                                                                     |       | 1,481,202                             |       | 1,163,745                   |       |
| Investment in  unconsolidated joint ventures                                                                                                                                                  |       | 57,373                                |       | 58,040                      |       |
| Loans held for  sale, net                                                                                                                                                                     |       | 62,441                                |       | 42,000                      |       |
| Operating real  estate, net                                                                                                                                                                   |       | 53,059                                |       | 51,173                      |       |
| Accrued interest                                                                                                                                                                              |       | 8,904                                 |       | 7,187                       |       |
| Deferred  financing costs                                                                                                                                                                     |       | 17,791                                |       | 17,488                      |       |
| Deferred costs                                                                                                                                                                                |       | 2,597                                 |       | 1,894                       |       |
| Derivative instruments,  at fair value                                                                                                                                                        |       | 5,600                                 |       | 2,271                       |       |
| Other assets                                                                                                                                                                                  |       | 3,489                                 |       | 1,603                       |       |
| Total assets                                                                                                                                                                                  |       | $                                     | 1,803,644  |                        | $          | 1,469,810 |   |
| ** **                                                                                                                                                                                    |       |                                  |       |                        |       |
| **Liabilities and Stockholders’  Equity:**                                                                                                                                               |       |                                  |       |                        |       |
| Repurchase  agreements                                                                                                                                                                        |       | $                                     | 377,193    |                        | $          | 117,366 |   |
| Collateralized  debt obligation                                                                                                                                                               |       | 810,500                               |       | 810,500                     |       |
| Mortgage note  payable                                                                                                                                                                        |       | 41,000                                |       | 41,000                      |       |
| Management fees  payable                                                                                                                                                                      |       | 1,432                                 |       | 1,329                       |       |
| Incentive fee  payable                                                                                                                                                                        |       | 1,193                                 |       | 1,237                       |       |
| Dividends  payable                                                                                                                                                                            |       | 11,290                                |       | 10,726                      |       |
| Accounts payable  and accrued expenses                                                                                                                                                        |       | 13,215                                |       | 11,561                      |       |
| Other  liabilities                                                                                                                                                                            |       | 16,430                                |       | 3,687                       |       |
| Junior  subordinated deferrable interest debentures held by trusts that issued trust  preferred securities                                                                                    |       | 150,000                               |       | 100,000                     |       |
| Total  liabilities                                                                                                                                                                            |       | 1,422,253                             |       | 1,097,406                   |       |
|                                                                                                                                                                                          |       |                                  |       |                        |       |
| Commitments and  contingencies                                                                                                                                                                |       | —                                |       | —                      |       |
| Minority  interest in operating real estate                                                                                                                                                   |       | 5,000                                 |       | —                      |       |
| ** **                                                                                                                                                                                    |       |                                  |       |                        |       |
| **Stockholders’ Equity:**                                                                                                                                                                |       |                                  |       |                        |       |
| Preferred stock,  par value $0.001, 25,000,000 shares authorized, no shares issued or  outstanding                                                                                       |       | —                                |       | —                      |       |
| Common stock,  par value $0.001, 100,000,000 shares authorized, 22,817,642 and 22,802,642 shares issued and outstanding  at March 31, 2006 and December 31, 2005, respectively |       | 22                                    |       | 22                          |       |
| Additional  paid-in-capital                                                                                                                                                                   |       | 370,470                               |       | 369,529                     |       |
| Accumulated  other comprehensive income                                                                                                                                                       |       | 6,635                                 |       | 2,851                       |       |
| Retained  earnings / (deficit)                                                                                                                                                                |       | (736                                  | )          | 2                           |       |
| Total stockholders’ equity                                                                                                                                                               |       | 376,391                               |       | 372,404                     |       |
| Total liabilities and  stockholders’ equity                                                                                                                                              |       | $                                     | 1,803,644  |                        | $          | 1,469,810 |   |

 

The accompanying notes are an integral part of thesefinancial statements.

1

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**Gramercy Capital Corp.Consolidated Statements of Income(Unaudited, amounts in thousands, except per share data)**
| ** **                                                                                              |   | **For the Three  Months Ended  March 31, 2006** | ** ** | **For the Three  Months Ended  March 31, 2005** |   |
|---------------------------------------------------------------------------------------------------------|--------|--------------------------------------------------------------------------|------------|--------------------------------------------------------------------------|--------|
| **Revenues**                                                                                            |   |                                                                     |       |                                                                     |   |
| Investment income                                                                                       |   | $                                                                        | 31,879     |                                                                     | $      | 10,250 |   |
| Rental revenue, net                                                                                     |   | 914                                                                      |       | —                                                                   |   |
| Gain on sales and other income                                                                          |   | 4,197                                                                    |       | 440                                                                      |   |
| Total revenues                                                                                          |   | 36,990                                                                   |       | 10,690                                                                   |   |
| ** **                                                                                              |   |                                                                     |       |                                                                     |   |
| **Expenses**                                                                                            |   |                                                                     |       |                                                                     |   |
| Interest expense                                                                                        |   | 17,721                                                                   |       | 2,801                                                                    |   |
| Management fees                                                                                         |   | 3,523                                                                    |       | 1,668                                                                    |   |
| Incentive fee                                                                                           |   | 1,193                                                                    |       | —                                                                   |   |
| Depreciation and amortization                                                                           |   | 455                                                                      |       | 22                                                                       |   |
| Marketing, general and administrative                                                                   |   | 2,770                                                                    |       | 1,633                                                                    |   |
| Total expenses                                                                                          |   | 25,662                                                                   |       | 6,124                                                                    |   |
| Income from continuing operations before equity in  net loss of unconsolidated joint ventures and taxes |   | 11,328                                                                   |       | 4,566                                                                    |   |
| Equity in net loss of unconsolidated joint ventures                                                     |   | (727                                                                     | )          | —                                                                   |   |
| Income from continuing operations before provision  for taxes                                           |   | 10,601                                                                   |       | 4,566                                                                    |   |
| Provision for taxes                                                                                     |   | (47                                                                      | )          | —                                                                   |   |
| Net income available to common stockholders                                                             |   | $                                                                        | 10,554     |                                                                     | $      | 4,566 |   |
|                                                                                                    |   |                                                                     |       |                                                                     |   |
| **Basic earnings per share:**                                                                           |   |                                                                     |       |                                                                     |   |
| Net income available to common stockholders                                                             |   | $                                                                        | 0.46       |                                                                     | $      | 0.24 |   |
| **Diluted earnings per share:**                                                                         |   |                                                                     |       |                                                                     |   |
| Net income available to common stockholders                                                             |   | $                                                                        | 0.44       |                                                                     | $      | 0.24 |   |
| Dividends per common share                                                                              |   | $                                                                        | 0.50       |                                                                     | $      | 0.22 |   |
| Basic weighted average common shares outstanding                                                        |   | 22,807                                                                   |       | 18,833                                                                   |   |
| Diluted weighted  average common shares and common share equivalents outstanding                        |   | 23,988                                                                   |       | 19,018                                                                   |   |

 

Theaccompanying notes are an integral part of these financial statements.

2

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**GramercyCapital Corp.Consolidated Statement ofStockholders’ Equity(Unaudited, amounts in thousands, except share data)**
| ** **                                           | ** ** | **Common Stock** | ** ** | ** **         | ** ** | ** **                        | ** ** | ** **                                    | ** ** | ** **             | ** ** | ** ** | ** ** |
|------------------------------------------------------|------------|-----------------------|------------|--------------------|------------|-----------------------------------|------------|-----------------------------------------------|------------|------------------------|------------|------------|------------|
| ** **                                           | ** ** | **Shares**            | ** ** | **Par Value** | ** ** | **Additional  Paid-  In-Capital** | ** ** | **Accumulated  Other  Comprehensive  Income** | ** ** | **Retained  Earnings** | ** ** | **Total**  | ** ** | **Comprehensive  Income** | ** ** |
| **Balance at  December 31, 2005**     |       | 22,803                | ** ** | $22                | ** ** | $369,529                          | ** ** | $2,851                                        | ** ** | $2                     | ** ** | $372,404   | ** ** |   |   |
| Net income                                           |       |                  |       |               |       |                              |       |                                          |       | 10,554                 |       | 10,554     |       | 10,554 |   |
| Net unrealized gain on derivative instruments        |       |                  |       |               |       |                              |       | 3,784                                         |       |                   |       | 3,784      |       | 3,784 |   |
| Stock-based compensation — fair value           |       |                  |       |               |       | 603                               |       |                                          |       |                   |       | 603        |       |   |   |
| Proceeds from stock option exercises                 |       | 3                     |       | —             |       | 45                                |       |                                          |       |                   |       | 45         |       |   |   |
| Deferred compensation plan, net                      |       | 12                    |       | —             |       | 293                               |       |                                          |       |                   |       | 293        |       |   |   |
| Cash distributions declared ($0.50 per common share) |       |                  |       |               |       |                              |       |                                          |       | (11,292                | )          | (11,292    | )          |   |   |
| **Balance  at March 31, 2006**                  |       | 22,818                |       | $                  | 22         |                              | $          | 370,470                                       |       | $                      | 6,635      |       | ($736      | ) | $ | 376,391 |   | $ | 14,338 |   |
|                                                      |            |                       |            |                    |            |                                   |            |                                               |            |                        |            |            |            |  |  |  |  |  |  |  |

 

Theaccompanying notes are an integral part of these financial statements

3

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**Gramercy CapitalCorp.****ConsolidatedStatements of Cash Flows(Unaudited, amounts in thousands)**

 
| ** **                                                                                                                  | ** ** | **Three Months ended  March 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                                                                  | ** ** | **2006**                                         | ** ** | **2005** | ** ** |
| **Operating  Activities**                                                                                                   | ** ** | ** **                                       | ** ** | ** ** | ** ** |
| Net income  available to common stockholders                                                                                |       | $                                                | 10,554     |   | $ | 4,566 |   |
| Adjustments to reconcile  net income available to common stockholders to net cash used / provided by  operating activities: |       |                                             |       |   |   |
| Depreciation and amortization                                                                                               |       | 1,422                                            |       | 22 |   |
| Amortization of discount on investments                                                                                     |       | (426                                             | )          | 248 |   |
| Equity in net loss of unconsolidated joint ventures                                                                         |       | 727                                              |       | — |   |
| Gain on sale of security interests in operating real  estate                                                                |       | 1,718                                            |       | — |   |
| Amortization of stock compensation                                                                                          |       | 896                                              |       | — |   |
| Changes in operating  assets and liabilities:                                                                               |       |                                             |       |   |   |
| New investments in loans held for sale                                                                                      |       | (62,441                                          | )          | — |   |
| Proceeds from sale of loans held for sale                                                                                   |       | 42,000                                           |       | — |   |
| Accrued interest                                                                                                            |       | (1,717                                           | )          | 126 |   |
| Other assets                                                                                                                |       | (1,716                                           | )          | 242 |   |
| Management fees payable                                                                                                     |       | 103                                              |       | 1,172 |   |
| Incentive fee payable                                                                                                       |       | (44                                              | )          | — |   |
| Settlement of derivative instruments                                                                                        |       | 843                                              |       | — |   |
| Accounts payable, accrued expenses and other  liabilities                                                                   |       | 7                                                |       | 74 |   |
| Net cash used /  provided by operating activities                                                                           |       | (8,074                                           | )          | 6,450 |   |
|                                                                                                                        |       |                                             |       |   |   |
| **Investing  Activities**                                                                                                   |       |                                             |       |   |   |
| New investment originations                                                                                                 |       | (388,621                                         | )          | (221,157 | ) |
| Principal collections on investments                                                                                        |       | 74,665                                           |       | 20,776 |   |
| Investment in operating real estate                                                                                         |       | (2,107                                           | )          | — |   |
| Proceeds from the sale of security interests in  operating real estate                                                      |       | 5,000                                            |       | — |   |
| Investment in joint ventures                                                                                                |       | (60                                              | )          | — |   |
| Change in restricted cash for investments                                                                                   |       | (3,320                                           | )          | — |   |
| Deferred investment costs                                                                                                   |       | (703                                             | )          | 14 |   |
| Net cash used in investing activities                                                                                       |       | (315,146                                         | )          | (200,367 | ) |
| **Financing  Activities**                                                                                                   |       |                                             |       |   |   |
| Proceeds from  repurchase facilities                                                                                        |       | 315,260                                          |       | 103,406 |   |
| Repayments of  repurchase facilities                                                                                        |       | (55,434                                          | )          | — |   |
| Settlement of  derivative instruments                                                                                       |       | 770                                              |       | — |   |
| Proceeds from  stock options exercised                                                                                      |       | 45                                               |       | — |   |
| Net proceeds  from sale of common stock                                                                                     |       | —                                           |       | 59,547 |   |
| Issuance of  trust preferred securities                                                                                     |       | 50,000                                           |       | — |   |
| Deferred  financing costs                                                                                                   |       | (1,270                                           | )          | (1,758 | ) |
| Dividends paid                                                                                                              |       | (10,726                                          | )          | (1,951 | ) |
| Net cash  provided by financing activities                                                                                  |       | 298,645                                          |       | 159,244 |   |
| Net decrease in  cash and cash equivalents                                                                                  |       | (24,575                                          | )          | (34,673 | ) |
| Cash and cash  equivalents at beginning of period                                                                           |       | 70,576                                           |       | 39,094 |   |
| Cash and cash  equivalents at end of period                                                                                 |       | $                                                | 46,001     |   | $ | 4,421 |   |
| **Supplemental  cash flow disclosures**                                                                                     |       |                                             |       |   |   |
| Interest paid                                                                                                               |       | $                                                | 7,754      |   | $ | 2,661 |   |
| Income taxes  paid                                                                                                          |       | $                                                | 249        |   | $ | — |   |

 

Theaccompanying notes are an integral part of these financial statements.

4

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**GramercyCapital Corp.Notes To Consolidated Financial Statements(Unaudited, amounts in thousands, except share and per share data)March 31, 2006**

**1.   Organization**

Gramercy Capital Corp. (the “Company” or “Gramercy”),was organized in Maryland on April 12, 2004 as a national commercial realestate specialty finance company that focuses on the direct origination andacquisition of whole loans, subordinate interests in whole loans, mezzanineloans, preferred equity, and net lease investments involving commercialproperties throughout the United States. When evaluating transactions, weassess our risk-adjusted return and target transactions with yields that ensurean equitable balance between risks and return.

Substantially all of our operations are conductedthrough GKK Capital LP, a Delaware limited partnership, or the OperatingPartnership. We, as the sole general partner of, and holder of 100% of thecommon units of, the Operating Partnership, have responsibility and discretionin the management and control of the Operating Partnership, and the limitedpartners of the Operating Partnership, in such capacity, have no authority totransact business for, or participate in the management activities of, theOperating Partnership. Accordingly, we consolidate the accounts of theOperating Partnership.

We are externally managed and advised by GKK ManagerLLC, or the Manager, a majority-owned subsidiary of SL Green Realty Corp., orSL Green. At March 31, 2006, SL Green also owned approximately 25% of theoutstanding shares of our common stock. We qualified as a real estateinvestment trust, or REIT, under the Internal Revenue Code commencing with ourtaxable year ending December 31, 2004 and expect to qualify for thecurrent fiscal year. To maintain our tax status as a REIT, we plan todistribute at least 90% of our taxable income. Unless the context requiresotherwise, all references to “we,” “our,” and “us” means Gramercy Capital Corp.

As of March 31,2006, we held loans and other lending investments of $1,543,643 net of fees,discounts, repayments, asset sales and unfunded commitments with an averagespread to LIBOR of 394 basis points for our floating rate investments and anaverage yield of 9.41% for our fixed rate investments. As of March 31,2006, we also held interests in three credit tenant lease, or CTL, investmentstotaling $110,432 comprised of the remaining 70.7% investment in the entitythat owns 200 Franklin Square Drive in Somerset, New Jersey and $57,373 injoint venture investments.

**Basis of QuarterlyPresentation**

The accompanying financialstatements have been prepared in accordance with accounting principlesgenerally accepted in the United States for interim financial information andwith the instructions to Form 10-Q and Article 10 of RegulationS-X. Accordingly, it does not include all of the information and footnotesrequired by accounting principles generally accepted in the United States, orGAAP, for complete financial statements. In management’s opinion, alladjustments (consisting of normal recurring accruals) considered necessary forfair presentation have been included. The 2006 operating results for theperiod presented are not necessarily indicative of the results that may beexpected for the year ending December 31, 2006. These financial statementsshould be read in conjunction with the financial statements and accompanying notesincluded in the Company’s annual report on Form 10-K for the yearended December 31, 2005.

The balance sheet at December 31,2005 has been derived from the audited financial statement at that date, butdoes not include all the information and footnotes required by GAAP forcomplete financial statements.

**2.   Significant Accounting Policies**

**Principles of Consolidation**

The consolidated financial statements include our accountsand those of our subsidiaries which are wholly-owned or controlled by us, or entitieswhich are variable interest entities in which we are the primary beneficiariesunder FASB Interpretation No. 46, FIN 46, “Consolidation of VariableInterest Entities.”  FIN 46 requires avariable interest entity, or VIE, to be consolidated by its primary beneficiary.The primary beneficiary is the party that absorbs a majority of the VIE’santicipated losses and/or a majority of the expected returns. We have evaluatedour investments for potential classification as variable interests byevaluating the sufficiency of the entities’ equity investment at risk to absorblosses, and determined that we are not the primary beneficiary for any of ourinvestments. Entities which we do not control and entities which are VIE’s, butwhere we are not the primary beneficiary, are accounted for under the equitymethod. All significant intercompany balances and transactions have beeneliminated.

5

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**Cash and Cash Equivalents**

We consider all highlyliquid investments with maturities of three months or less when purchased to becash equivalents.

**Restricted Cash**

**Restrictedcash consists primarily of $47,616 on deposit with the trustee of ourcollateralized debt obligation, or CDO. Also included are the proceeds ofrepayments from loans serving as CDO collateral, which will be used to fundinvestments to replace those trust assets which are repaid or sold by thetrust, interest payments received by the trustee on investments that serve ascollateral for the CDO, which are remitted to us on a quarterly basis in themonth following the end of our fiscal quarter, and future funding obligationson certain investments. The remaining $17,571 consists of interest reservesheld on behalf of borrowers.**

### **Loans and Investmentsand Loans Held for Sale**

Loans held for investment are intended to be held tomaturity and, accordingly, are carried at cost, net of unamortized loanorigination fees, discounts, repayments, sales of partial interests in loans,and unfunded commitments unless such loan or investment is deemed to beimpaired. Loans held for sale are carried at the lower of cost or market valueusing available market information obtained through consultation with dealersor other originators of such investments. We may originate or acquire preferredequity interests that allow us to participate in a percentage of the underlyingproperty’s cash flows from operations and proceeds from a sale or refinancing. Shouldwe make such a preferred equity investment, we must determine whether thatinvestment should be accounted for as a loan, joint venture or as an interestin real estate. Our current preferred equity investments do not entitle us to apercentage of the underlying properties’ cash flows from operations or proceedsfrom a sale or refinancing and are, therefore, accounted for as loans.

Specific valuation allowances are established forimpaired loans based on the fair value of collateral on an individual loanbasis. The fair value of the collateral is determined by selecting the mostappropriate valuation methodology, or methodologies, among several generallyavailable and accepted  in the commercialreal estate industry. The determination of the most appropriate valuationmethodology is based on the key characteristics of the collateral type. Thesemethodologies include the evaluation of operating cash flow from the propertyduring the projected holding period, and the estimated sales value of thecollateral computed by applying an expected capitalization rate to thestabilized net operating income of the specific property, less selling costs,all of which are discounted at market discount rates.

If upon completion of thevaluation, the fair value of the underlying collateral securing the impairedloan is less than the net carrying value of the loan, an allowance is createdwith a corresponding charge to the provision for loan losses. The allowance foreach loan is maintained at a level we believe is adequate to absorb probablelosses. At March 31, 2006 we maintained a reserve of $1,030.

Our Manager evaluates ourassets on a regular basis to determine if they continue to satisfy ourinvestment criteria. Subject to certain restrictions, our Manager may cause usto sell our investments opportunistically and use the proceeds of any such salefor debt reduction, additional acquisitions or working capital purposes.

#### **Classifications ofMortgage-Backed Securities**

Mortgage-backed securities, or MBS, are classified asavailable-for-sale securities. As a result, changes in fair value will berecorded as a balance sheet adjustment to accumulated other comprehensiveincome, which is a component of stockholders equity, rather than through ourstatement of operations. If available-for-sale securities were classified astrading securities, there could be substantially greater volatility in earningsfrom period-to-period as these investments would be marked to market and anyreduction in the value of the securities versus the previous carrying valuewould be considered an expense on our statement of operations. We had noinvestments as of March 31, 2006 that were accounted for as tradingsecurities.

#### **Valuations ofMortgage-Backed Securities**

All MBS are carried on the balance sheet at fair value.We determine the fair value of MBS based on the types of securities in which wehave invested. For liquid, investment-grade securities, we consult with dealersof such securities to periodically obtain updated market pricing for the sameor similar instruments. For non-investment grade securities, we activelymonitor the performance of the underlying properties and loans and update ourpricing model to reflect changes in projected cash flows. The value of thesecurities is derived by applying discount rates to such cash flows based oncurrent market yields. The yields employed are obtained from our own experiencein the market, advice from dealers and/or information obtained in consultationwith other investors in similar instruments. Because fair value estimates mayvary to some degree, we must make certain judgments and assumptions about theappropriate price to

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use to calculatethe fair values for financial reporting purposes. Different judgments andassumptions could result in different presentations of value.

When the fair value of anavailable-for-sale security is less than the amortized cost, we considerwhether there is an other-than-temporary impairment in the value of thesecurity (for example, whether the security will be sold prior to the recoveryof fair value). If, in our judgment, an other-than-temporary impairment exists,the cost basis of the security is written down to the then-current fair value,and this loss is realized and charged against earnings. The determination ofother-than-temporary impairment is a subjective process, and differentjudgments and assumptions could affect the timing of loss realization.

#### **Credit Tenant Lease Investments**

CTLinvestments are recorded at cost less accumulated depreciation. Costs directlyrelated to the acquisition of such investments are capitalized. Certainimprovements are capitalized when they are determined to increase the usefullife of the building. Capitalized items are depreciated using the straight-linemethod over the shorter of the useful lives of the capitalized item or 40 yearsfor buildings or facilities, the remaining life of the facility for facilityimprovements, four to seven years for personal property and equipment, and theshorter of the remaining lease term or the expected life for tenantimprovements.

Resultsof operations of properties acquired are included in the Statement of Incomefrom the date of acquisition.

Inaccordance with FASB No. 144, or SFAS 144, “Accounting for the Impairmentof Disposal of Long-Lived Assets,” a property to be disposed of is reported atthe lower of its carrying amount or its estimated fair value, less its cost tosell. Once an asset is held for sale, depreciation expense and straight-linerent adjustments are no longer recorded and historic results are reclassifiedas Discontinued Operations.

In accordance with FASB No. 141,or SFAS 141, “Business Combinations,” we allocate the purchase price of realestate to land and building and, if determined to be material, intangibles,such as the value of above, below and at-market leases and origination costsassociated with the in-place leases. We depreciate the amount allocated to buildingand other intangible assets over their estimated useful lives, which generallyrange from three to 40 years. The values of the above and below market leasesare amortized and recorded as either an increase (in the case of below marketleases) or a decrease (in the case of above market leases) to rental incomeover the remaining term of the associated lease. The value associated within-place leases and tenant relationships are amortized over the expected termof the relationship, which includes an estimated probability of the leaserenewal, and its estimated term. If a tenant vacates its space prior to thecontractual termination of the lease and no rental payments are being made onthe lease, any unamortized balance of the related intangible will be writtenoff. The tenant improvements and origination costs are amortized as an expenseover the remaining life of the lease (or charged against earnings if the leaseis terminated prior to its contractual expiration date). We assess fair valueof the leases based on estimated cash flow projections that utilize appropriatediscount and capitalization rates and available market information. Estimatesof future cash flows are based on a number of factors including the historicaloperating results, known trends, and market/economic conditions that may affectthe property.

As a result of ourevaluation under SFAS No. 141 of our acquisition of 200 Franklin SquareDrive, we recorded a liability of $889 representing the net value of theacquired below-market lease and assumed lease origination costs. We recognizeda decrease of approximately $17 in rental revenue for the three months ended March 31,2006 for the amortization of the below-market lease and lease origination costsincluding leasing commissions and tenant improvement costs that would be borneby us, resulting from the reallocation of the purchase price of the property.

As of March 31, 2006,we held interests in three CTL investments totaling $110,432 comprised of theremaining 70.7% investment in the entity that owns 200 Franklin Square Drive inSomerset, New Jersey and $57,373 in joint venture investments.

**Investments inUnconsolidated Joint Ventures**

#### We account forour investments in unconsolidated joint ventures under the equity method ofaccounting since we exercise significant influence, but do not unilaterallycontrol, the entities and are not considered to be the primary beneficiaryunder FIN 46. In the joint ventures, the rights of the other investor areprotective and participating. Unless we are determined to be the primarybeneficiary, these rights preclude us from consolidating the investments. Theinvestments are recorded initially at cost as an investment in unconsolidatedjoint ventures, and subsequently are adjusted for equity in net income (loss)and cash contributions and distributions. Any difference

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between thecarrying amount of the investments on our balance sheet and the underlyingequity in net assets is amortized as an adjustment to equity in net income(loss) of unconsolidated joint ventures over the lesser of the joint ventureterm or 40 years. None of the joint venture debt is recourse to us.

#### **Revenue Recognition**

Interest income ondebt investments is recognized over the life of the investment using theeffective interest method and recognized on the accrual basis. Fees received inconnection with loan commitments are deferred until the loan is funded and arethen recognized over the term of the loan as an adjustment to yield. Anticipatedexit fees, whose collection is expected, are also recognized over the term ofthe loan as an adjustment to yield. Fees on commitments that expire unused arerecognized at expiration. Fees received in exchange for the credit enhancementof another lender, either subordinate or senior to us, in the form of aguarantee are recognized over the term of that guarantee using thestraight-line method.

Income recognition is generally suspended for debt investments at theearlier of the date at which payments become 90 days past due or when, in ouropinion, a full recovery of income and principal becomes doubtful. Incomerecognition is resumed when the loan becomes contractually current andperformance is demonstrated to be resumed.

In some instances we may sell all or a portion of our investments to athird party. To the extent the fair value received for an investment exceedsthe amortized cost of that investment and FASB Statement No. 140, or SFAS140, “Accounting for Transfers and Servicing of Financial Assets andExtinguishments of Liabilities,” criteria is met, under which control of theasset that is sold is surrendered making it a “true sale,” a gain on the salewill be recorded through earnings as other income. To the extent an investmentthat is sold has a discount or fees, which were deferred at the time theinvestment was made and were being recognized over the term of the investment,the unamortized portion of the discount or fees are recognized at the time ofsale and recorded as a gain on the sale of the investment through other income.We recognized $1,114 in gains from the sale of two fixed rate debt investmentsand one fixed rate loan commitment for the three months ended March 31,2006.

Rental revenue is recognized on a straight-linebasis over the term of the lease. The excess of rents recognized over amountscontractually due pursuant to the underlying leases is included in other assetson the accompanying balance sheets. We may establish, on a current basis, anallowance against this account for future potential tenant credit losses, whichmay occur. The balance reflected on the balance sheet will be net of suchallowance.

In addition to base rent, the tenants in our CTLinvestments also pay all operating costs of owned property including realestate taxes.

#### **Reserve for PossibleCredit Losses**

The expense for possible credit losses in connection with debtinvestments is the charge to earnings to increase the allowance for possiblecredit losses to the level that management estimates to be adequate consideringdelinquencies, loss experience and collateral quality. Other factors consideredrelate to geographic trends and project diversification, the size of theportfolio and current economic conditions. Based upon these factors, we mayestablish the provision for possible credit losses by individual asset orcategory of asset. When it is probable that we will be unable to collect allamounts contractually due, the account is considered impaired.

Where impairment is indicated, a valuation write-down or write-off ismeasured based upon the excess of the recorded investment amount over the netfair value of the collateral, as reduced by selling costs. Any deficiencybetween the carrying amount of an asset and the net sales price offoreclosed collateral is charged to the allowance for credit losses. At March 31,2006 we maintained a reserve for possible credit losses of $1,030 againstinvestments with a carrying value of $69,133.

**Deferred Costs**

Deferred costsconsist of fees and direct costs incurred to originate new investments and areamortized using the effective yield method over the related term of theinvestment.

In March 2006, werecorded a nonrecurring charge of $525 for third-party professional expenses inconnection with a possible business combination involving the acquisition of apublicly-traded commercial real estate finance company with business linesconsidered by management to be highly complimentary to ours. The decision toexpense these costs was made once management concluded the proposed transactionwas unlikely to occur on terms advantageous to us.

**DeferredFinancing Costs**

Deferredfinancing costs represent commitment fees, legal and other third party costsassociated with obtaining commitments for financing which result in a closingof such financing. These costs are amortized over the terms of the respectiveagreements and the amortization is reflected in interest expense. Unamortizeddeferred financing costs are expensed when the associated debt is

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refinanced orrepaid before maturity. Costs incurred in seeking financing transactions, whichdo not close, are expensed in the period in which it is determined that thefinancing will not close.

**StockBased Compensation Plans**

We have a stock-based compensation plan, described more fully in Note13. We account for this plan using the fair value recognition provisions ofFASB Statement 123(R), “Share-Based Payment, a revision of FASB Statement No. 123,Accounting for Stock-Based Compensation.”

The Black-Scholes option-pricing model was developed for use inestimating the fair value of traded options, which have no vesting restrictionsand are fully transferable. In addition, option valuation models require theinput of highly subjective assumptions including the expected stock pricevolatility. Because our plan has characteristics significantly different fromthose of traded options and because changes in the subjective input assumptionscan materially affect the fair value estimate, in our opinion, the existingmodels do not necessarily provide a reliable single measure of the fair valueof our stock options.

Compensationcost for stock options, if any, is recognized ratably over the vesting periodof the award. Our policy is to grant options with an exercise price equal tothe quoted closing market price of our stock on the business day preceding thegrant date. Awards of stock or restricted stock are expensed as compensation ona current basis over the benefit period.

The fair value of each stock option granted is estimated onthe date of grant for awards to co-leased employees, and quarterly for optionsissued to non-employees, using the Black-Scholes option pricing model with thefollowing weighted average assumptions for grants in 2006 and 2005.

|                                  | ** ** | **2006**  | ** ** | **2005**  | ** ** |
|----------------------------------|------------|-----------|------------|-----------|------------|
| Dividend yield                   |       | 8.0       | %          | 8.4       | %          |
| Expected life of  option         |       | 7.0 years |       | 6.9 years |       |
| Risk-free  interest rate         |       | 3.94      | %          | 4.16      | %          |
| Expected stock price  volatility |       | 21.0      | %          | 19.1      | %          |

####  

**Incentive Distribution (Class BLimited Partner Interest)**

The Class Blimited partner interests are entitled to receive an incentive return equal to25% of the amount by which funds from operations (as defined in the partnershipagreement of the Operating Partnership which was amended and restated inApril 2006) plus certain accounting gains exceed the product of ourweighted average stockholders equity (as defined in the amended and restated partnershipagreement of the Operating Partnership) multiplied by 9.5% (divided by 4 toadjust for quarterly calculations). We will record any distributions on the Class Blimited partner interests as an incentive distribution expense in the periodwhen earned and when payment of such amounts has become probable and reasonablyestimable in accordance with the partnership agreement. These cashdistributions will reduce the amount of cash available for distribution to ourcommon unitholders in our Operating Partnership and to common stockholders. Weincurred approximately $1,193 with respect to such Class B limited partnerinterests for the three months ended March 31, 2006 and none for the threemonths ended March 31, 2005.

#### **DerivativeInstruments**

**In thenormal course of business, we use a variety of derivative instruments tomanage, or hedge, interest rate risk. We require that hedging derivativeinstruments be effective in reducing the interest rate risk exposure that theyare designated to hedge. This effectiveness is essential for qualifying forhedge accounting. Some derivative instruments are associated with ananticipated transaction. In those cases, hedge effectiveness criteria alsorequire that it be probable that the underlying transaction occurs. Instrumentsthat meet these hedging criteria are formally designated as hedges at theinception of the derivative contract.**

**Todetermine the fair value of derivative instruments, we use a variety of methodsand assumptions that are based on market conditions and risks existing at eachbalance sheet date. For the majority of financial instruments including mostderivatives, long-term investments and long-term debt, standard marketconventions and techniques such as discounted cash flow analysis,option-pricing models, replacement cost, and termination cost are used todetermine fair value. All methods of assessing fair value result in a generalapproximation of value, and such value may never actually be realized.**

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In the normalcourse of business, we are exposed to the effect of interest rate changes andlimit these risks by following established risk management policies andprocedures including the use of derivatives. To address exposure to interestrates, we use derivatives primarily to hedge the mark-to-market risk of ourliabilities with respect to certain of our assets. We may also use derivativesto hedge variability in sales proceeds to be received upon the sale of loansheld for sale.

We use a varietyof commonly used derivative products that are considered plain vanilladerivatives. These derivatives typically include interest rate swaps, caps,collars and floors. We also use total rate of return swaps, or TROR swaps,which are tied to the Lehman Brothers CMBS index. We expressly prohibit the useof unconventional derivative instruments and using derivative instruments fortrading or speculative purposes. Further, we have a policy of only enteringinto contracts with major financial institutions based upon their creditratings and other factors.

**FASB No. 133, or SFAS 133, “Accountingfor Derivative Instruments and Hedging Activities,” as amended by FASB No. 149,requires us to recognize all derivatives on the balance sheet at fair value. Derivativesthat are not hedges must be adjusted to fair value through income. If aderivative is a hedge, depending on the nature of the hedge, changes in thefair value of the derivative will either be offset against the change in fairvalue of the hedged asset, liability, or firm commitment through earnings, orrecognized in other comprehensive income until the hedged item is recognized inearnings. The ineffective portion of a derivative’s change in fair value willbe immediately recognized in earnings. SFAS 133 may increase or decreasereported net income and stockholders’ equity prospectively, depending on futurelevels of LIBOR, swap spreads and other variables affecting the fair values ofderivative instruments and hedged items, but will have no effect on cash flows,provided the contract is carried through to full term.**

We may employswaps, forwards or purchased options to hedge qualifying forecastedtransactions. Gains and losses related to these transactions are deferred andrecognized in net income as interest expense in the same period or periods thatthe underlying transaction occurs, expires or is otherwise terminated.

All hedges held byus are deemed to be effective in meeting the hedging objectives established byour corporate policy governing interest rate risk management. The effect of ourderivative instruments on our financial statements is discussed more fully inNote 17.

# **Income Taxes**

We elected to betaxed as a REIT, under Sections 856 through 860 of the Internal Revenue Code,beginning with our taxable year ended December 31, 2004. To qualify as aREIT, we must meet certain organizational and operational requirements,including a requirement to distribute at least 90% of our ordinary taxableincome to stockholders. As a REIT, we generally will not be subject to federalincome tax on taxable income that we distribute to our stockholders. If we failto qualify as a REIT in any taxable year, we will then be subject to federalincome taxes on our taxable income at regular corporate rates and we will notbe permitted to qualify for treatment as a REIT for federal income tax purposesfor four years following the year during which qualification is lost unless theInternal Revenue Service grants us relief under certain statutory provisions. Suchan event could materially adversely affect our net income and net cashavailable for distributions to stockholders. However, we believe that we willbe organized and operate in such a manner as to qualify for treatment as a REITand we intend to operate in the foreseeable future in such a manner so that wewill qualify as a REIT for federal income tax purposes. We may, however, besubject to certain state and local taxes.

Our taxable REITsubsidiaries, individually referred to as a TRS, are subject to federal, stateand local taxes.

**Underwriting Commissions and Costs**

**Underwriting commissions and costs incurred inconnection with our stock offerings are reflected as a reduction of additionalpaid-in-capital.**

**EarningsPer Share**

Wepresent both basic and diluted earnings per share, or EPS. Basic EPS excludesdilution and is computed by dividing net income available to commonstockholders by the weighted average number of common shares outstanding duringthe period. Diluted EPS reflects the potential dilution that could occur ifsecurities or other contracts to issue common stock were exercised or convertedinto common stock, where such exercise or conversion would result in a lowerEPS amount.

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**Use of Estimates**

The preparation of financialstatements in conformity with GAAP requires management to make estimates andassumptions that affect the amounts reported in the financial statements andaccompanying notes. Actual results could differ from those estimates.

**Concentrationsof Credit Risk**

**Financialinstruments that potentially subject us to concentrations of credit riskconsist primarily of cash investments, debt investments and accounts receivable.Gramercy places its cash investments in excess of insured amounts with highquality financial institutions. Our Manager performs ongoing analysis of creditrisk concentrations in our debt investment portfolio by evaluating exposure tovarious markets, underlying property types, investment structure, term,sponsors, tenants and other credit metrics. Four investments accounted for morethan 22% of the total carrying value of our debt investments as of March 31,2006 compared to two investments which accounted for more than 24% of the totalcarrying value of our debt investments as of March 31, 2005. Fiveinvestments accounted for approximately 22% of the revenue earned on our debtinvestments for the three months ended March 31, 2006 compared to twoinvestments which accounted for approximately 31% of the revenue earned on ourdebt investments for the three months ended March 31, 2005.**

**Recently Issued AccountingPronouncements**

**Statement of Financial AccountingStandard No. 123(R), or SFAS No. 123(R) “Share-Based Payment, arevision of FASB Statement No. 123, Accounting for Stock-BasedCompensation,” requires all share-based payments to employees, including grantsof employee stock options, to be recognized in the income statement based ontheir fair value. The new standard is effective for interim or annual reportingperiods beginning after January 1, 2006. The implementation of SFAS No. 123(R) didnot have a material effect on our financial position or results of operationsfor the three months ended March 31, 2006.**

**In June 2005, the FASBratified the consensus in EITF Issue No. 04-5, or Issue 04-5,Determining Whether a General Partner, or the General Partners as a Group,Controls a Limited Partnership or Similar Entity When the Limited Partners HaveCertain Rights, which provides guidance in determining whether a generalpartner controls a limited partnership. Issue 04-5 states that thegeneral partner in a limited partnership is presumed to control that limitedpartnership. The presumption may be overcome if the limited partners haveeither (1) the substantive ability to dissolve the limited partnership orotherwise remove the general partner without cause or (2) substantiveparticipating rights, which provide the limited partners with the ability toeffectively participate in significant decisions that would be expected to bemade in the ordinary course of the limited partnership’s business and thereby precludethe general partner from exercising unilateral control over the partnership. Ifthe criteria in Issue 04-5 are met, a company could be required toconsolidate certain of its existing unconsolidated joint ventures. Our adoptionof Issue 04-5 for new or modified limited partnership arrangementseffective June 30, 2005 and existing limited partnership arrangementseffective January 1, 2006 did not have a material effect on our financialposition or results of operations for the three months ended March 31,2006.**

**In February 2006, the FASBissued Statement of Financial Accounting Standard No. 155, or SFAS No. 155,“Accounting for Certain Hybrid Financial Instruments — an amendment of FASBStatements No. 133 and 140”. SFAS No. 155 (1) permits fair valuere-measurement for any hybrid financial instrument that contains an embeddedderivative that would otherwise require bifurcation, (2) clarifies whichinterest-only strips and principal-only strips are not subject to therequirements of FASB Statement No. 133, (3) establishes a requirementto evaluate interests in securitized financial assets to identify intereststhat are freestanding derivatives or that are hybrid financial instruments thatcontain an imbedded derivative requiring bifurcation, (4) clarifies thatconcentrations of credit risk in the form of subordination are not embeddedderivatives, and (5) amends FASB Statement No. 140 to eliminate theprohibition on a qualifying special-purpose entity from holding a derivativefinancial instrument that pertains to a beneficial interest in other thananother derivative financial instrument. SFAS No. 155 is effective January 1,2007 and we are currently evaluating the effect, if any, that thispronouncement will have on our future financial results.**

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**3.   Loans andOther Lending Investments**

**The aggregate carrying values, allocated by producttype and weighted average coupons of our loans and other lending investments asof March 31, 2006 and December 31, 2005 were as follows:**
| ** **                                          | ** ** | **Carrying Value (1)   ($ in thousands)** | ** ** | **Allocation by  Investment Type** | ** ** | **Fixed Rate:  Average Yield** | ** ** | **Floating Rate:  Average Spread  over LIBOR (2)** | ** ** |
|-----------------------------------------------------|------------|--------------------------------------------------------------------|------------|----------------------------------------------|------------|------------------------------------------|------------|------------------------------------------------------------------------|------------|
| ** **                                          | ** ** | **2006**                                                           | ** ** | **2005**                                     | ** ** | **2006**                                 | ** ** | **2005**                                                               | ** ** | **2006** | ** ** | **2005** | ** ** | **2006** | ** ** | **2005** | ** ** |
| Whole loans, floating rate                          |       | $                                                                  | 775,307    |                                         | $          | 561,388                                  |       | 50                                                                     | %          | 46 | % | — |   | — |   | 310 bps |   | 325 bps |   |
| Whole loans, fixed rate                             |       | 112,192                                                            |       | 94,448                                       |       | 7                                        | %          | 8                                                                      | %          | 9.46 | % | 10.64 | % | — |   | — |   |
| Subordinate interests in whole loans, floating rate |       | 391,167                                                            |       | 362,983                                      |       | 25                                       | %          | 30                                                                     | %          | — |   | — |   | 385 bps |   | 443 bps |   |
| Subordinate interests in whole loans, fixed rate    |       | 47,888                                                             |       | 37,104                                       |       | 3                                        | %          | 3                                                                      | %          | 9.55 | % | 9.19 | % | — |   | — |   |
| Mezzanine loans, floating rate                      |       | 150,057                                                            |       | 82,793                                       |       | 10                                       | %          | 7                                                                      | %          | — |   | — |   | 815 bps |   | 858 bps |   |
| Mezzanine loans, fixed rate                         |       | 43,319                                                             |       | 43,352                                       |       | 3                                        | %          | 4                                                                      | %          | 8.88 | % | 8.88 | % | — |   | — |   |
| Preferred equity, floating rate                     |       | 11,822                                                             |       | 11,795                                       |       | 1                                        | %          | 1                                                                      | %          | — |   | — |   | 900 bps |   | 900 bps |   |
| Preferred equity, fixed rate                        |       | 11,891                                                             |       | 11,882                                       |       | 1                                        | %          | 1                                                                      | %          | 10.28 | % | 10.28 | % | — |   | — |   |
| Commercial mortgage backed securities          |       | —                                                             |       | —                                       |       | —                                   |       | —                                                                 |       | — |   | — |   | — |   | — |   |
| Total / Average                                     |       | $                                                                  | 1,543,643  |                                         | $          | 1,205,745                                |       | 100                                                                    | %          | 100 | % | 9.41 | % | 9.92 | % | 394 bps |   | 417 bps |   |

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(1)             Debtinvestments are presented after scheduled amortization payments andprepayments, and are net of unamortized fees, discounts, asset sales andunfunded commitments.

(2)             Spreadsover an index other than LIBOR have been adjusted to a LIBOR based equivalent.

As of March 31,2006, our investment portfolio had the following maturity characteristics:

| Year of Maturity     | ** ** | **Number of  Investments  Maturing** | ** ** | **Current  Carrying Value  (In thousands)** | ** ** | **% of Total** | ** ** |
|--------------------------------|------------|-------------------------------------------|------------|-------------------------------------------------------|------------|--------------------------|------------|
| 2006                           |       | 7                                         |       | $                                                     | 150,630    |                     | 10         | % |
| 2007                           |       | 31                                        |       | 783,436                                               |       | 51                       | %          |
| 2008                           |       | 11                                        |       | 346,430                                               |       | 22                       | %          |
| 2009                           |       | 4                                         |       | 78,632                                                |       | 5                        | %          |
| 2010                           |       | 3                                         |       | 13,043                                                |       | 1                        | %          |
| Thereafter                     |       | 7                                         |       | 171,472                                               |       | 11                       | %          |
| Total                          |       | 63                                        |       | $                                                     | 1,543,643  |                     | 100        | % |
|                           |       |                                      |       |                                                  |       |                     |       |
| Weighted average  maturity (1) |       |                                      |       | 2.2 years                                             |       |                     |       |

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(1)             Thecalculation of weighted average maturity is based upon the initial term of theinvestment and does not include option or extension periods, which may beavailable to the borrower.

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For the three monthsended March 31, 2006 and 2005 the Company’s investment income from debtinvestments was generated by the following investment types:

 

|                                       | ** ** | **Three months ended  March 31, 2006** | ** ** | **Three months ended  March 31, 2005** | ** ** |
|---------------------------------------|------------|------------------------------------------------------------|------------|------------------------------------------------------------|------------|
| **Investment Type**              | ** ** | **Investment  Income**                                     | ** ** | **% of  Total**                                       | ** ** | **Investment  Income ** | ** ** | **% of  Total** | ** ** |
| Whole loans                           |       | $                                                          | 17,360     |                                                       | 55         | % | $ | 2,992 |   | 29 | % |
| Subordinate  interests in whole loans |       | 9,181                                                      |       | 29                                                         | %          | 5,643 |   | 55 | % |
| Mezzanine loans                       |       | 4,595                                                      |       | 14                                                         | %          | 948 |   | 9 | % |
| Preferred equity                      |       | 743                                                        |       | 2                                                          | %          | 306 |   | 3 | % |
| CMBS                                  |       | —                                                     |       | —                                                     |       | 361 |   | 4 | % |
| Total                                 |       | $                                                          | 31,879     |                                                       | 100        | % | $ | 10,250 |   | 100 | % |

 

At March 31, 2006and December 31, 2005, our debt investment portfolio had the followinggeographic diversification:

 

|            | ** ** | **2006**            | ** ** | **2005**             | ** ** |
|------------|------------|---------------------|------------|----------------------|------------|
| **Region** | ** ** | **Carrying  Value** | ** ** | **% of  Total** | ** ** | **Carrying  Value** | ** ** | **% of  Total** | ** ** |
| Northeast  |       | $                   | 791,271    |                 | 51         | % | $ | 464,054 |   | 39 | % |
| West       |       | 342,057             |       | 22                   | %          | 378,040 |   | 31 | % |
| South      |       | 297,371             |       | 19                   | %          | 258,511 |   | 21 | % |
| Midwest    |       | 85,551              |       | 6                    | %          | 74,949 |   | 6 | % |
| Various    |       | 27,393              |       | 2                    | %          | 30,191 |   | 3 | % |
| Total      |       | $                   | 1,543,643  |                 | 100        | % | $ | 1,205,745 |   | 100 | % |

** **

In connection witha preferred equity investment we have guaranteed a portion of the outstandingprincipal balance of the first mortgage loan that is a financial obligation ofthe entity in which we have invested in the event of a borrower default undersuch loan. The loan matures in 2032. This guarantee is considered to be anoff-balance-sheet arrangement. As compensation, we received a creditenhancement fee of $125 from the borrower, which is recognized as the fairvalue of the guarantee and has been recorded on our balance sheet as aliability. The liability will be amortized over the life of the guarantee usingthe straight-line method and corresponding fee income will be recorded. Ourmaximum exposure under this guarantee is approximately $1,452 as of March 31,2006. Under the terms of the guarantee, the investment sponsor is required toreimburse us for the entire amount paid under the guarantee until the guaranteeexpires.

**4. Investments inUnconsolidated Joint Ventures**

***South Buildingat One Madison Avenue, New York, New York***

**On April 29, 2005, we closedon a $57,503 initial investment in a joint venture with SL Green to acquire,own and operate the South Building located at One Madison Avenue, New York, NewYork, or the Property. The joint venture is owned 45% by our wholly-ownedsubsidiary and 55% by a wholly-owned subsidiary of SL Green. The joint ventureinterests are *pari passu*. Also onApril 29, 2005, the joint venture completed the acquisition of theProperty from Metropolitan Life Insurance Company for the purchase price ofapproximately $802,800 plus closing costs, financed in part through a $690,000first mortgage loan on the Property. The first mortgage is non-recourse to us. TheProperty comprises approximately 1.2 million square feet and is almost entirelynet leased to Credit Suisse Securities (USA) LLC, or CS, pursuant to a leasewith a 15-year remaining term. As of March 31, 2006 the investmenthas a carrying value of $56,491. For the three months ended March 31, 2006,we recorded our pro rata share of net losses of the joint venture of $400.**

***101 S. MarengoAvenue, Pasadena, California***

**On November 29, 2005, weclosed on the purchase of a 50% interest in an office building in Pasadena, CA.We also acquired an interest in certain related assets as part of thetransaction. The three hundred forty-five thousand square foot office property,which is net leased to Bank of America through September 2015, assumingthe exercise of options, and related collateral were acquired for $52,000 plusclosing**

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**costs, using a non-recourse,$50,000, 10-year fixed-rate first mortgage loan. As of March 31,2006 the investment has a carrying value of $882. For the three months ended March 31,2006, we recorded our pro rata share of net losses of the joint ventures of$327.**

**5. Dispositionof Security Interest in Property**

***200 FranklinSquare Drive***

On September 6,2005, we closed on the acquisition of a 100% fee interest in 200 FranklinSquare Drive, located in Somerset, New Jersey. The property is a two hundredthousand square foot building which is 100% net leased to Philips Holding USAInc., a wholly-owned subsidiary of Royal Philips Electronics, through December 2021.The property was acquired for a purchase price of $50,250, excluding closingcosts, and financed with a $41,000, 10-year, fixed-rate first mortgageloan.

**On March 31, 2006, followingthe conversion of the entity that own 200 Franklin Square Drive into a Delawarestatutory trust, or DST, we sold approximately 29.3% of our security interestsin the DST to a third party. We received consideration of $5,000 in cash equityfor these interests and the buyer assumed 29.3% of the DST’s underlyingmortgage debt as of the purchase date. This disposition resulted in a net gainof $1,718, after transaction costs, which was recognized during the threemonths ended March 31, 2006. Minority interest of $5,000 has been recordedon our balance sheet to reflect interests in the DST no longer held by us.**

**6. JuniorSubordinated Debentures**

**On January 27, 2006, wecompleted a third issuance of $50,000 in unsecured trust preferred securitiesthrough a separate newly formed Delaware statutory trust, Gramercy CapitalTrust III, or GCTIII, that is a wholly-owned subsidiary of the OperatingPartnership. The securities bear interest at a fixed rate of 7.65% for thefirst ten years ending January 2016, with an effective rate of 7.43% whengiving effect to the swap arrangement previously entered into in contemplationof this financing. Thereafter the rate will float based on the three-monthLIBOR plus 270 basis points.**

**In May and August 2005,we completed issuances of $50,000 each in unsecured trust preferred securitiesthrough two Delaware statutory trusts, Gramercy Capital Trust I, or GCTI, andGramercy Capital Trust II, or GCTII, that are also wholly-owned subsidiaries ofthe Operating Partnership. The securities issued in May 2005 bear interestat a fixed rate of 7.57% for the first ten years ending June 2015 and thesecurities issued in August 2005 bear interest at a fixed rate of 7.75%for the first ten years ending October 2015. Thereafter the rates willfloat based on the three-month LIBOR plus 300 basis points.**

**All issuances of trust preferredsecurities require quarterly interest distributions; however, payments may bedeferred while the interest expense is accrued for a period of up to fourconsecutive quarters if the Operating Partnership exercises its right to defersuch payments. The trust preferred securities are redeemable, at the option ofthe Operating Partnership, in whole or in part, with no prepayment premium anytime after June 30, 2010, October 30, 2010 or January 30, 2011for the securities issued by GCTI, GCTII and GCTIII, respectively.**

**GCTI, GCTII and GCTIII eachissued $1,550 aggregate liquidation amount of common securities, representing100% of the voting common stock of those entities to the Operating Partnershipfor a total purchase price of $4,650. GCTI, GCTII and GCTIII used the proceedsfrom the sale of the trust preferred securities and the common securities topurchase the Operating Partnership’s junior subordinated notes. The terms ofthe junior subordinated notes match the terms of the trust preferred securities.The notes are subordinate and junior in right of payment to all present andfuture senior indebtedness and certain other of our financial obligations. Werealized net proceeds from each offering of approximately $48,956.**

Our interests in GCTI, GCTII and GCTIII areaccounted for using the equity method and the assets and liabilities of thoseentities are not consolidated into our financial statements. Interest on thejunior subordinated notes is included in interest expense on our consolidatedincome statements while the value of the junior subordinated notes, net of ourinvestment in the trusts that issued the securities, are presented as aseparate item in our consolidated balance sheet.

**7. Collateralized Debt Obligations**

During 2005 we issuedapproximately $1,000,000 of CDOs through two newly-formed indirectsubsidiaries, Gramercy Real Estate CDO 2005-1 Ltd., or the Issuer,and Gramercy Real Estate CDO 2005-1 LLC, or the Co-Issuer. The CDOconsists of $810,500 of investment grade notes, and $84,500 of non-investmentgrade notes, which were co-issued by the Issuer and the Co-Issuer, and $105,000of preferred shares, which were issued by the Issuer. We retained allnon-investment grade securities, the preferred shares and the common shares inthe Issuer. The Issuer holds assets, consisting primarily of whole loans,subordinate interests in whole loans, 

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mezzanine loans andpreferred equity investments, which serve as collateral for the CDO. Theinvestment grade notes were issued with floating rate coupons with a combinedweighted average rate of three-month LIBOR plus 0.49%. The CDO may bereplenished, pursuant to certain rating agency guidelines relating to creditquality and diversification, with substitute collateral for loans that arerepaid during the first five years of the CDO. Thereafter, the CDO securitieswill be retired in sequential order from senior-most to junior-most as loansare repaid. We incurred approximately $11,770 of issuance costs, which isamortized on a level- yield basis over the average life of the CDO. The Issueris consolidated in our financial statements. The investment grade notes aretreated as a secured financing, and are non-recourse to us. Proceeds from thesale of the investment grade notes issued were used to repay substantially alloutstanding debt under our repurchase agreements and to fund additionalinvestments.

**8.  Debt Obligations**

#### **Repurchaseand Credit Facilities**

**We have three facilities: onerepurchase facility and one credit facility with Wachovia Capital Markets, LLCor one or more of its affiliates, or Wachovia, and one repurchase facility withGoldman Sachs Mortgage Company, or Goldman.**

The first facilitywith Wachovia is a $500,000 repurchase facility. This facility was initiallyestablished at $250,000, was increased to $350,000 from $250,000 effective January 3,2005, and was subsequently increased to $500,000 effective April 22, 2005.As part of the April 2005 increase to $500,000, the initial term of thefacility was modified to reflect staggered maturities in which $250,000 maturesin August 2007, $150,000 matures in December 2007 and the remaining$100,000 matures in June 2008. On March 21, 2006 we further modifiedthe facility by reducing the interest spreads. As a result of themodifications, the $500,000 facility bears interest at spreads of 1.00% to2.50% over a 30-day LIBOR and, based on our expected investmentactivities, provides for advance rates that vary from 60% to 100% based uponthe collateral provided under a borrowing base calculation. The lender has aconsent right to the inclusion of investments in this facility, determinesperiodically the market value of the investments, and has the right to requireadditional collateral if the estimated market value of the included investmentsdeclines. We had no accrued interest and borrowings of $198,427 at a weightedaverage spread to LIBOR of 1.03% and $67,717 at a weighted average spread toLIBOR of 1.50% under this facility at March 31, 2006 and December 31,2005, respectively. We can utilize the $25,000 revolving credit facilitydescribed below to fund requirements for additional collateral pursuant to therepurchase facility or to fund the acquisition of assets.

Borrowings under the Wachovia facility at March 31, 2006 and December 31,2005 were secured by the following investments:

 

|                                       | ** ** | **Carrying Value (1)** | ** ** |
|---------------------------------------|------------|----------------------------------|------------|
| **Investment Type**              | ** ** | **2006**                         | ** ** | **2005** | ** ** |
| Whole loans                           |       | $                                | 134,946    |   | $ | 33,223 |   |
| Subordinate  interests in whole loans |       | 131,266                          |       | 74,689 |   |
| CDO securities(2)                     |       | 49,500                           |       | 49,500 |   |
| CMBS                                  |       | —                           |       | — |   |
| Total                                 |       | $                                | 315,712    |   | $ | 157,412 |   |

----

**(1)**             Approximates fair value.

**(2)**             Represents the BB ratedsecurities in our CDO that were retained by us.

The secondfacility with Wachovia is a $25,000 revolving credit facility with a term oftwo years. Amounts drawn under this facility for liquidity purposes bearinterest at a rate equal to a spread over LIBOR of 525 basis points. Amountsdrawn under this facility for acquisition purposes bear interest at a spreadover LIBOR of 225 basis points. Amounts drawn under this facility for liquiditypurposes must be repaid within 105 days. Amounts drawn under this facilitygenerally will be secured by assets established under a borrowing basecalculation unless certain financial covenants are satisfied. These covenantsare generally more restrictive than those set forth below. At March 31,2006 and 2005, we had no borrowings under this facility.

We have anadditional repurchase facility of $200,000 with Goldman. This facility has aninitial term of three years expiring in January 2008 with one six-monthextension option. On March 21, 2006, we modified this facility by reducingthe interest spreads. As a result of the modifications, the facility bearsinterest at spreads of 1.00% to 2.25% over a 30-day LIBOR and, based onour expected investment activities, provides for advance rates that vary from40% to 85% based upon the collateral provided under a borrowing base 

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calculation. Aswith the Wachovia facility, the lender has a consent right to the inclusion ofinvestments in this facility, determines periodically the market value of theinvestments, and has the right to require additional collateral if theestimated market value of the included investments declines. We had no accruedinterest and borrowings of $178,766 at a weighted average spread to LIBOR of1.43% and accrued interest of $163 and borrowings of $49,648 at a weightedaverage spread to LIBOR of 1.71% under this facility at March 31, 2006 andDecember 31, 2005, respectively.

Borrowings under the Goldman facility at March 31, 2006 and December 31,2005 were secured by the following investments:

 

|                          | ** ** | **Carrying Value (1)** | ** ** |
|--------------------------|------------|----------------------------------|------------|
| **Investment Type** | ** ** | **2006**                         | ** ** | **2005** | ** ** |
| Whole loans              |       | $                                | 265,458    |   | $ | 59,457 |   |
| Total                    |       | $                                | 265,458    |   | $ | 57,491 |   |

----

**(1)**                    Approximates fair value.

The terms of bothof our repurchase facilities and our credit facility include covenants that****(a) limit our maximum totalindebtedness to no more than 85% of total assets, (b) require us tomaintain minimum liquidity of at least $10,000 for the first two years and$15,000 thereafter, (c) requires our fixed charge coverage ratio to be atno time less than 1.50 to 1.00, (d) requires our minimum interest coverageratio to be at no time less than 1.75 to 1.00, (e) require us to maintainminimum tangible net worth of not less than the greater of (i) $129,750,or (i) plus (ii) 75% of the proceeds of our subsequent equityissuances and (f) restrict the maximum amount of our total indebtedness. Thecovenants also restrict us from making distributions in excess of a maximum of103% of our funds from operations (as defined by the National Association ofReal Estate Investment Trusts) through July 2005 and 100% thereafter,except that we may in any case pay distributions necessary to maintain our REITstatus. Under our facility withWachovia, an event of default will be triggered if GKK Manager LLC ceases to beour Manager. As of March 31, 2006 and December 31, 2005, we were incompliance with all such covenants.

The revolvingcredit facility and the repurchase facilities require that we pay downborrowings under these facilities as principal payments on the loans andinvestments pledged to these facilities are received.

In certaincircumstances, we have purchased debt investments from a counterparty andsubsequently financed the acquisition of those debt investments throughrepurchase agreements with the same counterparty. We currently record theacquisition of the debt investments as assets and the related repurchaseagreements as financing liabilities gross on the consolidated balance sheets.Interest income earned on the debt investments and interest expense incurred onthe repurchase obligations are reported gross on the consolidated incomestatements. However, under a certain technical interpretation of FAS 140, suchtransactions may not qualify as a purchase by us. We believe, and it isindustry practice, that we are accounting for these transactions in anappropriate manner. However, the result of this technical interpretation wouldprevent us from presenting the debt investments and repurchase agreements andthe related interest income and interest expense on a gross basis on ourfinancial statements. Instead, we would present the net investment in thesetransactions with the counterparty and a derivative with the correspondingchange in fair value of the derivative being recorded through earnings. Thevalue of the derivative would reflect changes in the value of the underlyingdebt investments and changes in the value of the underlying credit provided bythe counterparty.

#### **MortgageLoan**

We have oneconsolidated interest-only mortgage loan of $41,000 that bears interest at afixed rate of 4.90% and has a term of ten years, resulting in a balloon paymentin 2015. This mortgage was used to finance our initial acquisition of 200Franklin Square Drive for approximately $50,250, excluding closing costs, in September 2005.On March 31, 2006, following the conversion of the entity that owns 200Franklin Square Drive to a DST, we sold approximately 29.3% of our securityinterests in the DST to a third party, at which time the purchaser assumed aproportionate share of the underlying mortgage debt on the property.

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**Combined aggregate principal maturities of our consolidatedCDO, repurchase facilities, trust preferred securities, mortgage note payableand revolving credit facility as of March 31, 2006 are as follows:**

 
| ** ** | ** ** | **Collateralized  Debt  Obligations** | ** ** | **Repurchase  Facilities** | ** ** | **Trust  Preferred  Securities** | ** ** | **Mortgage  Note  Payable** | ** ** | **Revolving  Credit  Facility** | ** ** | **Total** | ** ** |
|------------|------------|---------------------------------------|------------|----------------------------|------------|----------------------------------|------------|-----------------------------|------------|---------------------------------|------------|-----------|------------|
| 2006       |       | $                                     | —     |                       | $          | —                           |       | $                           | —     |                            | $          | —    |       | $ | — |   | $ | — |   |
| 2007       |       | —                                |       | 198,427                    |       | —                           |       | —                      |       | —                          |       | 198,427   |       |
| 2008       |       | —                                |       | 178,766                    |       | —                           |       | —                      |       | —                          |       | 178,766   |       |
| 2009       |       | —                                |       | —                     |       | —                           |       | —                      |       | —                          |       | —    |       |
| 2010       |       | —                                |       | —                     |       | —                           |       | —                      |       | —                          |       | —    |       |
| Thereafter |       | 810,500                               |       | —                     |       | 150,000                          |       | 41,000                      | (1)        | —                          |       | 1,001,500 |       |
| Total      |       | $                                     | 810,500    |                       | $          | 377,193                          |       | $                           | 150,000    |                            | $          | 41,000    |       | — |   | $ | 1,378,693 |   |
|            |            |                                       |            |                            |            |                                  |            |                             |            |                                 |            |           |            |  |  |  |  |  |  |

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(1) Wehave a 70.7% interest in the entity that is the obligor under the mortgagenote.

**9.**Operating Partnership Agreement / Manager

At March 31,2006, we owned all of the Class A limited partnership interests in ourOperating Partnership. At March 31, 2006, the majority of the Class Blimited partnership interests were owned by our Manager and SL Green OperatingPartnership, L.P. Interests were also held by certain officers and employees ofSL Green Realty Corp., including some of whom are among our executive officers,which interests are subject to performance thresholds.

At March 31, 2006,the majority of the interests in our Manager were held by SL Green OperatingPartnership, L.P. Interests were also held by certain officers and employees ofSL Green Realty Corp., including some of whom are among our executive officers,which interests are subject to performance thresholds.

**10.  Related Party Transactions**

In connection with our initial public offering, we entered into amanagement agreement with our Manager, which was subsequently amended andrestated in April 2006. The amended and restated agreement provides for aterm through December 2009 with automatic one-year extension options andis subject to certain termination rights. We pay our Manager an annualmanagement fee equal to 1.75% of our gross stockholders equity (as defined inthe amended and restated management agreement) inclusive of our trust preferredsecurities. We incurred expense to our Manager under this agreement of anaggregate of approximately $2,236 and $1,204 for the three months ended March 31,2006 and 2005, respectively.

To provide an incentivefor our Manager to enhance the value of the common stock, the holders of the Class Blimited partner interests of the Operating Partnership are entitled to anincentive return equal to 25% of the amount by which funds from operations (asdefined in the partnership agreement of the Operating Partnership which wasamended and restated in April 2006) plus certain accounting gains exceedthe product of our weighted average stockholders equity (as defined in the amendedand restated partnership agreement of the Operating Partnership) multiplied by9.5% (divided by 4 to adjust for quarterly calculations). We will record anydistributions on the Class B limited partner interests as an incentivedistribution expense in the period when earned and when payments of suchamounts have become probable and reasonably estimable in accordance with thepartnership agreement. We incurred approximately $1,193 of incentivedistribution expense for the three months ended March 31, 2006 and nonefor 2005.

We are obligatedto reimburse our Manager for its costs incurred under an asset servicingagreement between our Manager and an affiliate of SL Green OperatingPartnership, L.P. and a separate outsourcing agreement between our Manager andSL Green Operating Partnership, L.P. The asset servicing agreement, which wasamended and restated in April 2006, provides for an annual fee payable toSL Green Operating Partnership, L.P. by us of 0.05% of the book value of allcredit tenant lease assets and non-investment grade bonds and 0.15% of the bookvalue of all other assets. The asset servicing fee may be reduced by SL GreenOperating Partnership, L.P. for fees paid directly to outside servicers by us. Theoutsourcing agreement currently provides for a fee payable by us of $1,288 peryear, increasing 3% annually over the prior year. For the three months ended March 31,2006 and 2005, we realized expense of 

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$322 and $313,respectively, to our Manager under the outsourcing agreement. For the threemonths ended March 31, 2006 and 2005, we realized expense of $460 and$151, respectively, to our Manager under the asset servicing agreement.

In connection withthe closing of our CDO in July 2005, the Issuer entered into a collateralmanagement agreement with our Manager. Pursuant to the collateral managementagreement, our Manager has agreed to provide certain advisory andadministrative services in relation to the collateral debt securities and othereligible investments securing the CDO notes. The collateral managementagreement provides for a senior collateral management fee, payable quarterly inaccordance with the priority of payments as set forth in the indenture, equalto 0.15% per annum of the net outstanding portfolio balance, and an additionalsubordinate collateral management fee, payable quarterly in accordance with thepriority of payments as set forth in the indenture, equal to 0.25% per annum ofthe net outstanding portfolio balance. Net outstanding portfolio balance is thesum of the (i) aggregate principal balance of the collateral debtsecurities, excluding defaulted securities, (ii) aggregate principalbalance of all principal proceeds held as cash and eligible investments incertain accounts, and (iii) with respect to the defaulted securities, thecalculation amount of such defaulted securities. As compensation for theperformance of its obligations as collateral manager, our Board of Directorshas allocated to our Manager the portion of the subordinate collateralmanagement fee paid on securities not held by us. The senior collateral management fee andbalance of the subordinate collateral management fee is allocated to us. Forthe three months ended March 31, 2006 we realized expense of $500 to ourManager under the collateral management agreement.

**The amended and restatedmanagement agreement provides that in connection with formations of futurecollateralized debt obligations or other securitization vehicles, if acollateral manager is retained, our Manager or an affiliate will be thecollateral manager and will receive the following fees:  (i) 0.25%per annum of the book value of the assets owned for transitional “managed”CDOs, (ii) 0.15% per annum of the book value of the assets owned fornon-transitional “managed” CDOs, (iii) 0.10% per annum of the book valueof the assets owned for static CDOs that own primarily non-investment gradebonds, and (iv) 0.05% per annum of the book value of the assets owned forstatic CDOs that own primarily investment grade bonds; limited in each instanceby the fees that are paid to the collateral manager. The balance of the feespaid by the CDO for collateral management services are paid to us.**

In connection withthe 5,500,000 shares of common stock that were sold on December 3, 2004and settled on December 31, 2004 and January 3, 2005 in a privateplacement, we agreed to pay our Manager a fee of $1,000 as compensation forfinancial advisory, structuring and costs incurred on our behalf.  This fee was recorded as a reduction in theproceeds of the private placement. Apart from legal fees and stock clearingcharges totaling $245, no other fees were paid by us to an investment bank,broker/dealer or other financial advisor in connection with the privateplacement, resulting in total costs of 1.3% of total gross proceeds.

**On April 29, 2005, we closedon a $57,503 initial investment in a joint venture with SL Green to acquire,own and operate the South Building located at One Madison Avenue, New York, NewYork, or the Property. The joint venture, which was created to acquire, own andoperate the Property, is owned 45% by a wholly-owned subsidiary of us and 55%by a wholly-owned subsidiary of SL Green. The joint venture interests are *pari passu*. Also on April 29, 2005,the joint venture completed the acquisition of the Property from MetropolitanLife Insurance Company for the purchase price of approximately $802,800 plusclosing costs, financed in part through a $690,000 first mortgage loan on theProperty. The Property comprises approximately 1.2 million square feet and isalmost entirely net leased to CS pursuant to a lease with a 15-yearremaining term.**

Commencing May 1, 2005 we are party to a leaseagreement with SLG Graybar Sublease LLC, an affiliate of SL Green, for ourcorporate offices at 420 Lexington Avenue, New York, New York. The lease is forapproximately five thousand square feet with an option to lease an additionalapproximately two thousand square feet and carries a term of ten years withrents on the entire seven thousand square feet of approximately $249 per annumfor year one rising to $315 per annum in year ten. For the three months ended March 31,2006 we paid $62 under this lease.

**BrightStar Couriers LLC, or Bright Star, provides messenger services to us. BrightStar is owned by Gary Green, a son of Stephen L. Green, our Chairman. Theaggregate amount of fees paid by us for such services for the three monthsended March 31, 2006 and 2005 was less than $1.**

**SL GreenOperating Partnership, L.P. has invested $75,000 and $6,100 in preferred equityinterests that are subordinate to two of our investments with book values of$26,818 and $6,443, respectively, as of March 31, 2006 and $29,026 and$6,441, respectively, as of December 31, 2005.**

 

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**On July 14,2005, we closed on the purchase from an SL Green affiliate of a $40,000mezzanine loan which bears interest at 11.20%. As part of that sale, the sellerretained an interest-only participation. We have determined that the yield onour mezzanine loan after giving effect to the interest-only participationretained by the seller is at market. The mezzanine loan is secured by theequity interests in an office property in New York, New York.**

**On February 27,2006, we closed on the purchase of a $90,000 whole loan, which bears interestat 30-day LIBOR plus 2.15%, to a joint venture in which SL Green is anequity holder. The loan is secured by an office building in Bridgewater, NewJersey.**

**On March 17,2006, we closed on the purchase of a $25,000 mezzanine loan, which bearsinterest at 30-day LIBOR plus 8.00%, to a joint venture in which SL Greenis an equity holder. The loan is secured by office and industrial properties innorthern New Jersey.**

**During the three months ended March 31, 2006,we earned fees of $162,500 from SL Green representing SL Green’s proportionateshare of fees for financing and structural advisory services related to aspecific potential transaction.**

**11. Deferred Costs**

Deferred costs at March 31, 2006 and December 31,2005 consisted of the following:

|                                | ** ** | **March 31,  2006** | ** ** | **December 31,  2005** | ** ** |
|--------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| Deferred  financing            |       | $                        | 21,817     |                        | $          | 20,553 |   |
| Deferred  acquisition          |       | 3,115                    |       | 2,210                       |       |
|                           |       | 24,932                   |       | 22,763                      |       |
| Less accumulated  amortization |       | (4,544                   | )          | (3,381                      | )          |
|                           |       | $                        | 20,388     |                        | $          | 19,382 |   |

 

Deferred financing costs relate to our existing repurchase and creditfacilities with Wachovia and Goldman, our CDO, the trust preferred securitiesand our mortgage note. These costs are amortized on a straight-line basis tointerest expense based on the remaining term of the related financing.

 

Deferred acquisition costs consist of fees and direct costs incurred tooriginate our investments and are amortized using the effective yieldmethod over the related term of the investment.

**12. Fair Value of Financial Instruments**

The following discussion of fairvalue was determined by our Manager, using available market information andappropriate valuation methodologies. Considerable judgment is necessary tointerpret market data and develop estimated fair value. Accordingly, fairvalues are not necessarily indicative of the amounts we could realize ondisposition of the financial instruments. The use of different marketassumptions and/or estimation methodologies may have a material effect onestimated fair value amounts.

Cash equivalents, accruedinterest, and accounts payable balances reasonably approximate their fairvalues due to the short maturities of these items. The carrying value of ourCDO, repurchase and credit facilities approximate fair value because they bearinterest at floating rates, which we believe, for facilities with a similarrisk profile, reasonably approximate market rates. Our junior subordinateddebentures reasonably approximate fair value based upon the amount at whichsimilarly issued instruments have been valued. Our fixed rate mortgage payableis carried at its unpaid principal balance, which approximates fair value dueto the short period of time the note has been outstanding. Loans and commercialmortgage backed securities are carried at amounts, which reasonably approximatetheir fair value as determined by our Manager. The fair value of our fixed-ratedebt investments as determined by our Manager in consultation with marketdealers of such instruments as of March 31, 2006 were determined to becarried at their fair value.

Disclosure about fair value offinancial instruments is based on pertinent information available to us at March 31,2006. Although we are not aware of any factors that would significantly affectthe reasonable fair value amounts, such amounts have not been

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comprehensively revalued forpurposes of these financial statements since that date and current estimates offair value may differ significantly from the amounts presented herein.

**13. Stockholders’ Equity**

**Common Stock**

Our authorized capital stockconsists of 125,000,000 shares, $0.001 par value, of which we have authorizedthe issuance of up to 100,000,000 shares of common stock, $0.001 par value pershare, and 25,000,000 shares of preferred stock, par value $0.001 per share.

As of the date of our formation,April 12, 2004, we had 500,000 shares of common stock outstanding valuedat approximately $200. On August 2, 2004 we completed our initial publicoffering of 12,500,000 shares of common stock resulting in net proceeds ofapproximately $172,900, which was used to fund investments and commence ouroperations. As of March 31, 2006, 350,000 restricted shares had also beenissued under our 2004 Equity Incentive Plan, or the Equity Incentive Plan. Theseshares have a vesting period of three to four years and are not entitled toreceive distributions declared by us on our common stock until such time as theshares have vested, or the shares have been designated to receive dividends bythe Compensation Committee of our Board of Directors.

On December 3, 2004, wesold 5,500,000 shares of common stock, at a price of $17.27 per share,resulting in net proceeds of approximately $93,740 under a private placementexemption from the registration requirements of Section 5 of the SecuritiesAct of 1933, as amended. A total of 4,225,000 shares were sold to variousinstitutional investors and an additional 1,275,000 shares were sold to SLGreen Operating Partnership, L.P. pursuant to its contractual right to chooseto maintain a 25% ownership interest in the outstanding shares of our commonstock. Of the 5,500,000 shares sold, 2,000,000 shares were settled on December 31,2004 and the remaining 3,500,000 shares were settled on January 3, 2005.

On September 14, 2005, wesold 3,833,333 shares of common stock, at a price of $25.80 per share,resulting in net proceeds of approximately $97,830. A total of 2,875,000 shareswere sold through public offering and an additional 958,333 shares were sold toSL Green Operating Partnership, L.P. pursuant to its contractual right tochoose to maintain a 25% ownership interest in our outstanding shares of commonstock. After this offering, SL Green Operating Partnership, L.P. owned5,668,333 shares of our common stock. Net proceeds were used for acquisitions,repayment of outstanding principal under one of our repurchase facilities andgeneral corporate purposes.

In August 2005 our $350,000shelf registration statement was declared effective by the Securities andExchange Commission, or SEC. This registration statement provides us with theability to issue common and preferred stock, depository shares and warrants. Wecurrently have $251,100 available under the shelf.

As of March 31, 2006,22,817,642 shares of common stock and no shares of preferred stock were issuedand outstanding.

**EquityIncentive Plan**

Aspart of our initial public offering, we instituted our Equity Incentive Plan. TheEquity Incentive Plan, as amended, authorizes (i) the grant of stockoptions that qualify as incentive stock options under Section 422 of theInternal Revenue Code of 1986, as amended, or ISOs, (ii) the grant ofstock options that do not qualify, or NQSOs, (iii) the grant of stockoptions in lieu of cash directors’ fees and (iv) grants of shares ofrestricted and unrestricted common stock. The exercise price of stock optionswill be determined by the compensation committee, but may not be less than 100%of the fair market value of the shares of common stock on the date of grant. AtMarch 31, 2006, approximately 901,432 shares of common stock wereavailable for issuance under the Equity Incentive Plan.

Managementand outsourcing fees paid to our Manager and SL Green Operating Partnership,L.P. are sufficient to reimburse our Manager and SL Green OperatingPartnership, L.P. for the applicable compensation, including payroll taxes, ofthe employees who provide services to Gramercy pursuant to the confirmatoryaddendum to the Management Agreement between Gramercy, our Manager and theOperating Partnership. These awardees are considered co-leased employees. Optionsgranted under the Equity Incentive Plan to recipients who are co-leasedemployees of Gramercy are exercisable at the fair market value on the date ofgrant and, subject to termination of employment, expire ten years from the dateof grant, are not transferable other than on death, and are exercisable in

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threeto four annual installments commencing one year from the date of grant. In someinstances, options may be granted under the Equity Incentive Plan to personswho provide significant services to us or our affiliates, but are notconsidered co-leased employees because compensation for their services is notcovered by our management agreement or outsourcing agreement. Options grantedto recipients that are not co-leased employees have the same terms as thoseissued to co-leased employees except as it relates to any performance-basedprovisions within the grant. To the extent there are performance provisionsassociated with a grant to a recipient who is not a co-leased employee, anestimated expense related to these options is recognized over the vestingperiod and the final expense is reconciled at the point performance has beenmet, or the measurement date. If no performance based provision exists, thefair value of the options is calculated on a quarterly basis and the relatedexpense is recognized over the vesting period.

Asummary of the status of our stock options as of March 31, 2006 and December 31,2005 are presented below:

|                               | ** ** | **March 31, 2006**  | ** ** | **December 31, 2005**             | ** ** |
|-------------------------------|------------|--------------------------|------------|----------------------------------------|------------|
| ** **                    | ** ** | **Options  Outstanding** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Options  Outstanding** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
| Balance at  beginning of year |       | 733,584                  |       | $16.47                                 |       | 640,500 |   | $15.05 |   |
| Granted                       |       | 174,500                  |       | $23.18                                 |       | 236,000 |   | $19.62 |   |
| Exercised                     |       | (3,000                   | )          | $15.00                                 |       | (131,249 | ) | $15.01 |   |
| Lapsed or  cancelled          |       | (9,000                   | )          | $16.24                                 |       | (11,667 | ) | $18.20 |   |
| Balance at end of  period     |       | 896,084                  |       | $17.79                                 |       | 733,584 |   | $16.47 |   |

 

All options were granted withina price range of $15.00 to $23.53. The remaining weighted average contractuallife of the options was 8.8 years. Compensation expense of $86 and $16 wasrecorded for the three months ended March 31, 2006 and 2005, respectively,related to the issuance of stock options.

Through March 31, 2006,350,000 restricted shares had been issued under the Equity Incentive Plan, ofwhich 31% have vested.  The unvestedshares are not currently entitled to receive distributions declared by us onour common stock until such time as the shares have vested. Unvested shares maybe entitled to receive dividends at the discretion of the CompensationCommittee of our Board of Directors. Holders of restricted shares areprohibited from selling such shares until they vest but are provided theability to vote such shares beginning on the date of grant. Compensationexpense of $356 and $627 was recorded for the three months ended March 31,2006 and 2005, respectively, related to the issuance of restricted shares.

**OutperformancePlan**

In June 2005, the compensation committee of our board of directorsapproved a long-term incentive compensation program, the 2005 OutperformancePlan. Participants in the 2005 Outperformance Plan, all of whom are co-leasedemployees, will share in a “performance pool” if our total return tostockholders for the period from June 1, 2005 through May 31, 2008exceeds a cumulative total return to stockholders of 30% during the measurementperiod over a base share price of $20.21 per share. The size of the pool willbe 10% of the outperformance amount in excess of the 30% benchmark, subject toa maximum limit equal to the lesser of 4% of our outstanding shares and unitsof limited partnership interest as of the end of the performance period, or1,200,000 shares. If our total return to stockholders from June 1, 2005 toany subsequent date exceeds 80% and remains at that level or higher for 30consecutive days, then a minimum performance pool will be established. In theevent the potential performance pool reaches the maximum dilution cap before May 31,2008 and remains at that level or higher for 30 consecutive days, theperformance period will end early and the pool will be formed on the last dayof such 30 day period. Each participant’s award under the 2005 OutperformancePlan is designated as a specified percentage of the aggregate performance poolto be allocated to such participant assuming the 30% benchmark is achieved. Individualawards under the 2005 Outperformance Plan will be made in the form ofpartnership units, or LTIP Units, that may ultimately become exchangeable forshares of our common stock or cash, at our election. Under the 2005Outperformance Plan, LTIP Units have been granted and additional LTIP Units maybe granted in the future prior to the determination of the performance pool;however, these LTIP Units will only vest upon satisfaction of performance andother thresholds, and will not be entitled to distributions until after theperformance pool, or minimum performance pool, is established. The 2005Outperformance Plan provides that if a pool is established, each participantwill also be entitled to the distributions that would have been paid on thenumber of LTIP Units earned, had they been issued at the beginning of theperformance period. Those distributions will be paid in the form of additionalLTIP

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Units. Once a performance pool has been established, the earned LTIPUnits will receive regular quarterly distributions on a per unit basis equal tothe dividends per share paid on our common stock, whether or not they arevested. Any LTIP Units that are not earned upon the establishment of theperformance pool will be automatically forfeited, and the LTIP Units that areearned will be subject to time-based vesting, with 50% of the LTIP Units earnedvesting in May 2009 and the balance vesting one year later based on continuedemployment with our Manager or SL Green.  We will record the expense of the restrictedstock award in accordance with FASB Statement No. 123(R). Compensationexpense of $293 was recorded for the three months ended March 31, 2006related to the 2005 Outperformance Plan.

**Deferred StockCompensation Plan for Directors**

Underour Independent Director’s Deferral Program, which commenced April 2005,our independent directors may elect to defer up to 100% of their annualretainer fee, chairman fees and meeting fees. Unless otherwise elected by aparticipant, fees deferred under the program shall be credited in the form ofphantom stock units. The phantom stock units are convertible into an equalnumber of shares of common stock upon such directors’ termination of servicefrom the Board of Directors or a change in control by us, as defined by theprogram. Phantom stock units are credited to each independent directorquarterly using the closing price of our common stock on the applicabledividend record date for the respective quarter. Each participating independentdirector who elects to receive fees in the form of phantom stock units has theoption to have their account credited for an equivalent amount of phantom stockunits based on the dividend rate for each quarter or have dividends paid incash.

As of March 31,2006 there were approximately 9,106 phantom stock units outstanding, of which3,106 units are vested.

**Earnings per Share**

Earnings per share for the threemonths ended March 31, 2006 and 2005 is computed as follows:

|                                             | ** ** | **Three Months ended March 31,** | ** ** |
|---------------------------------------------|------------|------------------------------------------------------|------------|
| **Numerator (Income)**                 | ** ** | **2006**                                             | ** ** | **2005** | ** ** |
| Basic Earnings:                             |       |                                                 |       |   |   |
| Net income available to common stockholders |       | $                                                    | 10,554     |   | $ | 4,566 |   |
| Effect of  dilutive securities              |       | —                                               |       | — |   |
| Diluted Earnings:                           |       |                                                 |       |   |   |
| Net income available to common stockholders |       | $                                                    | 10,554     |   | $ | 4,566 |   |
|                                        |       |                                                 |       |   |   |
| **Denominator (Weighted Average  Shares)**  |       |                                                 |       |   |   |
| Basic                                       |       |                                                 |       |   |   |
| Shares available to common stockholders     |       | 22,807                                               |       | 18,833 |   |
| Effect of Diluted  Securities:              |       |                                                 |       |   |   |
| Stock-based compensation plans              |       | 1,178                                                |       | 185 |   |
| Phantom stock units                         |       | 3                                                    |       | — |   |
| Diluted Shares                              |       | 23,988                                               |       | 19,018 |   |

 

**14. Benefit Plans**

**We do not maintain a defined benefit pension plan,post-retirement health and welfare plan, 401(k) plan or other benefitsplans as we do not have any employees. These benefits are provided to itsemployees by our Manager, a majority-owned subsidiary of SL Green.**

**15.**       Commitmentsand Contingencies

We and our Operating Partnership are not presently involvedin any material litigation nor, to our knowledge, is any material litigationthreatened against us or our investments, other than routine litigation arisingin the ordinary course of business. Management believes the costs, if any,incurred by us and our Operating Partnership related to litigation will not materiallyaffect our financial position, operating results or liquidity.

Our corporate offices at 420 Lexington Avenue, New York, NewYork are subject to an operating lease agreement with SLG Graybar Sublease LLC,an affiliate of SL Green, effective May 1, 2005. The lease is forapproximately five thousand square feet with an option

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to lease an additional approximately two thousand squarefeet and carries a term of ten years with rents on the entire seven thousandsquare feet of approximately $249 per annum for year one rising to $315 perannum in year ten.

The following is a schedule of future minimum lease paymentsunder our operating lease as of March 31, 2006.

|                               | ** ** | **Operating Lease** | ** ** |
|-------------------------------|------------|--------------------------|------------|
| 2006                          |       | $                        | 190        |   |
| 2007                          |       | 256                      |       |
| 2008                          |       | 261                      |       |
| 2009                          |       | 265                      |       |
| 2010                          |       | 283                      |       |
| Thereafter                    |       | 1,351                    |       |
| Total minimum  lease payments |       | $                        | 2,606      |   |

 

**16.**        Financial Instruments: Derivatives andHedging

FASB No. 133, or SFAS 133, “Accounting for Derivative Instrumentsand Hedging Activities,” which became effective January 1, 2001, requiresGramercy to recognize all derivatives on the balance sheet at fair value. Derivativesthat are not hedges must be adjusted to fair value through income. If aderivative is a hedge, depending on the nature of the hedge, changes in thefair value of the derivative will either be offset against the change in fairvalue of the hedged asset, liability, or firm commitment through earnings, orrecognized in other comprehensive income until the hedged item is recognized inearnings. The ineffective portion of a derivative’s change in fair value willbe immediately recognized in earnings. SFAS 133 may increase or decreasereported net income and stockholders’ equity prospectively, depending on futurelevels of LIBOR interest rates and other variables affecting the fair values ofderivative instruments and hedged items, but will have no effect on cash flows,provided the contract is carried through to full term.

 

The following table summarizes the notional and fair value of ourderivative financial instrument at March 31, 2006. All derivativeinstruments have been designated as cash flow hedges. The notional value is anindication of the extent of our involvement in this instrument at that time,but does not represent exposure to credit, interest rate or market risks:

 
| ** **         | ** ** | **Benchmark Rate** | ** ** | **Notional  Value** | ** ** | **Strike  Rate** | ** ** | **Effective  Date** | ** ** | **Expiration  Date** | ** ** | **Fair  Value** | ** ** |
|--------------------|------------|-------------------------|------------|---------------------|------------|------------------|------------|---------------------|------------|----------------------|------------|-----------------|------------|
| Interest Rate Swap |       | 3 month LIBOR           |       | $                   | 40,000     |             | 4.420      | %                   | 7/2005     |                 | 2/2014     |            | $          | 1,933 |   |
| Interest Rate Swap |       | 1 month LIBOR           |       | 3,465               |       | 4.280            | %          | 7/2005              |       | 12/2009              |       | 99              |       |
| Interest Rate Swap |       | 1 month LIBOR           |       | 31,686              |       | 3.855            | %          | 7/2005              |       | 11/2009              |       | 1,341           |       |
| Interest Rate Swap |       | 1 month LIBOR           |       | 3,960               |       | 4.959            | %          | 12/2005             |       | 12/2015              |       | 85              |       |
| Interest Rate Swap |       | 1 month LIBOR           |       | 61,603              |       | 4.760            | %          | 1/2006              |       | 3/2015               |       | 1,916           |       |
| Interest Rate Swap |       | 1 month LIBOR           |       | 6,402               |       | 4.760            | %          | 1/2006              |       | 3/2015               |       | 199             |       |
| Interest Rate Swap |       | 3 month LIBOR           |       | 3,465               |       | 5.178            | %          | 4/2006              |       | 3/2010               |       | (3              | )          |
| Interest Rate Cap  |       | 3 month LIBOR           |       | 23,713              |       | 5.700            | %          | 11/2005             |       | 12/2007              |       | 27              |       |
| Interest Rate Cap  |       | 1 month LIBOR           |       | 14,120              |       | 5.500            | %          | 12/2005             |       | 1/2007               |       | 3               |       |
| Total              |       |                    |       | $                   | 188,414    |             |       |                |       |                 |       |            | $          | 5,600 |   |

 

At March 31, 2006, thederivative instruments were reported as an asset at their fair value of $5,600.Offsetting adjustments are represented as deferred gains or losses inAccumulated Other Comprehensive Income of $6,635. During the three months endedMarch 31, 2005 we reclassified through earnings $943 representing thegains and losses previously reported in Accumulated Other Comprehensive Income,which were reclassified into earnings at the same time that the forecastedtransaction associated with derivative instrument affected earnings. Over time,the realized and unrealized gains and losses held in Accumulated OtherComprehensive Income will be reclassified into earnings in the same periods inwhich the hedged interest payments affect earnings.

We are hedgingexposure to variability in future interest payments on our debt facilities andcash flows for future transactions except in the case of swaps we may enterinto from time to time, including TROR swaps, which are intended to hedgeproceeds from the sale of fixed rate mortgage loan assets held as available forsale.

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**17.****                               IncomeTaxes**

We have elected tobe taxed as a REIT, under Sections 856 through 860 of the Internal Revenue Codebeginning with our taxable year ending December 31, 2004. To qualify as aREIT, we must meet certain organizational and operational requirements,including a requirement to distribute at least 90% of our ordinary taxableincome to stockholders. As a REIT, we generally will not be subject to federalincome tax on taxable income that we distribute to our stockholders. If we failto qualify as a REIT in any taxable year, we will then be subject to federalincome taxes on our taxable income at regular corporate rates and we will notbe permitted to qualify for treatment as a REIT for federal income tax purposesfor four years following the year during which qualification is lost unless theInternal Revenue Service grants us relief under certain statutory provisions. Suchan event could materially adversely affect our net income and net cashavailable for distributions to stockholders. However, we believe that we areorganized and will operate in such a manner as to qualify for treatment as aREIT and we intend to operate in the foreseeable future in such a manner sothat we will qualify as a REIT for federal income tax purposes. We may,however, be subject to certain state and local taxes.

For the three months ended March 31, 2006, we recorded $47 ofincome tax expense in income from continuing operations for income attributableour wholly-owned taxable REIT subsidiaries. We have assumed an effective taxrate for the three months ended March 31, 2006 of 40% taking intoconsideration the anticipated applicable U.S. federal statutory tax rate at March 31,2006 of 34% and state and local taxes, net of federal tax benefit.

 

**18.**                               Environmental Matters

**Our management believes we are in compliance in allmaterial respects with applicable Federal, state and local ordinances andregulations regarding environmental issues. Our management is not aware of anyenvironmental liability that it believes would have a materially adverse impacton our financial position, results of operations or cash flows.**

**19.**                               Segment Reporting

**Statementof Financial Accounting Standard No. 131, or “SFAS No. 131,”establishes standards for the way that public entities report information aboutoperating segments in their annual financial statements. We are a REIT focusedprimarily on originating and acquiring loans and securities related to realestate and under the provisions of SFAS No. 131 currently operate in onlyone segment.**

**20.**                               SupplementalDisclosure of Non-Cash Investing and Financing Activities

The following table represents non-cashinvesting and financing activities:

|                                       | ** ** | **2006** | ** ** | **2005** | ** ** |
|---------------------------------------|------------|----------|------------|----------|------------|
| Derivative  instruments at fair value |       | $        | 5,600      |     | $          | 839 |   |
|                                       |            |          |            |          |            |  |  |

** **

**21.**                               Subsequent Events

**OnMay 9, 2006, we originated a $90,287 first mortgage loan, which bearsinterest at 30-day LIBOR plus 2.75%, to a joint venture in which SL Green is anequity holder. The loan is secured by office properties in Northern New Jersey.**

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**ITEM 2****:  Management’s Discussion and Analysis ofFinancial Condition and Results of Operations**

**Overview**

We are a nationalcommercial real estate specialty finance company that focuses on the directorigination and acquisition of whole loans, subordinate interests in wholeloans, mezzanine loans, preferred equity, and net lease investments involvingcommercial properties throughout the United States. When evaluatingtransactions, we assess our risk-adjusted return and target transactions withyields that ensure an equitable balance between risks and return. We conductsubstantially all of our operations through our operating partnership, GKKCapital LP. We are externally managed and advised by GKK Manager LLC, or theManager, a majority-owned subsidiary of SL Green Realty Corp., or SL Green. Wehave elected to be taxed as a REIT under the Internal Revenue Code andgenerally will not be subject to federal income taxes to the extent wedistribute our income to our stockholders. However, we may establish TRSs to effectvarious taxable transactions. Those TRSs would incur federal, state and localtaxes on the taxable income from their activities. Unless the context requiresotherwise, all references to “we,” “our” and “us” mean Gramercy Capital Corp.

In each financingtransaction we undertake, we seek to control as much of the capital structureas possible in order to be able to identify and retain that portion thatprovides the best risk adjusted returns. This is generally achieved through thedirect origination of whole loans, the ownership of which permits a widevariety of financing syndication and securitization executions to achieveexcess returns. By providing a single source of financing for developers andsponsors, we streamline the lending process, provide greater certainty forborrowers and retain the high yield debt instruments that we manufacture. Bycreating, rather than buying whole loans, subordinate interests in whole loans,mezzanine debt and preferred equity, we strive to deliver superior returns toour shareholders.

Since our inception, wehave completed transactions in a variety of markets and secured by a variety ofproperty types. Since our inception, the market for commercial real estate debthas continued to demonstrate low rates of default, high relative returns andtremendous inflows of capital. Consequently, the market for debt instrumentshas evidenced moderately declining yields and more flexible credit standardsand loan structures. In particular, “conduit” originators who package whole loansfor resale to investors have driven debt yields lower while maintainingsubstantial liquidity because of the strong demand for the resulting securities.Because of reduced profits in the most liquid sectors of the mortgage financebusiness, several large institutions have begun originating large bridge loansfor the purpose of generating interest income, rather than the typical focus ontrading profits. In this environment we have focused on areas where we havecomparative advantages rather than competing for product merely on the basis ofyield or structure. This has particularly included whole loan origination inmarkets and transactions where we have an advantage due to (i) knowledgeor relationships we have, (ii) knowledge or relationships of our largestshareholder, SL Green, and (iii) where we have an ability to better assessand manage risks over time. When considering investment opportunities insecondary market transactions in tranched debt, we generally avoid first lossrisk in larger transactions due to the high current valuation of the underlyingreal estate relative to historic valuation levels. Because of the significantincrease in the value of institutional quality assets relative to historicnorms, we typically focus on positions in which a conventional refinancing atloan maturity would provide for a complete return of our investment.

Because of the highrelative valuation of debt instruments in the current market and a generallyincreasing rate environment, we have carefully managed our exposure to interestrate changes that could affect our liquidity. We generally match our assets andliabilities in terms of base interest rate (generally 30-day LIBOR) andexpected duration. We raised $95.0 million of additional equity in December 2004and January 2005 to reduce our outstanding indebtedness and maintainsufficient liquidity for our investment portfolio. We have sold a total of$150.0 million of trust preferred securities in three $50.0 million issuancesin May and August 2005 and January 2006 through wholly-ownedsubsidiaries of the Operating Partnership with 30 year terms. The securitiesissued in May bear interest at a fixed rate of 7.57% for the first tenyears ending, the securities issued in August bear interest at a fixedrate of 7.75% for the first ten years and the securities issued in January 2006bear interest at a fixed rate of 7.65% for the first ten years. After the firstten years, the 2005 issuances bear interest at three-month LIBOR plus 300 basispoints while the 2006 issuance bears interest at three-month LIBOR plus 270basis points. The proceeds from the issuances of the trust preferred securitieswere used to fund existing and future investment opportunities. In July 2005we closed on $1.0 billion of collateralized debt obligations, or CDO, whichextended the term of our liabilities and reduced our overall cost of funds withrespect to debt investments financed by the CDO and previously financed by ourrepurchase agreements, to approximately 49 basis points over LIBOR, excludingtransaction costs. The proceeds of the CDO were used to refinance ourrepurchase facilities and to fund additional investment activities. In September 2005we sold 3,833,333 shares of common stock resulting in net proceeds ofapproximately $97.8 million, which was used to fund acquisitions, repayoutstanding principal amounts under our repurchase facilities and for generalcorporate purposes. In April 2006 we received a commitment from acommercial banking institution for a $100,000 unsecured credit facility with aninitial term of ten years and interest spreads between 1.90% and 2.10%.

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As of March 31,2006, we held loans and other lending investments of $1,543,643 net of fees,discounts, repayments, asset sales and unfunded commitments with an averagespread to LIBOR of 394 basis points for our floating rate investments and anaverage yield of 9.41% for our fixed rate investments. As of March 31,2006 we also held interests in three CTL investments totaling $110,432comprised of the remaining 70.7% investment in the entity that owns 200Franklin Square Drive in Somerset, New Jersey and $57,373 in joint ventureinvestments.

**The aggregate carrying values,allocated by product type and weighted average coupons of our loans and otherlending investments as of March 31, 2006 and December 31, 2005 wereas follows:**
| ** **                                          | ** ** | **Carrying Value (1)  ($ in thousands)** | ** ** | **Allocation by  Investment Type** | ** ** | **Fixed Rate:  Average Yield** | ** ** | **Floating Rate:  Average Spread  over LIBOR (2)** | ** ** |
|-----------------------------------------------------|------------|--------------------------------------------------------------|------------|----------------------------------------------|------------|------------------------------------------|------------|------------------------------------------------------------------------|------------|
| ** **                                          | ** ** | **2006**                                                     | ** ** | **2005**                                     | ** ** | **2006**                                 | ** ** | **2005**                                                               | ** ** | **2006** | ** ** | **2005** | ** ** | **2006** | ** ** | **2005** | ** ** |
| Whole loans, floating rate                          |       | $                                                            | 775,307    |                                         | $          | 561,388                                  |       | 50                                                                     | %          | 46 | % | — |   | — |   | 310 bps |   | 325 bps |   |
| Whole loans, fixed rate                             |       | 112,192                                                      |       | 94,448                                       |       | 7                                        | %          | 8                                                                      | %          | 9.46 | % | 10.64 | % | — |   | — |   |
| Subordinate interests in whole loans, floating rate |       | 391,167                                                      |       | 362,983                                      |       | 25                                       | %          | 30                                                                     | %          | — |   | — |   | 385 bps |   | 443 bps |   |
| Subordinate interests in whole loans, fixed rate    |       | 47,888                                                       |       | 37,104                                       |       | 3                                        | %          | 3                                                                      | %          | 9.55 | % | 9.19 | % | — |   | — |   |
| Mezzanine loans, floating rate                      |       | 150,057                                                      |       | 82,793                                       |       | 10                                       | %          | 7                                                                      | %          | — |   | — |   | 815 bps |   | 858 bps |   |
| Mezzanine loans, fixed rate                         |       | 43,319                                                       |       | 43,352                                       |       | 3                                        | %          | 4                                                                      | %          | 8.88 | % | 8.88 | % | — |   | — |   |
| Preferred equity, floating rate                     |       | 11,822                                                       |       | 11,795                                       |       | 1                                        | %          | 1                                                                      | %          | — |   | — |   | 900 bps |   | 900 bps |   |
| Preferred equity, fixed rate                        |       | 11,891                                                       |       | 11,882                                       |       | 1                                        | %          | 1                                                                      | %          | 10.28 | % | 10.28 | % | — |   | — |   |
| Commercial mortgage backed securities          |       | —                                                       |       | —                                       |       | —                                   |       | —                                                                 |       | — |   | — |   | — |   | — |   |
| Total / Average                                     |       | $                                                            | 1,543,643  |                                         | $          | 1,205,745                                |       | 100                                                                    | %          | 100 | % | 9.41 | % | 9.92 | % | 394 bps |   | 417 bps |   |

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**(1)**          Debt investments arepresented after scheduled amortization payments and prepayments, and are net ofunamortized fees, discounts, asset sales and unfunded commitments.

**(2)**          Spreads over an indexother than LIBOR have been adjusted to a LIBOR based equivalent.

**Critical Accounting Policies**

## Our discussionand analysis of financial condition and results of operations is based on ourfinancial statements, which have been prepared in accordance with accountingprinciples generally accepted in the United States, known as GAAP. Theseaccounting principles require us to make some complex and subjective decisionsand assessments. Our most critical accounting policies involve decisions andassessments, which could significantly affect our reported assets, liabilitiesand contingencies, as well as our reported revenues and expenses. We believethat all of the decisions and assessments upon which our financial statementsare based were reasonable at the time made based upon information available tous at that time. We evaluate these decisions and assessments on an ongoingbasis. Actual results may differ from these estimates under differentassumptions or conditions. We have identified our most critical accountingpolicies to be the following:

### **Loans and Investmentsand Loans Held for Sale**

Loans held for investment are intended to be held tomaturity and, accordingly, are carried at cost, net of unamortized loanorigination fees, discounts, repayments, sales of partial interests in loans,and unfunded commitments unless such loan or investment is deemed to beimpaired. Loans held for sale are carried at the lower of cost or market valueusing available market information obtained through consultation with dealersor other originators of such investments. We may originate or acquire preferredequity interests that allow us to participate in a percentage of the underlyingproperty’s cash flows from operations and proceeds from a sale or refinancing. Shouldwe make such a preferred equity investment, we must determine whether thatinvestment should be accounted for as a loan, joint venture or as an interestin real estate. Our current preferred equity investments do not entitle us to apercentage of the underlying properties’ cash flows from operations or proceedsfrom a sale or refinancing and are, therefore, accounted for as loans.

Specific valuation allowances are established forimpaired loans based on the fair value of collateral on an individual loanbasis. The fair value of the collateral is determined by selecting the mostappropriate valuation methodology, or methodologies, among several generallyavailable and accepted  in the commercialreal estate industry. The determination of the most appropriate valuationmethodology is based on the key characteristics of the collateral type. Thesemethodologies include the evaluation of operating cash flow from the propertyduring the projected holding period, and the estimated sales value of the collateralcomputed by applying an

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expected capitalization rate to the stabilized netoperating income of the specific property, less selling costs, all of which arediscounted at market discount rates.

If upon completion of thevaluation, the fair value of the underlying collateral securing the impairedloan is less than the net carrying value of the loan, an allowance is createdwith a corresponding charge to the provision for loan losses. The allowance foreach loan is maintained at a level we believe is adequate to absorb probablelosses. At March 31, 2006 we maintained a reserve of $1,030.

Our Manager evaluates ourassets on a regular basis to determine if they continue to satisfy ourinvestment criteria. Subject to certain restrictions, our Manager may cause usto sell our investments opportunistically and use the proceeds of any such salefor debt reduction, additional acquisitions or working capital purposes.

#### **Classifications ofMortgage-Backed Securities**

**Mortgage-backedsecurities, or MBS, are classified as available-for-sale securities. As aresult, changes in fair value will be recorded as a balance sheet adjustment toaccumulated other comprehensive income, which is a component of stockholdersequity, rather than through our statement of operations. If available-for-salesecurities were classified as trading securities, there could be substantiallygreater volatility in earnings from period-to-period as these investments wouldbe marked to market and any reduction in the value of the securities versus theprevious carrying value would be considered an expense on our statement ofoperations. We had no investments as of March 31, 2006 that were accountedfor as trading securities.**

#### **Valuations ofMortgage-Backed Securities**

All MBS are carried on the balance sheet at fair value.We determine the fair value of MBS based on the types of securities in which wehave invested. For liquid, investment-grade securities, we consult with dealersof such securities to periodically obtain updated market pricing for the sameor similar instruments. For non-investment grade securities, we activelymonitor the performance of the underlying properties and loans and update ourpricing model to reflect changes in projected cash flows. The value of thesecurities is derived by applying discount rates to such cash flows based oncurrent market yields. The yields employed are obtained from our own experiencein the market, advice from dealers and/or information obtained in consultationwith other investors in similar instruments. Because fair value estimates mayvary to some degree, we must make certain judgments and assumptions about theappropriate price to use to calculate the fair values for financial reportingpurposes. Different judgments and assumptions could result in differentpresentations of value.

When the fair value of anavailable-for-sale security is less than the amortized cost, we considerwhether there is an other-than-temporary impairment in the value of thesecurity (for example, whether the security will be sold prior to the recoveryof fair value). If, in our judgment, an other-than-temporary impairment exists,the cost basis of the security is written down to the then-current fair value,and this loss is realized and charged against earnings. The determination ofother-than temporary impairment is a subjective process, and differentjudgments and assumptions could affect the timing of loss realization.

#### **Credit Tenant Lease Investments**

CTLinvestments are recorded at cost less accumulated depreciation. Costs directlyrelated to the acquisition of such investments are capitalized. Certainimprovements are capitalized when they are determined to increase the usefullife of the building. Capitalized items are depreciated using the straight-linemethod over the shorter of the useful lives of the capitalized item or 40 yearsfor buildings or facilities, the remaining life of the facility for facilityimprovements, four to seven years for personal property and equipment, and theshorter of the remaining lease term or the expected life for tenantimprovements.

Resultsof operations of properties acquired are included in the Statement of Incomefrom the date of acquisition.

Inaccordance with FASB No. 144, or SFAS 144, “Accounting for the Impairmentof Disposal of Long-Lived Assets,” a property to be disposed of is reported atthe lower of its carrying amount or its estimated fair value, less its cost tosell. Once an asset is held for sale, depreciation expense and straight-linerent adjustments are no longer recorded and historic results are reclassifiedas Discontinued Operations.

In accordance with FASB No. 141,or SFAS 141, “Business Combinations,” we allocate the purchase price of realestate to land and building and, if determined to be material, intangibles,such as the value of above, below and at-market leases and origination costsassociated with the in-place leases. We depreciate the amount allocated tobuilding and other intangible assets over their estimated useful lives, whichgenerally range from three to 40 years. The values of the above and belowmarket leases are amortized and recorded as either an increase (in the case ofbelow market leases) or a decrease (in the case of above market leases) torental income

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over the remaining termof the associated lease. The value associated with in-place leases and tenantrelationships are amortized over the expected term of the relationship, whichincludes an estimated probability of the lease renewal, and its estimated term.If a tenant vacates its space prior to the contractual termination of the leaseand no rental payments are being made on the lease, any unamortized balance ofthe related intangible will be written off. The tenant improvements andorigination costs are amortized as an expense over the remaining life of thelease (or charged against earnings if the lease is terminated prior to itscontractual expiration date). We assess fair value of the leases based onestimated cash flow projections that utilize appropriate discount andcapitalization rates and available market information. Estimates of future cashflows are based on a number of factors including the historical operatingresults, known trends, and market/economic conditions that may affect theproperty.

As a result of ourevaluation under SFAS No. 141 of our acquisition of 200 Franklin SquareDrive, we recorded a liability of $889 representing the net value of theacquired below-market lease and assumed lease origination costs. We recognizeda decrease of approximately $17 in rental revenue for the three months ended March 31,2006 for the amortization of the below-market lease and lease origination costsincluding leasing commissions and tenant improvement costs that would be borneby us, resulting from the reallocation of the purchase price of the property.

As of March 31, 2006,we held interests in three CTL investments totaling $110,432 comprised of theremaining 70.7% investment in the entity that owns 200 Franklin Square Drive inSomerset, New Jersey and $57,373 in joint venture investments.

**Investments in Unconsolidated Joint Ventures**

#### We account forour investments in unconsolidated joint ventures under the equity method ofaccounting since we exercise significant influence, but do not unilaterallycontrol, the entities and are not considered to be the primary beneficiaryunder FIN 46. In the joint ventures, the rights of the other investor areprotective and participating. Unless we are determined to be the primarybeneficiary, these rights preclude us from consolidating the investments. Theinvestments are recorded initially at cost as an investment in unconsolidatedjoint ventures, and subsequently are adjusted for equity in net income (loss)and cash contributions and distributions. Any difference between the carryingamount of the investments on our balance sheet and the underlying equity in netassets is amortized as an adjustment to equity in net income (loss) ofunconsolidated joint ventures over the lesser of the joint venture term or 40years. None of the joint venture debt is recourse to us.

#### **RevenueRecognition**

Interest income on debt investments is recognized overthe life of the investment using the effective interest method and recognizedon the accrual basis. Fees received in connection with loan commitments aredeferred until the loan is funded and are then recognized over the term of theloan as an adjustment to yield. Anticipated exit fees, whose collection isexpected, are also recognized over the term of the loan as an adjustment toyield. Fees on commitments that expire unused are recognized at expiration. Feesreceived in exchange for the credit enhancement of another lender, eithersubordinate or senior to us, in the form of a guarantee are recognized over theterm of that guarantee using the straight-line method.

Incomerecognition is generally suspended for debt investments at the earlier of thedate at which payments become 90 days past due or when, in our opinion, a fullrecovery of income and principal becomes doubtful. Income recognition isresumed when the loan becomes contractually current and performance isdemonstrated to be resumed.

Insome instances we may sell all or a portion of our investments to a third party.To the extent the fair value received for an investment exceeds the amortizedcost of that investment and FASB Statement No. 140, or SFAS 140, “Accountingfor Transfers and Servicing of Financial Assets and Extinguishments ofLiabilities,” criteria is met, under which control of the asset that is sold issurrendered making it a “true sale,” a gain on the sale will be recorded throughearnings as other income. To the extent an investment that is sold has adiscount or fees, which were deferred at the time the investment was made andwere being recognized over the term of the investment, the unamortized portionof the discount or fees are recognized at the time of sale and recorded as again on the sale of the investment through other income. We recognized $1,114in gains from the sale of two fixed rate debt investments and one fixed rateloan commitment for the three months ended March 31, 2006.

Rental revenue is recognized on a straight-line basis over the term ofthe lease. The excess of rents recognized over amounts contractually duepursuant to the underlying leases is included in other assets on theaccompanying balance sheets. We may establish, on a current basis, an allowanceagainst this account for future potential tenant credit losses, which mayoccur. The balance reflected on the balance sheet will be net of suchallowance.

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In addition to base rent, the tenants in our CTL investments also pay alloperating costs of owned property including real estate taxes.

#### **Reserve for PossibleCredit Losses**

Theexpense for possible credit losses in connection with debt investments is thecharge to earnings to increase the allowance for possible credit losses to thelevel that management estimates to be adequate considering delinquencies, lossexperience and collateral quality. Other factors considered relate togeographic trends and project diversification, the size of the portfolio andcurrent economic conditions. Based upon these factors, we may establish theprovision for possible credit losses by individual asset or category of asset. Whenit is probable that we will be unable to collect all amounts contractually due,the account is considered impaired.

Whereimpairment is indicated, a valuation write-down or write-off is measured basedupon the excess of the recorded investment amount over the net fair value ofthe collateral, as reduced by selling costs. Any deficiency between the carryingamount of an asset and the net sales price of foreclosed collateral ischarged to the allowance for credit losses. At March 31, 2006 wemaintained a reserve for possible credit losses of $1,030 against investmentswith a carrying value of $69,133.

**StockBased Compensation Plans**

We have a stock-basedcompensation plan, described more fully in Note 13. We account for this planusing the fair value recognition provisions of FASB Statement 123(R), “Share-BasedPayment, a revision of FASB Statement No. 123, Accounting for Stock-BasedCompensation.”

The Black-Scholesoption-pricing model was developed for use in estimating the fair value oftraded options, which have no vesting restrictions and are fully transferable. Inaddition, option valuation models require the input of highly subjectiveassumptions including the expected stock price volatility. Because our plan hascharacteristics significantly different from those of traded options andbecause changes in the subjective input assumptions can materially affect thefair value estimate, in our opinion, the existing models do not necessarilyprovide a reliable single measure of the fair value of our stock options.

Compensation costfor stock options, if any, is recognized ratably over the vesting period of theaward. Our policy is to grant options with an exercise price equal to thequoted closing market price of our stock on the business day preceding thegrant date. Awards of stock or restricted stock are expensed as compensation ona current basis over the benefit period.

The fair value of each stock option granted is estimated onthe date of grant, and quarterly for options issued to non-employees, using theBlack-Scholes option pricing model with the following weighted averageassumptions for grants in 2006 and 2005.

|                                  | ** ** | **2006**  | ** ** | **2005**  | ** ** |
|----------------------------------|------------|-----------|------------|-----------|------------|
| Dividend yield                   |       | 8.0       | %          | 8.4       | %          |
| Expected life of  option         |       | 7.0 years |       | 6.9 years |       |
| Risk-free  interest rate         |       | 3.94      | %          | 4.16      | %          |
| Expected stock price  volatility |       | 21.0      | %          | 19.1      | %          |

 

**IncentiveDistribution (Class B Limited Partner Interest)**

The Class B limited partner interests areentitled to receive an incentive return equal to 25% of the amount by whichfunds from operations (as defined in the partnership agreement of the OperatingPartnership which was amended and restated in April 2006) plus certainaccounting gains exceed the product of our weighted average stockholders equity(as defined in the partnership agreement of the Operating Partnership)multiplied by 9.5% (divided by 4 to adjust for quarterly calculations). We willrecord any distributions on the Class B limited partner interests as anincentive distribution expense in the period when earned and when payment ofsuch amounts has become probable and reasonably estimable in accordance withthe partnership agreement. These cash distributions will reduce the amount ofcash available for distribution to our common unitholders in our OperatingPartnership and to common stockholders. We incurred approximately $1,193 withrespect to such Class B limited partner interests for the three monthsended March 31, 2006 and none for the three months ended March 31,2005.

**Derivative Instruments**

**In the normal course of business, we use a varietyof derivative instruments to manage, or hedge, interest rate risk. We requirethat hedging derivative instruments be effective in reducing the interest raterisk exposure that they are designated to hedge. This effectiveness isessential for qualifying for hedge accounting. Some derivative instruments areassociated with an anticipated transaction. In those cases, hedge effectivenesscriteria also require that it be probable that the underlying transactionoccurs. Instruments that meet these hedging criteria are formally designated ashedges at the inception of the derivative contract.**

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**To determine the fair value of derivativeinstruments, we use a variety of methods and assumptions that are based onmarket conditions and risks existing at each balance sheet date. For themajority of financial instruments including most derivatives, long-terminvestments and long-term debt, standard market conventions and techniques suchas discounted cash flow analysis, option-pricing models, replacement cost, andtermination cost are used to determine fair value. All methods of assessingfair value result in a general approximation of value, and such value may neveractually be realized.**

In the normal course ofbusiness, we are exposed to the effect of interest rate changes and limit theserisks by following established risk management policies and proceduresincluding the use of derivatives. To address exposure to interest rates, we usederivatives primarily to hedge the mark-to-market risk of our liabilities withrespect to certain of our assets. We may also use derivatives to hedgevariability in sales proceeds to be received upon the sale of loans held forsale.

We use a variety of commonly used derivative productsthat are considered plain vanilla derivatives. These derivatives typicallyinclude interest rate swaps, caps, collars and floors. We also use total rateof return swaps, or TROR swaps, which are tied to the Lehman Brothers CMBSindex. We expressly prohibit the use of unconventional derivative instrumentsand using derivative instruments for trading or speculative purposes. Further,we have a policy of only entering into contracts with major financialinstitutions based upon their credit ratings and other factors.

**FASB No. 133,or SFAS 133, “Accounting for Derivative Instruments and Hedging Activities,” asamended by FASB No. 149, requires us to recognize all derivatives on thebalance sheet at fair value. Derivatives that are not hedges must be adjustedto fair value through income. If a derivative is a hedge, depending on thenature of the hedge, changes in the fair value of the derivative will either beoffset against the change in fair value of the hedged asset, liability, or firmcommitment through earnings, or recognized in other comprehensive income untilthe hedged item is recognized in earnings. The ineffective portion of aderivative’s change in fair value will be immediately recognized in earnings. SFAS133 may increase or decrease reported net income and stockholders’ equityprospectively, depending on future levels of LIBOR, swap spreads and othervariables affecting the fair values of derivative instruments and hedged items,but will have no effect on cash flows, provided the contract is carried throughto full term.**

We may employ swaps,forwards or purchased options to hedge qualifying forecasted transactions. Gainsand losses related to these transactions are deferred and recognized in netincome as interest expense in the same period or periods that the underlyingtransaction occurs, expires or is otherwise terminated.

All hedges held by us aredeemed to be highly effective in meeting the hedging objectives established byour corporate policy governing interest rate risk management.

# **Income Taxes**

We elected to be taxed as a REIT, under Sections 856through 860 of the Internal Revenue Code, beginning with our taxable yearending December 31, 2004. To qualify as a REIT, we must meet certainorganizational and operational requirements, including a requirement todistribute at least 90% of our ordinary taxable income to stockholders. As aREIT, we generally will not be subject to federal income tax on taxable incomethat we distribute to our stockholders. If we fail to qualify as a REIT in anytaxable year, we will then be subject to federal income taxes on our taxableincome at regular corporate rates and we will not be permitted to qualify fortreatment as a REIT for federal income tax purposes for four years followingthe year during which qualification is lost unless the Internal Revenue Servicegrants us relief under certain statutory provisions. Such an event couldmaterially adversely affect our net income and net cash available fordistributions to stockholders. However, we believe that we will be organizedand operate in such a manner as to qualify for treatment as a REIT and weintend to operate in the foreseeable future in such a manner so that we willqualify as a REIT for federal income tax purposes. We may, however, be subjectto certain state and local taxes.

**Our wholly-owned TRSs are subjectto federal, state and local taxes.**

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# **Results of Operations (Amounts inthousands)**

### ***Comparison of thethree months ended March 31, 2006 to the three months ended March 31,2005***

***Revenues***
| ** **                                           | ** ** | **2006** | ** ** | **2005** | ** ** | **$ Change** | ** ** |
|------------------------------------------------------|------------|----------|------------|----------|------------|-------------------|------------|
| Investment  income                                   |       | $31,879  |       | $10,250  |       | $21,629           |       |
| Rental revenue,  net                                 |       | 914      |       | —   |       | 914               |       |
| Gain on sales  and other income                      |       | 4,197    |       | 440      |       | 3,757             |       |
| Total revenues                                       |       | $36,990  |       | $10,690  |       | $26,300           |       |
|                                                 |       |     |       |     |       |              |       |
| Equity in net loss of  unconsolidated joint ventures |       | ($727    | )          | $—  |       | ($727             | )          |

 

Investment income is generated on our whole and bridgeloans, subordinate interests in whole loans, mezzanine loans, preferred equityinterests and CMBS investments. For the three months ended March 31, 2006,$5,430 was earned on fixed rate investments while the remaining $26,449 wasearned on floating rate investments. The increase over the prior year is due toa significantly higher number of investments in 2006 versus 2005.

**Rentalrevenue of $914 in 2006 was earned on 200 Franklin Square Drive, which wasacquired in September 2005. This amount includes the effect of adjustmentsfor straight-line rent and FASB 141 adjustments for below-market leases. We didnot hold any real estate investments during the same period in 2005.**

Other income of $4,197 for the three months ended March 31,2006 is comprised primarily of income recorded on the sale of two fixed ratedebt investments and one debt commitment of $1,114, and the gain on the sale ofsecurity interests in the entity that owns 200 Franklin Square Drive of $1,718.The remaining increase over the prior year is primarily attributable tointerest on restricted cash balances in the CDO (which was not in place in thesame period of 2005) and other cash balances held by us. For the three monthsended March 31, 2005, other income of $440 was comprised primarily of thegain on the sale of one fixed rate debt investment of $413 and interest incomeon cash balances.

**The losson investments in unconsolidated joint ventures of $727 for the three monthsended March 31, 2006 represents our proportionate share of the lossesgenerated by our joint venture interests including $1,880 of real estate-relateddepreciation and amortization, which when added back, results in a contributionto FFO of $1,153. We did not maintain any joint venture investments during thesame period of 2005. Our use of FFO as an important financial measure isdiscussed in more detail below.**

***Expenses***
| ** **                             | ** ** | **2006** | ** ** | **2005** | ** ** | **$ Change** | ** ** |
|----------------------------------------|------------|----------|------------|----------|------------|-------------------|------------|
| Interest expense                       |       | $        | 17,721     |     | $          | 2,801             |       | $ | 14,920 |   |
| Management fees                        |       | 3,523    |       | 1,668    |       | 1,855             |       |
| Incentive fee                          |       | 1,193    |       | —   |       | 1,193             |       |
| Depreciation and  amortization         |       | 455      |       | 22       |       | 433               |       |
| Marketing,  general and administrative |       | 2,770    |       | 1,633    |       | 1,137             |       |
| Provision for  taxes                   |       | 47       |       | —   |       | 47                |       |
| Total expenses                         |       | $        | 25,709     |     | $          | 6,124             |       | $ | 19,585 |   |

 

Interest expense was$17,721 for the three months ended March 31, 2006 compared to $2,801 forthe three months ended March 31, 2005. Interest expense for the threemonths ended March 31, 2006 consisted primarily of $10,130 of interest onthe investment grade tranches of our CDO (which was not in place during thesame period in 2005), $3,524 of interest on borrowings on our master repurchasefacilities with Wachovia and Goldman, and $2,555 of expense accrued against ourthree $50,000 issuances of trust preferred securities. The $2,801 of interestexpense during the same period in 2005 was comprised primarily of interest onborrowings on the master repurchase facility with Wachovia and Goldman and theamortization of deferred financing costs.

Management fees increased$1,855 for the three months ended March 31, 2006 to $3,523 versus $1,668for the same period in 2005 due primarily to an increase in our stockholder’sequity and the issuance of $150,000 of trust preferred securities, on whichmanagement fees are based. The remaining increase is comprised of $500 paid orpayable to our Manager under the CDO collateral management agreement in lieu ofthe 0.15% fee otherwise payable to SL Green Operating Partnership, L.P. oninvestments in the CDO under the asset servicing agreement, higher fees paid orpayable to SL Green Operating Partnership, L.P. under our outsourcing and

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servicing agreements dueto the increase in our investment balances and the scheduled 3% annual increasein the fee payable under our outsourcing agreement.

We recorded an incentivefee expense of $1,193 during the three months ended March 31, 2006 inaccordance with requirements of the partnership agreement of the OperatingPartnership which entitles owners of Class B limited partner interests inthe Operating Partnership to an incentive return equal to 25% of the amount bywhich funds from operations (as defined in the amended and restated partnershipagreement of the Operating Partnership) plus certain accounting gains exceedthe product of our weighted average stockholders equity (as defined in the amendedand restated partnership agreement of the Operating Partnership) multiplied by 9.5%(divided by 4 to adjust for quarterly calculations). This threshold was notreached during the same period in 2005 and, consequently, no expense wasrecorded.

The increase in marketing, general and administrativeexpenses of $1,137 for the three months ended March 31, 2006 versus thesame period in 2005 was due primarily to a nonrecurring charge of $525 forthird-party professional expenses in connection with a possible businesscombination involving the acquisition of a publicly-traded commercial realestate finance company with business lines considered by management to behighly complementary to ours. The decision to expense these costs was made oncemanagement concluded the proposed transaction was unlikely to occur on termsadvantageous to us. The remaining increase reflects higher professional fees,stock-based compensation, insurance and general overhead costs.

## **Liquidity and Capital Resources**

**Liquidityis a measurement of the ability to meet cash requirements, including ongoingcommitments to repay borrowings, fund and maintain loans and investments, paydividends and other general business needs. Our principal sources of workingcapital and funds for additional investments primarily include: 1) cash flowfrom operations; 2) borrowings under our repurchase and credit facilities; 3)our CDO; 4) other forms of financing or additional securitizations includingCMBS or subsequent CDO offerings; 5) proceeds from common or preferred equityofferings, 6) issuances of trust preferred securities and, to a lesser extent,7) the proceeds from principal payments on our investments, and 8) the sale orsyndication of certain of our debt investments. We believe these sources offinancing will be sufficient to meet our short-term liquidity needs.**

Our ability to meet ourlong-term liquidity and capital resource requirements will be subject toobtaining additional debt financing and equity capital. Our inability to renew,replace or expand our sources of financing on substantially similar terms, mayhave an adverse effect on our business and results of operations. In addition,an event of default is triggered under our repurchase facility with Wachovia ifthe management agreement with our Manager is terminated. Depending on marketconditions, our debt financing will generally be in the range of 70% to 80% ofthe carrying value of our total assets. Any indebtedness we incur will likelybe subject to continuing covenants and we will likely be required to makecontinuing representations and warranties in connection with such debt. Ourdebt financing terms may require us to keep uninvested cash on hand, or tomaintain a certain portion of our assets free of liens, each of which couldserve to limit our borrowing ability. Moreover, our debt may be secured by ourassets. If we default in the payment of interest or principal on any such debt,breach any representation or warranty in connection with any borrowing orviolate any covenant in any loan document, our lender may accelerate thematurity of such debt requiring us to immediately repay all outstandingprincipal. If we are unable to make such payment, our lender could foreclose onour assets that are pledged as collateral to such lender. The lender could alsosue us or force us into bankruptcy. Any such event would have a materialadverse effect on our liquidity and the value of our common stock. In addition,posting additional collateral to support our credit and repurchase facilitieswill reduce our liquidity and limit our ability to leverage our assets.

**Tomaintain our status as a REIT under the Internal Revenue Code, we mustdistribute annually at least 90% of our taxable income. These distributionrequirements limit our ability to retain earnings and thereby replenish orincrease capital for operations. However, we believe that our significantcapital resources and access to financing will provide us with financialflexibility at levels sufficient to meet current and anticipated capitalrequirements, including funding new lending and investment opportunities.**

## **Cash Flows (Amounts in thousands)**

Net cash from operating activities decreased $14,524to a use of cash of $8,074 for the three months ended March 31, 2006compared to cash provided of $6,450 for the three months ended March 31,2005. Operating cash flow was generated primarily by interest income on ourwhole and bridge loans, subordinate interests in whole loans, mezzanine loansand preferred equity interests and gains on loan sales. Increased cash flowfrom a larger number of investments in 2006 versus 2005 was offset primarily bya $20,441 net use of cash related to the origination of investments held forsale at March 31, 2006 whereas we did not originate any loans that wereheld for sale during the three months ended March 31, 2005.

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Net cash used in investing activities increased$114,779 to $315,146 for the three months ended March 31, 2006 compared to$200,367 used during the three months ended March 31, 2005. The primaryreason for the additional use of cash is related to increased debt investmentoriginations of $167,464, offset by higher principal collections on our debtinvestments of $53,889.

Net cash provided byfinancing activities increased $139,400 to $298,645 for the three months ended March 31,2006 compared to $159,244 provided during the same period in 2005. Thisincrease was due primarily to higher net borrowings on our repurchasefacilities of $156,420 and proceeds from the sale of trust preferred securitiesin January 2006 of $50,000, offset by reduced proceeds from the issuanceof common stock of $59,547 and an increase in the dividend paid to our commonshareholders.

**Capitalization**

Our authorized capital stock consists of 125,000,000 shares,$0.001 par value, of which we have authorized the issuance of up to 100,000,000shares of common stock, $0.001 par value per share, and 25,000,000 shares ofpreferred stock, par value $0.001 per share.

As of the date of our formation, April 12, 2004, we had500,000 shares of common stock outstanding valued at approximately $200,000. OnAugust 2, 2004 we completed our initial public offering of 12,500,000shares of common stock resulting in net proceeds of approximately $172.9million, which was used to fund investments and commence our operations. As of March 31,2006, 350,000 restricted shares had also been issued under our 2004 EquityIncentive Plan, or the Equity Incentive Plan. These shares have a vestingperiod of three to four years and are not entitled to receive distributionsdeclared by us on our common stock until such time as the shares have vested,or the shares have been designated to receive dividends by the CompensationCommittee of our Board of Directors.

On December 3, 2004, we sold 5,500,000 shares of commonstock resulting in net proceeds of approximately $93.7 million under a privateplacement exemption from the registration requirements of Section 5 of theSecurities Act of 1933, as amended. A total of 4,225,000 shares were sold tovarious institutional investors and an additional 1,275,000 shares were sold toSL Green Operating Partnership, L.P. pursuant to its contractual right tochoose to maintain a 25% ownership interest in the outstanding shares of ourcommon stock. Of the 5,500,000 shares sold, 2,000,000 shares were settled on December 31,2004 and the remaining 3,500,000 shares were settled on January 3, 2005.

On September 14, 2005, we sold 3,833,333 shares ofcommon stock resulting in net proceeds of approximately $97.8 million. A totalof 2,875,000 shares were sold through public offering and an additional 958,333shares were sold to SL Green Operating Partnership, L.P. pursuant to itscontractual right to choose to maintain a 25% ownership interest in ouroutstanding shares of common stock. After this offering, SL Green OperatingPartnership, L.P. owned 5,668,333 shares of our common stock. Net proceeds wereused for acquisitions, repayment of outstanding principal under one of ourrepurchase facilities and general corporate purposes.

In August 2005 our $350 million shelf registrationstatement was declared effective by the Securities and Exchange Commission, orSEC. This registration statement provides us with the ability to issue commonand preferred stock, depository shares and warrants. We currently have $251.1million available under the shelf.

As of March 31,2006, 22,817,642 shares of common stock and no shares of preferred stock wereissued and outstanding.

**Outperformance Plan (Amounts in thousands except per sharedata)**

In June 2005,the compensation committee of our board of directors approved a long-termincentive compensation program, the 2005 Outperformance Plan. Participants inthe 2005 Outperformance Plan, all of whom are co-leased employees, will sharein a “performance pool” if our total return to stockholders for the period fromJune 1, 2005 through May 31, 2008 exceeds a cumulative total returnto stockholders of 30% during the measurement period over a base share price of$20.21 per share. The size of the pool will be 10% of the outperformance amountin excess of the 30% benchmark, subject to a maximum limit equal to the lesserof 4% of our outstanding shares and units of limited partnership interest as ofthe end of the performance period, or 1,200,000 shares. If our total return tostockholders from June 1, 2005 to any subsequent date exceeds 80% andremains at that level or higher for 30 consecutive days, then a minimumperformance pool will be established. In the event the potential performancepool reaches the maximum dilution cap before May 31, 2008 and remains atthat level or higher for 30 consecutive days, the performance period will endearly and the pool will be formed on the last day of such 30 day period. Eachparticipant’s award under the 2005 Outperformance Plan is designated as aspecified percentage of the aggregate performance pool to be allocated to suchparticipant assuming the 30% benchmark is achieved. Individual awards under the2005 Outperformance Plan will be made in the form of partnership units, or LTIPUnits, that may ultimately become exchangeable for shares of our common stockor cash, at our election. Under the 2005 Outperformance

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Plan, LTIP Unitshave been granted and additional LTIP Units may be granted in the future priorto the determination of the performance pool; however, these LTIP Units willonly vest upon satisfaction of performance and other thresholds, and will notbe entitled to distributions until after the performance pool, or minimumperformance pool, is established. The 2005 Outperformance Plan provides that ifa pool is established, each participant will also be entitled to thedistributions that would have been paid on the number of LTIP Units earned, hadthey been issued at the beginning of the performance period. Thosedistributions will be paid in the form of additional LTIP Units. Once a performancepool has been established, the earned LTIP Units will receive regular quarterlydistributions on a per unit basis equal to the dividends per share paid on ourcommon stock, whether or not they are vested. Any LTIP Units that are notearned upon the establishment of the performance pool will be automaticallyforfeited, and the LTIP Units that are earned will be subject to time-basedvesting, with 50% of the LTIP Units earned vesting in May 2009 and thebalance vesting one year later based on continued employment with our Manageror SL Green.  We will record the expenseof the restricted stock award in accordance with FASB Statement No. 123(R).Compensation expense of $293 was recorded for the three months ended March 31,2006 related to the 2005 Outperformance Plan.

**Deferred Stock Compensation Plan for Directors**

Under our IndependentDirector’s Deferral Program, which commenced April 2005, our independentdirectors may elect to defer up to 100% of their annual retainer fee, chairmanfees and meeting fees. Unless otherwise elected by a participant, fees deferredunder the program shall be credited in the form of phantom stock units. Thephantom stock units are convertible into an equal number of shares of commonstock upon such directors’ termination of service from the Board of Directorsor a change in control by us, as defined by the program. Phantom stock unitsare credited to each independent director quarterly using the closing price ofour common stock on the applicable dividend record date for the respectivequarter. Each participating independent director who elects to receive fees inthe form of phantom stock units has the option to have their account creditedfor an equivalent amount of phantom stock units based on the dividend rate foreach quarter or have dividends paid in cash.

As of March 31,2006 there were approximately 9,106 phantom stock units outstanding, of which 3,106units are vested.

**MarketCapitalization**

At March 31, 2006, our CDO and borrowings underour repurchase facilities, revolving credit facility and mortgage loans(excluding our share of joint venture debt of $335.5 million) represented 68%of our consolidated market capitalization of $1.8 billion (based on a commonstock price of $24.93 per share, the closing price of our common stock on theNew York Stock Exchange on March 31, 2006). Market capitalization includesour consolidated debt and common stock.

**Indebtedness**

**The tablebelow summarizes borrowings under our Wachovia and Goldman repurchasefacilities and any consolidated mortgage debt or term loans at March 31,2006 and 2005, respectively (amounts in thousands).**

|                                              | ** ** | **March 31,  2006** | ** ** | **December 31,  2005** | ** ** |
|----------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| **Debt Summary:**                            |       |                     |       |                        |       |
| **Balance:**                                 |       |                     |       |                        |       |
| Fixed rate                                   |       | $                        | 41,000     | (1)                         | $          | — |   |
| Variable rate                                |       | 377,193                  |       | 342,291                     |       |
| Total                                        |       | $                        | 418,193    |                        | $          | 342,291 |   |
|                                         |       |                     |       |                        |       |
| **Effective interest rate for the  period:** |       |                     |       |                        |       |
| Fixed rate                                   |       | 4.90                     | %          | —                      |       |
| Variable rate                                |       | LIBOR + 1.22             | %          | LIBOR + 2.07                | %          |

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**(1) We have a 70.7% interest in the entity thatis the obligor under the mortgage note.**

**RepurchaseFacilities**

We have two repurchasefacilities with an aggregate of $700 million of total debt capacity. In August 2004we closed on a $250 million repurchase facility with Wachovia. This facilitywas then increased to $350 million on January 3, 2005 and subsequentlyincreased to $500 million on April 22, 2005. As part of the April 2005increase to $500 million, the initial term of this facility was modified toreflect a staggered term in which $250 million matures in August 2007,$150 million matures in December 2007 and the remaining $100 millionmatures in June 2008. On March 21, 2006 we further modified thefacility by reducing the interest spreads. As a result of the modifications,the $500,000 facility bears interest at spreads of 1.00% to 2.50% over a 30-dayLIBOR and, based on our expected investment activities, provides for advancerates that vary from 60% to 100% based upon the collateral provided under aborrowing base calculation. The lenderhas a consent right with respect to the inclusion of investments in thisfacility, determines

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periodically the marketvalue of the investments, and has the right to require additional collateral ifthe estimated market value of the included investments declines. We hadno accrued interest and borrowings of $198,427 at a weighted average spread toLIBOR of 1.03% and $67,717 at a weighted average spread to LIBOR of 1.50% underthis facility at March 31, 2006 and December 31, 2005, respectively. Wecan utilize the $25 million revolving credit facility described below to fundrequirements for additional collateral pursuant to the repurchase facility orto fund the acquisition of assets.

On January 3, 2005, we closed an additionalrepurchase facility of $200 million with Goldman. This facility has an initialterm of three years expiring in January 2008 with one six-month extensionoption. On March 21, 2006 we modified this facility by reducing theinterest spreads. As a result of the modifications, the facility bears interestat spreads of 1.00% to 2.25% over a 30-day LIBOR and, based on ourexpected investment activities, provides for advance rates that vary from 40%to 85% based upon the collateral provided under a borrowing base calculation. Aswith the Wachovia repurchase facility, the lender has a consent right to theinclusion of investments in this facility, determines periodically the marketvalue of the investments, and has the right to require additional collateral ifthe estimated market value of the included investments declines. We had noaccrued interest and borrowings of $178,766 at a weighted average spread toLIBOR of 1.43% and accrued interest of $163 and borrowings of $49,648 at aweighted average spread to LIBOR of 1.71% under this facility at March 31,2006 and December 31, 2005, respectively.

The repurchase facilitiesrequire that we pay down borrowings under these facilities as principalpayments on the loans and investments pledged to these facilities are received.Assets pledged ascollateral under these facilities may include stabilized and transitional wholeloans, subordinate interests in whole loans, mezzanine loans, and rated CMBS orcommercial real estate CDO securities originated or acquired by us.

In certain circumstances,we have purchased debt investments from a counterparty and subsequentlyfinanced the acquisition of those debt investments through repurchaseagreements with the same counterparty. We currently record the acquisition ofthe debt investments as assets and the related repurchase agreements asfinancing liabilities gross on the consolidated balance sheets. Interest incomeearned on the debt investments and interest expense incurred on the repurchaseobligations are reported gross on the consolidated income statements. However,under a certain technical interpretation of FAS 140, such transactions may notqualify as a purchase by us. We believe, and it is industry practice, that weare accounting for these transactions in an appropriate manner. However, theresult of this technical interpretation would prevent us from presenting thedebt investments and repurchase agreements and the related interest income andinterest expense on a gross basis on our financial statements. Instead, wewould present the net investment in these transactions with the counterpartyand a derivative with the corresponding change in fair value of the derivativebeing recorded through earnings. The value of the derivative would reflectchanges in the value of the underlying debt investments and changes in thevalue of the underlying credit provided by the counterparty.

**CreditFacility**

We have one $25 million credit facility with Wachovia with a term of two years. Amountsdrawn under this facility for liquidity purposes bear interest at a spread overLIBOR of 525 basis points. Amounts drawn under this facility for acquisitionpurposes bear interest at a spread over LIBOR of 225 basis points. Amountsdrawn under this facility for liquidity purposes must be repaid within 105 days.Amounts drawn under this facility generally will be secured by assetsestablished under a borrowing base calculation unless certain financialcovenants are satisfied. These covenants are generally more restrictive thanthose set forth below. We had no borrowings under this facility at March 31,2006 and 2005.

**Thecredit facility requires that we pay down borrowings under this facility asprincipal payments on our loans and investments pledged to this facility arereceived.**

**RestrictiveCovenants**

**The termsof both of our repurchase facilities and our credit facility include covenantsthat (a) limit our maximum total indebtedness to no more than 85% of ourtotal assets, (b) require us to maintain minimum liquidity of at least $10million for the first two years and $15 million thereafter, (c) requires ourfixed charge coverage ratio to be at no time less than 1.50 to 1.00, (d) requiresour minimum interest coverage ratio to be at no time less than 1.75 to 1.00, (e) requireus to maintain minimum tangible net worth of not less than the greater of (i) $129.75million, or (i) plus (ii) 75% of the proceeds of our subsequentequity issuances and (f) restrict the maximum amount of our totalindebtedness. The covenants also restrict us from making distributions inexcess of a maximum of 103% of our funds from operations (as defined by theNational Association of Real Estate Investment Trusts, or NAREIT) through July 2005and 100% thereafter, except that we may in any case pay distributions necessaryto maintain our REIT status. Under our facility with Wachovia, an event ofdefault will be triggered if our Manager ceases to be our Manager. As of March 31,2006 and December 31, 2005, we were in compliance with all such covenants.**

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#### **Mortgage Loan**

We have one consolidatedinterest-only mortgage loan of $41,000 that bears interest at a fixed rate of4.90% and has a term of ten years, resulting in a balloon payment in 2015. Thismortgage was used to finance our initial acquisition of 200 Franklin SquareDrive for approximately $50,250, excluding closing costs, in September 2005.On March 31, 2006, following the conversion of the entity that owns 200Franklin Square Drive to a DST, we sold approximately 29.3% of our securityinterests in the DST to a third party, at which time the purchaser assumed aproportionate share of the underlying mortgage debt on the property.

#### **CollateralizedDebt Obligations**

#### On July 14, 2005, we issued approximately $1.0 billion ofcollateralized debt obligations through two newly-formed indirect subsidiaries,Gramercy Real Estate CDO 2005-1 Ltd., or the Issuer, and GramercyReal Estate CDO 2005-1 LLC, or the Co-Issuer. The CDO consists of $810.5million of investment grade notes, and $84.5 million of non-investment gradenotes, which were co-issued by the Issuer and the Co-Issuer, and $105.0 millionof preferred shares, which were issued by the Issuer. We retained allnon-investment grade securities, the preferred shares and the common shares inthe Issuer. The Issuer holds assets, consisting primarily of whole loans,subordinate interests in whole loans, mezzanine loans and preferred equityinvestments, which serve as collateral for the CDO. The investment grade noteswere issued with floating rate coupons with a combined weighted average rate ofthree-month LIBOR plus 0.49%. The CDO may be replenished, pursuant to certainrating agency guidelines relating to credit quality and diversification, withsubstitute collateral for loans that are repaid during the first five years ofthe CDO. Thereafter, the CDO securities will be retired in sequential orderfrom senior-most to junior-most as loans are repaid. We incurred approximately$11.8 million of issuance costs, which will be amortized on a level-yield basisover the average life of the CDO. The Issuer is consolidated in our financialstatements. The investment grade notes are treated as a secured financing, andare non-recourse to us. Proceeds from the sale of the investment grade notesissued were used to repay substantially all outstanding debt under ourrepurchase agreements and fund additional investments.

**Junior Subordinated Debentures**

**On January 27, 2006, wecompleted a third issuance of $50,000 in unsecured trust preferred securitiesthrough a separate newly formed Delaware statutory trust, Gramercy CapitalTrust III, or GCTIII, that is a wholly-owned subsidiary of the OperatingPartnership. The securities bear interest at a fixed rate of 7.65% for thefirst ten years ending January 2016, with an effective rate of 7.43% whengiving effect to the swap arrangement previously entered into in contemplationof this financing. Thereafter the rate will float based on the three-monthLIBOR plus 270 basis points.**

**In May and August 2005,we completed issuances of $50,000 each in unsecured trust preferred securitiesthrough two Delaware statutory trusts, Gramercy Capital Trust I, or GCTI, andGramercy Capital Trust II, or GCTII, that are also wholly-owned subsidiaries ofthe Operating Partnership. The securities issued in May 2005 bear interestat a fixed rate of 7.57% for the first ten years ending June 2015 and thesecurities issued in August 2005 bear interest at a fixed rate of 7.75%for the first ten years ending October 2015. Thereafter the rates willfloat based on the three-month LIBOR plus 300 basis points.**

**All issuances of trust preferredsecurities require quarterly interest distributions; however, payments may bedeferred while the interest expense is accrued for a period of up to fourconsecutive quarters if the Operating Partnership exercises its right to defersuch payments. The trust preferred securities are redeemable, at the option ofthe Operating Partnership, in whole or in part, with no prepayment premium anytime after June 30, 2010, October 30, 2010 or January 30, 2011for the securities issued by GCTI, GCTII and GCTIII, respectively.**

**GCTI, GCTII and GCTIII eachissued $1,550 aggregate liquidation amount of common securities, representing100% of the voting common stock of those entities to the Operating Partnershipfor a total purchase price of $4,650. GCTI, GCTII and GCTIII used the proceedsfrom the sale of the trust preferred securities and the common securities topurchase the Operating Partnership’s junior subordinated notes. The terms ofthe junior subordinated notes match the terms of the trust preferred securities.The notes are subordinate and junior in right of payment to all present andfuture senior indebtedness and certain other of our financial obligations. Werealized net proceeds from each offering of approximately $48,956.**

Ourinterests in GCTI, GCTII and GCTIII are accounted for using the equity methodand the assets and liabilities of those entities are not consolidated into ourfinancial statements. Interest on the junior subordinated notes is included ininterest expense on our consolidated income statements while the value of thejunior subordinated notes, net of our investment in the trusts that issued thesecurities, are presented as a separate item in our consolidated balance sheet.

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**Contractual Obligations**

Combined aggregateprincipal maturities of our CDO, repurchase facilities, trust preferredsecurities, revolving credit facility and our obligations under our managementagreement, outsourcing agreement, CDO collateral management agreement andoperating lease as of March 31, 2006 are as follows (amounts inthousands):
| ** ** | ** ** | **CDO** | ** ** | **Repurchase  Facilities** | ** ** | **Trust  Preferred  Securities** | ** ** | **Mortgage  Note  Payable(2)** | ** ** | **Revolving  Credit  Facility** | ** ** | **Outsourcing  and  Management  Agreements(1)** | ** ** | **CDO  Collateral  Management  Agreement** | ** ** | **Operating  Lease** | ** ** | **Total** | ** ** |
|------------|------------|---------|------------|----------------------------|------------|----------------------------------|------------|--------------------------------|------------|---------------------------------|------------|-------------------------------------------------|------------|--------------------------------------------|------------|----------------------|------------|-----------|------------|
| 2006       |       | $       | —     |                       | $          | —                           |       | $                              | —     |                            | $          | —                                          |       | $                                          | —     |                 | $          | 8,006     |       | $ | 1,526 |   | $ | 190 |   | $ | 9,722 |   |
| 2007       |       | —  |       | 198,427                    |       | —                           |       | —                         |       | —                          |       | 10,666                                          |       | 2,026                                      |       | 256                  |       | 211,375   |       |
| 2008       |       | —  |       | 178,766                    |       | —                           |       | —                         |       | —                          |       | 10,706                                          |       | 2,026                                      |       | 261                  |       | 191,759   |       |
| 2009       |       | —  |       | —                     |       | —                           |       | —                         |       | —                          |       | 10,748                                          |       | 2,026                                      |       | 265                  |       | 13,039    |       |
| 2010       |       | —  |       | —                     |       | —                           |       | —                         |       | —                          |       | —                                          |       | 1,092                                      |       | 283                  |       | 1,375     |       |
| Thereafter |       | 810,500 |       | —                     |       | 150,000                          |       | 41,000                         |       | —                          |       | —                                          |       | —                                     |       | 1,351                |       | 1,002,851 |       |
| Total      |       | $       | 810,500    |                       | $          | 377,193                          |       | $                              | 150,000    |                            | $          | 41,000                                          |       | —                                     |       | $                    | 40,126     |      | $          | 8,696 |   | $ | 2,606 |   | $ | 1,430,121 |   |
|            |            |         |            |                            |            |                                  |            |                                |            |                                 |            |                                                 |            |                                            |            |                      |            |           |            |  |  |  |  |  |  |  |  |  |

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(1)          Management fee iscalculated as 1.75% of our gross stockholders equity (as defined in the amendedand restated management agreement) on March 31, 2006, inclusive of thetrust preferred securities issued on May 20, 2005, August 9, 2005 andJanuary 27, 2006.

(2)          We have a 70.7% interestin the entity that holds the mortgage.

**Off-Balance-SheetArrangements**

We have several off-balance-sheet investments, includingjoint ventures and structured finance investments. These investments all havevarying ownership structures. Substantially all of our joint venturearrangements are accounted for under the equity method of accounting as we havethe ability to exercise significant influence, but not control over theoperating and financial decisions of these joint venture arrangements. Ouroff-balance-sheet arrangements are discussed in Note 4, “Investments inUnconsolidated Joint Ventures” in the accompanying financial statements.

**Dividends**

To maintain ourqualification as a REIT, we must pay annual dividends to our stockholders of atleast 90% of our REIT taxable income, determined before taking intoconsideration the dividends paid deduction and net capital gains. We intend tocontinue to pay regular quarterly dividends to our stockholders. Before we payany dividend, whether for Federal income tax purposes or otherwise, which wouldonly be paid out of available cash to the extent permitted under our unsecuredand secured credit and repurchase facilities, and our term loans, we must firstmeet both our operating requirements and scheduled debt service on ourmortgages and loans payable.

**RelatedParty Transactions (Amounts in thousands)**

In connection with our initialpublic offering, we entered into a management agreement with our Manager, whichwas subsequently amended and restated in April 2006. The amended andrestated agreement provides for a term through December 2009 withautomatic one-year extension options and is subject to certain terminationrights. We pay our Manager an annual management fee equal to 1.75% of our grossstockholders equity (as defined in the amended and restated managementagreement) inclusive of our trust preferred securities. We incurred expense toour Manager under this agreement of an aggregate of approximately $2,236 and$1,204 for the three months ended March 31, 2006 and 2005, respectively.

At March 31,2006, the majority of the Class B limited partnership interests were ownedby our Manager and SL Green Operating Partnership, L.P. Interests were alsoheld by certain officers and employees of SL Green, including some of whom areamong our executive officers, which interests are subject to performancethresholds. To provide an incentive for our Manager to enhance the value of thecommon stock, the holders of the Class B limited partner interests of theOperating Partnership are entitled to an incentive return equal to 25% of theamount by which funds from operations (as defined in the partnership agreementof the Operating Partnership which was amended and restated in April 2006)plus certain accounting gains exceed the product of our weighted averagestockholders equity (as defined in the amended and restated partnershipagreement of the Operating Partnership) multiplied by 9.5% (divided by 4 toadjust for quarterly calculations). We will record any distributions on the Class Blimited partner interests as an incentive distribution expense in the periodwhen earned and when payments of such amounts have become probable andreasonably estimable in accordance with the partnership agreement. We

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incurredapproximately $1,193 of incentive distribution expense for the three monthsended March 31, 2006 and none for 2005.

We are obligated to reimburse our Manager for itscosts incurred under an asset servicing agreement between our Manager and anaffiliate of SL Green Operating Partnership, L.P. and a separate outsourcingagreement between our Manager and SL Green Operating Partnership, L.P. Theasset servicing agreement, which was amended and restated in April 2006,provides for an annual fee payable to SL Green Operating Partnership, L.P. byus of 0.05% of the book value of all credit tenant lease assets andnon-investment grade bonds and 0.15% of the book value of all other assets. Theasset servicing fee may be reduced by SL Green Operating Partnership, L.P. forfees paid directly to outside servicers by us. The outsourcing agreementcurrently provides for a fee payable by us of $1,288 per year, increasing 3%annually over the prior year. For the three months ended March 31, 2006and 2005, we realized expense of $322 and $313, respectively, to our Managerunder the outsourcing agreement. For the three months ended March 31, 2006and 2005, we realized expense of $460 and $151, respectively, to our Managerunder the asset servicing agreement.

In connection with the closing of our CDO in July 2005,the Issuer entered into a collateral management agreement with our Manager.Pursuant to the collateral management agreement, our Manager has agreed toprovide certain advisory and administrative services in relation to thecollateral debt securities and other eligible investments securing the CDOnotes. The collateral management agreement provides for a senior collateralmanagement fee, payable quarterly in accordance with the priority of paymentsas set forth in the indenture, equal to 0.15% per annum of the net outstandingportfolio balance, and an additional subordinate collateral management fee, payablequarterly in accordance with the priority of payments as set forth in theindenture, equal to 0.25% per annum of the net outstanding portfolio balance. Netoutstanding portfolio balance is the sum of the (i) aggregate principalbalance of the collateral debt securities, excluding defaulted securities, (ii) aggregateprincipal balance of all principal proceeds held as cash and eligibleinvestments in certain accounts, and (iii) with respect to the defaultedsecurities, the calculation amount of such defaulted securities. Ascompensation for the performance of its obligations as collateral manager, ourBoard of Directors has allocated to our Manager the portion of the subordinatecollateral management fee paid on securities not held by us. The senior collateral management fee andbalance of the subordinate collateral management fee is allocated to us. Forthe three months ended March 31, 2006 we realized expense of $500 to ourManager under the collateral management agreement.

**Theamended and restated management agreement provides that in connection withformations of future collateralized debt obligations or other securitizationvehicles, if a collateral manager is retained, our Manager or an affiliate willbe the collateral manager and will receive the following fees:  (i) 0.25%per annum of the book value of the assets owned for transitional “managed”CDOs, (ii)  0.15% per annum of the book value of the assets owned fornon-transitional “managed” CDOs, (iii) 0.10% per annum of the book valueof the assets owned for static CDOs that own primarily non-investment gradebonds, and (iv) 0.05% per annum of the book value of the assets owned forstatic CDOs that own primarily investment grade bonds; limited in each instanceby the fees that are paid to the collateral manager. The balance of the feespaid by the CDO for collateral management services are paid to us.**

In connection with the 5,500 shares of common stockthat were sold on December 3, 2004 and settled on December 31, 2004and January 3, 2005 in a private placement, we agreed to pay our Manager afee of $1,000 as compensation for financial advisory, structuring and costsincurred on our behalf.  This fee wasrecorded as a reduction in the proceeds of the private placement. Apart fromlegal fees and stock clearing charges totaling $245, no other fees were paid byus to an investment bank, broker/dealer or other financial advisor inconnection with the private placement, resulting in total costs of 1.3% oftotal gross proceeds.

**On April 29,2005, we closed on a $57,503 initial investment in a joint venture with SLGreen to acquire, own and operate the South Building located at One MadisonAvenue, New York, New York, or the Property. The joint venture, which wascreated to acquire, own and operate the Property, is owned 45% by awholly-owned subsidiary of us and 55% by a wholly-owned subsidiary of SL Green.The joint venture interests are *pari passu*.Also on April 29, 2005, the joint venture completed the acquisition of theProperty from Metropolitan Life Insurance Company for the purchase price ofapproximately $802,800 plus closing costs, financed in part through a $690,000first mortgage loan on the Property. The Property comprises approximately 1.2million square feet and is almost entirely net leased to CS pursuant to a leasewith a 15-year remaining term.**

CommencingMay 1, 2005 we are party to a lease agreement with SLG Graybar SubleaseLLC, an affiliate of SL Green, for our corporate offices at 420 LexingtonAvenue, New York, New York. The lease is for approximately five thousand squarefeet with an option to lease an additional approximately two thousand squarefeet and carries a term of ten years with rents on the entire seven thousandsquare feet of approximately $249 per annum for year one rising to $315 perannum in year ten. For the three months ended March 31, 2006 we paid $62under this lease.

**Bright Star Couriers LLC, or Bright Star, providesmessenger services to us. Bright Star is owned by Gary Green, a son of StephenL.**

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**Green, our Chairman. The aggregate amount of feespaid by us for such services for the three months ended March 31, 2006 and2005 was less than $1.**

**SL Green Operating Partnership, L.P. has invested$75,000 and $6,100 in preferred equity interests that are subordinate to two ofour investments with book values of $26,818 and $6,443, respectively, as of March 31,2006 and $29,026 and $6,441, respectively, as of December 31, 2005.**

**On July 14, 2005, we closed on the purchasefrom an SL Green affiliate of a $40,000 mezzanine loan which bears interest at11.20%. As part of that sale, the seller retained an interest-onlyparticipation. We have determined that the yield on our mezzanine loan aftergiving effect to the interest-only participation retained by the seller is atmarket. The mezzanine loan is secured by the equity interests in an officeproperty in New York, New York.**

**On February 27, 2006, we closed on the purchaseof a $90,000 whole loan, which bears interest at 30-day LIBOR plus 2.15%,to a joint venture in which SL Green is an equity holder. The loan is securedby an office building in Bridgewater, New Jersey.**

**On March 17, 2006, we closed on the purchase ofa $25,000 mezzanine loan, which bears interest at 30-day LIBOR plus8.00%, to a joint venture in which SL Green is an equity holder. The loan issecured by office and industrial properties in northern New Jersey**

**During the three months ended March 31, 2006,we earned fees of $162,500 from SL Green representing SL Green’s proportionateshare of fees for financing and structural advisory services related to aspecific potential transaction.**

**Fundsfrom Operations**

FFO is a widelyrecognized measure of REIT performance. We compute FFO in accordance withstandards established by the National Association of Real Estate InvestmentTrusts, or NAREIT, which may not be comparable to FFO reported by other REITsthat do not compute FFO in accordance with the NAREIT definition, or thatinterpret the NAREIT definition differently than we do. The revised White Paperon FFO approved by the Board of Governors of NAREIT in April 2002 definesFFO as net income (loss) (computed in accordance with GAAP), excluding gains(or losses) from debt restructuring and sales of properties, plus real estate-related depreciation and amortization and after adjustments for unconsolidatedpartnerships and joint ventures. We present FFO because we consider it animportant supplemental measure of our operating performance and believe that itis frequently used by securities analysts, investors and other interested partiesin the evaluation of REITS. We also use FFO as one of several criteria todetermine performance-based bonuses for members of our senior management. FFOis intended to exclude GAAP historical cost depreciation and amortization ofreal estate and related assets, which assumes that the value of real estateassets diminishes ratably over time. Historically, however, real estate valueshave risen or fallen with market conditions. Because FFO excludes depreciationand amortization unique to real estate, gains and losses from propertydispositions and extraordinary items, it provides a performance measure that,when compared year over year, reflects the impact to operations from trends inoccupancy rates, rental rates, operating costs, interest costs, providing perspectivenot immediately apparent from net income. We consider gains and losses on the sales of debt investments to be anormal part of our recurring operations and therefore do not exclude such gainsand losses when arriving at FFO. FFO does not represent cash generatedfrom operating activities in accordance with GAAP and should not be consideredas an alternative to net income (determined in accordance with GAAP), as anindication of our financial performance or to cash flow from operatingactivities (determined in accordance with GAAP) as a measure of our liquidity,nor is it indicative of funds available to fund our cash needs, including ourability to make cash distributions.

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Fundsfrom Operations for the three months ended March 31, 2006 and 2005 are asfollows (amounts in thousands):
| ** **                                          | ** ** | **For the Three  Months Ended  March 31, 2006** | ** ** | **For the Three  Months Ended  March 31, 2005** | ** ** |
|-----------------------------------------------------|------------|--------------------------------------------------------------------------|------------|--------------------------------------------------------------------------|------------|
| Net income  available to common stockholders        |       | $                                                                        | 10,554     |                                                                     | $          | 4,566 |   |
| Add:                                                |       |                                                                     |       |                                                                     |       |
| Depreciation and amortization                       |       | 1,422                                                                    |       | 417                                                                      |       |
| FFO adjustment for unconsolidated joint ventures    |       | 1,879                                                                    |       | —                                                                   |       |
| Less:                                               |       |                                                                     |       |                                                                     |       |
| Non real estate depreciation and amortization       |       | (1,184                                                                   | )          | (417                                                                     | )          |
| Funds from  operations                              |       | 12,671                                                                   |       | 4,566                                                                    |       |
| ** **                                          |       |                                                                     |       |                                                                     |       |
| Cash flows used  / provided by operating activities |       | $                                                                        | (8,074     | )                                                                        | $          | 6,450 |   |
| Cash flows used  in investing activities            |       | $                                                                        | (315,146   | )                                                                        | $          | (200,367 | ) |
| Cash flows provided by  financing activities        |       | 298,645                                                                  |       | $                                                                        | 159,244    |   |

 

**CautionaryNote Regarding Forward-Looking Information**

Thisreport contains “forward-looking statements” within the meaning of Section 27Aof the Securities Act of 1933, as amended, or the Act, and Section 21E ofthe Securities Exchange Act of 1934, as amended, or the Exchange Act. You canidentify forward-looking statements by the use of forward-looking expressionssuch as “may,” “will,” “should,” “expect,” “anticipate,” “estimate,” “believe,”“intend,” “plan,” “project,” “continue,” or any negative or other variations onsuch expressions. Forward-looking statements include information concerningpossible or assumed future results of our operations, including any forecasts,projections, plans and objectives for future operations. Although we believethat our plans, intentions and expectations as reflected in or suggested bythose forward-looking statements are reasonable, we can give no assurance thatthe plans, intentions or expectations will be achieved. We have listed belowsome important risks, uncertainties and contingencies which could cause ouractual results, performance or achievements to be materially different from theforward-looking statements we make in this report. These risks, uncertaintiesand contingencies include, but are not limited to, the following:

·                  the success orfailure of our efforts to implement our current business strategy;

·                  economicconditions generally and in the commercial finance and commercial real estatemarkets specifically;

·                  the performanceand financial condition of borrowers and corporate customers;

·                  the actions of ourcompetitors and our ability to respond to those actions;

·                  the cost of ourcapital, which depends in part on our asset quality, the nature of ourrelationships with our lenders and other capital providers, our businessprospects and outlook and general market conditions;

·                  availability ofqualified personnel;

·                  availability ofinvestment opportunities on real estate related and other securities;

·                  the adequacy ofour cash reserves and working capital;

·                  unanticipatedincreases in financing and other costs, including a rise in interest rates;

·                  the timing ofcash flows , if any, from our investments;

·                  risks ofstructured finance investments;

·                  GKK Manager LLCremaining as our Manager;

·                  environmentaland/or safety requirements;

·                  continuingthreats or terrorist attacks on the national, regional and local economies;

·                  competition withother companies;

·                  our ability tosatisfy complex rules in order for us to qualify as a REIT for federalincome tax purposes and qualify for our exemption under the Investment CompanyAct, our operating partnership’s ability to satisfy the rules in order forit to qualify as a partnership for federal income tax purposes, the ability ofcertain of our subsidiaries to qualify as REITs, and the ability of certain ofour subsidiaries to qualify as taxable REIT subsidiaries for federal income taxpurposes, and our ability and the ability of our subsidiaries to operateeffectively within the limitations imposed by these rules;

·                  changes ingovernmental regulations, tax rates and similar matters; and

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·                  legislative andregulatory changes (including changes to laws governing the taxation of REITs),and other factors, many of which are beyond our control.

Weundertake no obligation to publicly update or revise any forward-lookingstatements, whether as a result of future events, new information or otherwise.

The risks included here are not exhaustive. Other sections of thisreport may include additional factors that could adversely affect our businessand financial performance. Moreover, we operate in a very competitive andrapidly changing environment. New risk factors emerge from time to time and itis not possible for management to predict all such risk factors, nor can itassess the impact of all such risk factors on our business or the extent towhich any factor, or combination of factors, may cause actual results to differmaterially from those contained in any forward-looking statements. Given theserisks and uncertainties, investors should not place undue reliance onforward-looking statements as a prediction of actual results.

**RecentlyIssued Accounting Pronouncements**

**Statement of Financial AccountingStandard No. 123(R), or SFAS No. 123(R) “Share-Based Payment, arevision of FASB Statement No. 123, Accounting for Stock-Based Compensation,”requires all share-based payments to employees, including grants of employeestock options, to be recognized in the income statement based on their fairvalue. The new standard is effective for interim or annual reporting periodsbeginning after January 1, 2006. The implementation of SFAS No. 123(R) didnot have a material effect on our financial position or results of operationsfor the three months ended March 31, 2006.**

**In June 2005, the FASBratified the consensus in EITF Issue No. 04-5, or Issue 04-5,Determining Whether a General Partner, or the General Partners as a Group,Controls a Limited Partnership or Similar Entity When the Limited Partners HaveCertain Rights, which provides guidance in determining whether a generalpartner controls a limited partnership. Issue 04-5 states that thegeneral partner in a limited partnership is presumed to control that limitedpartnership. The presumption may be overcome if the limited partners haveeither (1) the substantive ability to dissolve the limited partnership orotherwise remove the general partner without cause or (2) substantiveparticipating rights, which provide the limited partners with the ability toeffectively participate in significant decisions that would be expected to bemade in the ordinary course of the limited partnership’s business and therebypreclude the general partner from exercising unilateral control over thepartnership. If the criteria in Issue 04-5 are met, a company could berequired to consolidate certain of its existing unconsolidated joint ventures. Ouradoption of Issue 04-5 for new or modified limited partnershiparrangements effective June 30, 2005 and existing limited partnershiparrangements effective January 1, 2006 did not have a material effect onour financial position or results of operations for the three months ended March 31,2006.**

In February 2006, the FASB issued Statement ofFinancial Accounting Standard No. 155, or SFAS No. 155, “Accountingfor Certain Hybrid Financial Instruments — an amendment of FASB Statements No. 133and 140”. SFAS No. 155 (1) permits fair value re-measurement for anyhybrid financial instrument that contains an embedded derivative that wouldotherwise require bifurcation, (2) clarifies which interest-only stripsand principal-only strips are not subject to the requirements of FASB StatementNo. 133, (3) establishes a requirement to evaluate interests insecuritized financial assets to identify interests that are freestandingderivatives or that are hybrid financial instruments that contain an imbeddedderivative requiring bifurcation, (4) clarifies that concentrations ofcredit risk in the form of subordination are not embedded derivatives, and (5) amendsFASB Statement No. 140 to eliminate the prohibition on a qualifyingspecial-purpose entity from holding a derivative financial instrument thatpertains to a beneficial interest in other than another derivative financialinstrument. SFAS No. 155 is effective January 1, 2007 and we arecurrently evaluating the effect, if any, that this pronouncement will have onour future financial results.

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**ITEM 3. Quantitative and Qualitative Disclosure AboutMarket Risk**

##### **Market Risk**

Market riskincludes risks that arise from changes in interest rates, commodity prices,equity prices and other market changes that affect market sensitive instruments.In pursuing our business plan, we expect that the primary market risks to whichwe will be exposed are real estate and interest rate risks.

#### **Real Estate Risk**

Commercial andmulti-family property values and net operating income derived from suchproperties are subject to volatility and may be affected adversely by a numberof factors, including, but not limited to, national, regional and localeconomic conditions which may be adversely affected by industry slowdowns andother factors), local real estate conditions (such as an oversupply of retail,industrial, office or other commercial or multi-family space), changes orcontinued weakness in specific industry segments, construction quality, age anddesign, demographic factors, retroactive changes to building or similar codes,and increases in operating expenses (such as energy costs). In the event netoperating income decreases, a borrower may have difficulty repaying our loans,which could result in losses to us. In addition, decreases in property valuesreduce the value of the collateral and the potential proceeds available to aborrower to repay our loans, which could also cause us to suffer losses. Evenwhen a property’s net operating income is sufficient to cover the property’sdebt service, at the time a loan is made, there can be no assurance that thiswill continue in the future.

###### **InterestRate Risk**

Interest rate riskis highly sensitive to many factors, including governmental monetary and taxpolicies, domestic and international economic and political considerations andother factors beyond our control.

Our operatingresults will depend in large part on differences between the income from ourassets and our borrowing costs. Most of our assets and borrowings arevariable-rate instruments that we finance with variable rate debt. Theobjective of this strategy is to minimize the impact of interest rate changeson the spread between the yield on our assets and our cost of funds. We enterinto hedging transactions with respect to all liabilities relating to fixedrate assets. If we were to finance fixed rate assets with variable rate debtand the benchmark for our variable rate debt increased, our net income woulddecrease. Furthermore, as most of our available financing provides for anability of the lender to mark-to-market our assets and make margin calls basedon a change in the value of our assets, financing fixed rate assets with thisdebt creates the risk that an increase in fixed rate benchmarks (such as “swap”yields) would decrease the value of our fixed rate assets. We have entered intocertain swap transactions in anticipation of drawing upon our mark-to-marketdebt to hedge against this risk. Some of our loans are subject to variousinterest rate floors. As a result, if interest rates fall below the floorrates, the spread between the yield on our assets and our cost of funds willincrease, which will generally increase our returns. Because we generate incomeprincipally from the spread between the yields on our assets and the cost ofour borrowing and hedging activities, our net income will generally increase ifLIBOR increases and decreases if LIBOR decreases, but this may not always betrue in the future. Our exposure to interest rates will also be affected by ouroverall corporate leverage, which we generally target to be 70% to 80% of thecarrying value of our assets, although our actual leverage may vary dependingon our mix of assets.

In theevent of a significant rising interest rate environment and/or economicdownturn, delinquencies and defaults could increase and result in credit lossesto us, which could adversely affect our liquidity and operating results. Further,such delinquencies or defaults could have an adverse effect on the spreadsbetween interest-earning assets and interest-bearing liabilities.

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**The aggregate carrying values, allocated by producttype and weighted average coupons of our loans and other lending investments asof March 31, 2006 and December 31, 2005 were as follows:**
| ** **                                          | ** ** | **Carrying Value (1)  ($ in thousands)** | ** ** | **Allocation by  Investment Type** | ** ** | **Fixed Rate:  Average Yield** | ** ** | **Floating Rate:  Average Spread  over LIBOR (2)** | ** ** |
|-----------------------------------------------------|------------|--------------------------------------------------------------|------------|----------------------------------------------|------------|------------------------------------------|------------|------------------------------------------------------------------------|------------|
| ** **                                          | ** ** | **2006**                                                     | ** ** | **2005**                                     | ** ** | **2006**                                 | ** ** | **2005**                                                               | ** ** | **2006** | ** ** | **2005** | ** ** | **2006** | ** ** | **2005** | ** ** |
| Whole loans, floating rate                          |       | $                                                            | 775,307    |                                         | $          | 561,388                                  |       | 50                                                                     | %          | 46 | % | — |   | — |   | 310 bps |   | 325 bps |   |
| Whole loans, fixed rate                             |       | 112,192                                                      |       | 94,448                                       |       | 7                                        | %          | 8                                                                      | %          | 9.46 | % | 10.64 | % | — |   | — |   |
| Subordinate interests in whole loans, floating rate |       | 391,167                                                      |       | 362,983                                      |       | 25                                       | %          | 30                                                                     | %          | — |   | — |   | 385 bps |   | 443 bps |   |
| Subordinate interests in whole loans, fixed rate    |       | 47,888                                                       |       | 37,104                                       |       | 3                                        | %          | 3                                                                      | %          | 9.55 | % | 9.19 | % | — |   | — |   |
| Mezzanine loans, floating rate                      |       | 150,057                                                      |       | 82,793                                       |       | 10                                       | %          | 7                                                                      | %          | — |   | — |   | 815 bps |   | 858 bps |   |
| Mezzanine loans, fixed rate                    |       | 43,319                                                       |       | 43,352                                       |       | 3                                        | %          | 4                                                                      | %          | 8.88 | % | 8.88 | % | — |   | — |   |
| Preferred equity, floating rate                |       | 11,822                                                       |       | 11,795                                       |       | 1                                        | %          | 1                                                                      | %          | — |   | — |   | 900 bps |   | 900 bps |   |
| Preferred equity, fixed rate                   |       | 11,891                                                       |       | 11,882                                       |       | 1                                        | %          | 1                                                                      | %          | 10.28 | % | 10.28 | % | — |   | — |   |
| Commercial mortgage backed securities               |       | —                                                       |       | —                                       |       | —                                   |       | —                                                                 |       | — |   | — |   | — |   | — |   |
| Total / Average                                     |       | $                                                            | 1,543,643  |                                         | $          | 1,205,745                                |       | 100                                                                    | %          | 100 | % | 9.41 | % | 9.92 | % | 394 bps |   | 417 bps |   |

 

**(1)**          Debt investments arepresented after scheduled amortization payments and prepayments, and are net ofunamortized fees, discounts, asset sales and unfunded commitments.

**(2)**          Spreads over an indexother than LIBOR have been adjusted to a LIBOR based equivalent.

As of March 31,2006, our investment portfolio had the following maturity characteristics:

| Year of Maturity     | ** ** | **Number of  Investments  Maturing** | ** ** | **Current  Carrying Value  (In thousands)** | ** ** | **% of  Total** | ** ** |
|--------------------------------|------------|-------------------------------------------|------------|-------------------------------------------------------|------------|----------------------|------------|
| 2006                           |       | 7                                         |       | $                                                     | 150,630    |                 | 10         | % |
| 2007                           |       | 31                                        |       | 783,436                                               |       | 51                   | %          |
| 2008                           |       | 11                                        |       | 346,430                                               |       | 22                   | %          |
| 2009                           |       | 4                                         |       | 78,632                                                |       | 5                    | %          |
| 2010                           |       | 3                                         |       | 13,043                                                |       | 1                    | %          |
| Thereafter                     |       | 7                                         |       | 171,472                                               |       | 11                   | %          |
| Total                          |       | 63                                        |       | $                                                     | 1,543,643  |                 | 100        | % |
|                           |       |                                      |       |                                                  |       |                 |       |
| Weighted average  maturity (1) |       |                                      |       | 2.2 years                                             |       |                 |       |

 

**(1)**          The calculation ofweighted average maturity is based upon the initial term of the investment anddoes not include option or extension periods, which may be available to theborrower.

Combined aggregateprincipal maturities of our consolidated CDO, repurchase facilities, trustpreferred securities, mortgage note payable and revolving credit facility as ofMarch 31, 2006 are as follows:

|            | ** ** | **Collateralized  Debt  Obligations** | ** ** | **Repurchase  Facilities** | ** ** | **Trust  Preferred  Securities** | ** ** | **Mortgage  Note  Payable** | ** ** | **Revolving  Credit  Facility** | ** ** | **Total** | ** ** |
|------------|------------|---------------------------------------|------------|----------------------------|------------|----------------------------------|------------|-----------------------------|------------|---------------------------------|------------|-----------|------------|
| 2006       |       | $                                     | —     |                       | $          | —                           |       | $                           | —     |                            | $          | —    |       | $ | — |   | $ | —- |   |
| 2007       |       | —                                |       | 198,427                    |       | —                           |       | —                      |       | —                          |       | 198,427   |       |
| 2008       |       | —                                |       | 178,766                    |       | —                           |       | —                      |       | —                          |       | 178,766   |       |
| 2009       |       | —                                |       | —                     |       | —                           |       | —                      |       | —                          |       | —    |       |
| 2010       |       | —                                |       | —                     |       | —                           |       | —                      |       | —                          |       | —    |       |
| Thereafter |       | 810,500                               |       | —                     |       | 150,000                          |       | 41,000                      | (1)        | —                          |       | 1,001,500 |       |
| Total      |       | $                                     | 810,500    |                       | $          | 377,193                          |       | $                           | 150,000    |                            | $          | 41,000    |       | — |   | $ | 1,378,693 |   |
|            |            |                                       |            |                            |            |                                  |            |                             |            |                                 |            |           |            |  |  |  |  |  |  |

 

(1)          We have a 70.7% interest in the entitythat is the obligor under the mortgage note.

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The following table summarizes the notional and fairvalue of our derivative financial instrument at March 31, 2006. Allderivative instruments have been designated as cash flow hedges. The notionalvalue is an indication of the extent of our involvement in this instrument atthat time, but does not represent exposure to credit, interest rate or marketrisks:
| ** **         | ** ** | **Benchmark  Rate** | ** ** | **Notional  Value** | ** ** | **Strike  Rate** | ** ** | **Effective  Date** | ** ** | **Expiration  Date** | ** ** | **Fair  Value** | ** ** |
|--------------------|------------|---------------------|------------|---------------------|------------|------------------|------------|---------------------|------------|----------------------|------------|-----------------|------------|
| Interest Rate Swap |       | 3 month LIBOR       |       | $                   | 40,000     |             | 4.420      | %                   | 7/2005     |                 | 2/2014     |            | $          | 1,933 |   |
| Interest Rate Swap |       | 1 month LIBOR       |       | 3,465               |       | 4.280            | %          | 7/2005              |       | 12/2009              |       | 99              |       |
| Interest Rate Swap |       | 1 month LIBOR       |       | 31,686              |       | 3.855            | %          | 7/2005              |       | 11/2009              |       | 1,341           |       |
| Interest Rate Swap |       | 1 month LIBOR       |       | 3,960               |       | 4.959            | %          | 12/2005             |       | 12/2015              |       | 85              |       |
| Interest Rate Swap |       | 1 month LIBOR       |       | 61,603              |       | 4.760            | %          | 1/2006              |       | 3/2015               |       | 1,916           |       |
| Interest Rate Swap |       | 1 month LIBOR       |       | 6,402               |       | 4.760            | %          | 1/2006              |       | 3/2015               |       | 199             |       |
| Interest Rate Swap |       | 3 month LIBOR       |       | 3,465               |       | 5.178            | %          | 4/2006              |       | 3/2010               |       | (3              | )          |
| Interest Rate Cap  |       | 3 month LIBOR       |       | 23,713              |       | 5.700            | %          | 11/2005             |       | 12/2007              |       | 27              |       |
| Interest Rate Cap  |       | 1 month LIBOR       |       | 14,120              |       | 5.500            | %          | 12/2005             |       | 1/2007               |       | 3               |       |
| Total              |       |                |       | $                   | 188,414    |             |       |                |       |                 |       |            | $          | 5,600 |   |

v

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**ITEM 4. Controls and Procedures**

**Evaluation of Disclosure Controls and Procedures**

Wemaintain disclosure controls and procedures that are designed to ensure thatinformation required to be disclosed in our Exchange Act reports is recorded,processed, summarized and reported within the time periods specified in the SEC’srules and forms, and that such information is accumulated and communicatedto our management, including our Chief Executive Officer and Chief FinancialOfficer, as appropriate, to allow timely decisions regarding requireddisclosure based closely on the definition of “disclosure controls andprocedures” in Rule 13a-15(e). Notwithstanding the foregoing, acontrol system, no matter how well designed and operated, can provide onlyreasonable, not absolute, assurance that it will detect or uncover failureswithin the Company to disclose material information otherwise required to beset forth in the Company’s periodic reports. Also, we may have investments incertain unconsolidated entities. As we do not control these entities, ourdisclosure controls and procedures with respect to such entities arenecessarily substantially more limited than those we maintain with respect toour consolidated subsidiaries.

As ofthe end of the period covered by this report, we carried out an evaluation,under the supervision and with the participation of our management, includingour Chief Executive Officer and our Chief Financial Officer, of theeffectiveness of the design and operation of our disclosure controls andprocedures. Based upon that evaluation, our Chief Executive Officer and ChiefFinancial Officer concluded that our disclosure controls and procedures wereeffective as of the end of the period covered by this report.

**Changes inInternal Controls over Financial Reporting**

**There were no changes in our internal control overfinancial reporting identified in connection with the evaluation of suchinternal control that occurred during Gramercy’s last fiscal quarter that havematerially affected, or are reasonably likely to materially**affect,Gramercy’s internal control over financial reporting.

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**PART II OTHERINFORMATION**

##### **ITEM1.  LEGAL PROCEEDINGS**

See Note 15 to the Consolidated Financial Statements

##### **ITEM1A. RISK FACTORS**

##### There havebeen no material changes to the risk factors disclosed in Item 1A of Part Iin our Annual Report on Form 10-K for the year ended December 31,2005.

##### **ITEM2.  UNREGISTERED SALES OF EQUITYSECURITIES AND USE OF PROCEEDS**

None

#### **ITEM3.  DEFAULTS UPON SENIOR SECURITIES**

None

#### **ITEM4.  SUBMISSION OF MATTERS TO A VOTE OFSECURITY HOLDERS**

None

#### **ITEM5.  OTHER INFORMATION**

On May 10, 2006 we entered into a Sales Agreement (the “SalesAgreement”) with Cantor Fitzgerald & Co., as sales agent (the “SalesAgent”). In accordance with the terms of the Agreement, the Company may offerand sell up to 1,000,000 shares of its common stock (the “Shares”) fromtime to time through the Sales Agent (collectively, the “Transaction”). Salesof the Shares, if any, may be made in privately negotiated transactions and/orany other method permitted by law, including but not limited to sales at otherthan a fixed price made on or through the facilities of the New York StockExchange or sales made to or through a market maker or in any other manner thatmay be deemed to be an at-the-market offering as defined in Rule 415 ofthe Securities Act of 1933, as amended. The Sales Agent will make all sales ona best efforts basis using commercially reasonable efforts consistent with itsnormal trading and sales practices, on mutually agreed terms between the SalesAgent and the Company. The Sales Agent will be entitled to a commission equalto two and one half percent (2.5%) of the Shares sold pursuant to the terms ofthe Sales Agreement. In July 2005, the Company filed a registration statement(File No. 333-126938) on Form S-3 with the SEC, which wasdeclared effective in August 2005 (the prospectus contained therein is referredto as the “Prospectus”). In connection with the Transactions, we will file asupplement to the Prospectus (the “Prospectus Supplement”) with the SEC.

On May 10, 2006 we entered into a Sales Agreement (the “SalesAgreement”) with Merrill Lynch & Co., Merrill Lynch, Pierce, Fenner &Smith Incorporated, as sales agent (the “Sales Agent”). In accordance with theterms of the Agreement, the Company may offer and sell up to1,000,000 shares of its common stock (the “Shares”) from time to timethrough the Sales Agent (collectively, the “Transaction”). Sales of the Shares,if any, may be made in privately negotiated transactions and/or any othermethod permitted by law, including but not limited to sales at other than afixed price made on or through the facilities of the New York Stock Exchange orsales made to or through a market maker or in any other manner that may be deemedto be an at-the-market offering as defined in Rule 415 of the SecuritiesAct of 1933, as amended. The Sales Agent will make all sales on a best effortsbasis using commercially reasonable efforts consistent with its normal tradingand sales practices, on mutually agreed terms between the Sales Agent and theCompany. The Sales Agent will be entitled to a commission equal to two and onehalf percent (2.5%) of the Shares sold pursuant to the terms of the SalesAgreement. In July 2005, the Company filed a registration statement (FileNo. 333-126938) on Form S-3 with the SEC, which wasdeclared effective in August 2005 (the prospectus contained therein is referredto as the “Prospectus”). In connection with the Transactions, we will file asupplement to the Prospectus (the “Prospectus Supplement”) with the SEC.

**ITEM 6.  EXHIBITS**

(a)          Exhibits:

**10.1**                           Form of Amended andRestated Trust Agreement among GKK Capital LP, as depositor, JPMorgan ChaseBank, National Association, as property trustee, Chase Bank USA, NationalAssociation, as Delaware trustee, and the administrative trustees namedtherein, dated January 27, 2006, incorporated by reference to the Company’sAnnual Report on Form 10-K for the fiscal year ended December 31,2005.

**10.2**                           Form of JuniorSubordinated Indenture between GKK Capital LP and JPMorgan Chase Bank, NationalAssociation, as trustee, dated January 27, 2006, incorporated by referenceto the Company’s Annual Report on Form 10-K for the fiscal yearended December 31, 2005.

**10.3**                           Form of Amended andRestated Management Agreement by and between the Company and GKK Manager LLC,incorporated by reference to the Company’s Form 8-K, dated April 19,2006, filed with the Commission on April 20, 2006.

**10.4**                           Form of Amended andRestated Origination Agreement by and between the Company and SL Green RealtyCorp., incorporated by reference to the Company’s Form 8-K, dated April 19,2006, filed with the Commission on April 20, 2006.

**10.5**                           Form of Amended andRestated Agreement of Limited Partnership of GKK Capital LP, incorporated byreference to the Company’s Form 8-K, dated April 19, 2006,filed with the Commission on April 20, 2006.

**10.6**                           Form of Amended andRestated Asset Servicing Agreement by and between GKK Manager LLC and SLGGramercy Services LLC, incorporated by reference to the Company’s Form 8-K,dated April 19, 2006, filed with the Commission on April 20, 2006.

**10.7**                        Form of SecondAmended and Restated Registration Rights Agreement by and between the Companyand SL Green Operating

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**                       **        Partnership, L.P., incorporated by reference to the Company’sForm 8-K, dated April 19, 2006, filed with the Commission on April 20,2006.

**10.8**           Amended and Restated Outsourcing Agreement by and between GKKManager LLC and SL Green Operating Partnership, L.P., filed herewith.

**10.9**           Third Amendment to Master Repurchase Agreement, dated March 21, 2006, by and among GoldmanSachs Mortgage Company, Gramercy Warehouse Funding II LLC and GKK TradingWarehouse II LLC, filed herewith.

**10.10**                     Pricing Letter, datedMarch 21, 2006, by and between Gramercy Warehouse Funding I LLC andWachovia Bank, National Association, filed herewith.

**10.11**                     Form of Sales Agreement,dated May 10, 2006, by and among the Company, GKK Capital LP, GKKManager LLC and Cantor Fitzgerald & Co., filed herewith.

**10.12**                     Form of Sales Agreement,dated May 10, 2006, by and among the Company, GKK Capital LP andMerrill Lynch & Co., Merrill Lynch, PierceFenner & Smith Incorporated, filed herewith.

31.1                           Certificationby the Chief Executive Officer pursuant to Section 302 of theSarbanes-Oxley Act of 2002 filed herewith.

31.2                         Certificationby the Chief Financial Officer pursuant to Section 302 of theSarbanes-Oxley Act of 2002 filed herewith.

32.1                        Certification pursuant to 18U.S.C. section 1350, as adopted pursuant to Section 906 of theSarbanes-Oxley Act of 202 filed herewith.

32.2                        Certification pursuant to 18U.S.C. section 1350, as adopted pursuant to Section 906 of theSarbanes-Oxley Act of 2002 filed herewith.

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**SIGNATURES**

Pursuant to the requirements of the Securities Exchange Act of 1934, theregistrant has duly caused this report to be signed on its behalf by theundersigned thereunto duly authorized.
|        | GRAMERCY CAPITAL CORP. |
|--------|------------------------|
|   |                   |   |
|   |                   |   |
|   | By:                    | /s/ Robert R. Foley |
|   |                   | Robert R. Foley |
|   |                   | Chief Financial Officer |

 

Date:       May 10, 2006

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