**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

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**FORM 10-Q**

 

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x                               **QUARTERLY REPORT PURSUANT TOSECTION 13 OR 15(d) OFTHE SECURITIES EXCHANGE ACT OF 1934**

 

**For thequarterly period ended March 31, 2008**

 

o                                  **TRANSITION REPORT PURSUANT TOSECTION 13 OR 15(d) OFTHE SECURITIES EXCHANGE ACT OF 1934**

 

**For thetransition period from           to           .**

 

**CommissionFile Number: 001-32248**

 

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**GRAMERCYCAPITAL CORP.**

(Exact name ofregistrant as specified in its charter)

 

| **Maryland**                                                      | **** **** | ****06-1722127****                     |
|-------------------------------------------------------------------|----------------|----------------------------------------|
| (State or other  jurisdiction of

incorporation or  organization) |           | (I.R.S. Employer

Identification  No.) |

 

**420Lexington Avenue, New York, New York 10170**

(Address ofprincipal executive offices) (Zip Code)

 

**(212)297-1000**

(Registrant’stelephone number, including area code)

 

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Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days.  YES x     NO o

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, anon-accelerated filer, or a smaller reporting company. See definitions of“large accelerated filer,” “accelerated filer,” and “smaller reporting company”in Rule 12b-2 of the Exchange Act. (Check one):

 
| Large accelerated filer o | Accelerated filer x | Non-accelerated filer o                        | Smaller reporting  company o |
|---------------------------|--------------------------|------------------------------------------------|-----------------------------------|
|                      |                     | (Do not check if a  smaller reporting company) |                              |

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act).     YES o     NO x

 

The number of sharesoutstanding of the registrant’s common stock, $0.001 par value, was 51,208,934as of May 8, 2008.

 

 

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**GRAMERCYCAPITAL CORP.**

 

**INDEX**

 
| **PART I.** | **FINANCIAL INFORMATION** |
|------------------|---------------------------|
|             |                      |
| **ITEM 1.**      | **FINANCIAL STATEMENTS**  |

 
| ** **                                                                                                       | ** **                                                                                      | **PAGE**   |
|------------------------------------------------------------------------------------------------------------------|-------------------------------------------------------------------------------------------------|------------|
|                                                                                                             |                                                                                            |       |
| Consolidated  Balance Sheets as of March 31, 2008 (unaudited) and December 31,  2007                   | 1                                                                                               |
|                                                                                                             |                                                                                            |       |
| Consolidated  Statements of Income for the three months ended March 31, 2008 and 2007  (unaudited)          | 2                                                                                               |
|                                                                                                             |                                                                                            |       |
| Consolidated  Statement of Stockholders’ Equity for the three months ended March 31,  2008 (unaudited) | 3                                                                                               |
|                                                                                                             |                                                                                            |       |
| Consolidated  Statements of Cash Flows for the three months ended March 31, 2008 and 2007  (unaudited)      | 4                                                                                               |
|                                                                                                             |                                                                                            |       |
| Notes to  Consolidated Financial Statements (unaudited)                                                          | 5                                                                                               |
|                                                                                                             |                                                                                            |       |
| **ITEM 2.**                                                                                                      | **MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS** | 35         |
| ** **                                                                                                       | ** **                                                                                      |       |
| **ITEM 3.**                                                                                                      | **QUANTITATIVE  AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**                                 | 58         |
| ** **                                                                                                       | ** **                                                                                      |       |
| **ITEM 4.**                                                                                                      | **CONTROLS AND  PROCEDURES**                                                                    | 60         |
| ** **                                                                                                       | ** **                                                                                      |       |
| **PART II.**                                                                                                | **OTHER INFORMATION**                                                                           | 62         |
| ** **                                                                                                       | ** **                                                                                      |       |
| **ITEM 1.**                                                                                                      | **LEGAL PROCEEDINGS**                                                                           | 62         |
| ** **                                                                                                       | ** **                                                                                      |       |
| **ITEM 1A.**                                                                                                     | **RISK FACTORS**                                                                                | 62         |
| ** **                                                                                                       | ** **                                                                                      |       |
| **ITEM 2.**                                                                                                      | **UNREGISTERED  SALES OF EQUITY SECURITIES AND USE OF PROCEEDS**                                | 62         |
| ** **                                                                                                       | ** **                                                                                      | ** ** |
| **ITEM 3.**                                                                                                      | **DEFAULTS UPON  SENIOR SECURITIES**                                                            | 62         |
| ** **                                                                                                       | ** **                                                                                      | ** ** |
| **ITEM 4.**                                                                                                      | **SUBMISSION OF  MATTERS TO A VOTE OF SECURITY HOLDERS**                                        | 62         |
| ** **                                                                                                       | ** **                                                                                      | ** ** |
| **ITEM 5.**                                                                                                      | **OTHER INFORMATION**                                                                           | 62         |
| ** **                                                                                                       | ** **                                                                                      |       |
| **ITEM  6.**                                                                                                     | **EXHIBITS**                                                                                    | 63         |
| ** **                                                                                                       | ** **                                                                                      |       |
| **SIGNATURES**                                                                                                   | 65                                                                                              |

 

i

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| **PART I.** | **FINANCIAL INFORMATION** |
|------------------|---------------------------|
| **ITEM 1.**      | **Financial Statements**  |

 

**GramercyCapital Corp.**

**Consolidated Balance Sheets**

**(Unaudited,amounts in thousands, except share and per share data)**

** **
| ** **                                                                                                                                                                                                                                      | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                                                                      | ** ** | **2008**           | ** ** | **2007**              | ** ** |
| **Assets:**                                                                                                                                                                                                                                     | ** ** | ** **         | ** ** | ** **            | ** ** |
| Cash and cash equivalents                                                                                                                                                                                                                       |       | $                  | 307,647    |                  | $          | 293,126 |   |
| Restricted cash                                                                                                                                                                                                                                 |       | 75,547             |       | 135,957               |       |
| Loans and other lending investments, net                                                                                                                                                                                                        |       | 2,358,732          |       | 2,441,747             |       |
| Commercial mortgage-backed securities                                                                                                                                                                                                           |       | 835,922            |       | 791,983               |       |
| Investment in unconsolidated joint ventures                                                                                                                                                                                                     |       | 53,066             |       | 49,440                |       |
| Loans held for sale, net                                                                                                                                                                                                                        |       | 195,178            |       | 194,998               |       |
| Commercial real estate, net                                                                                                                                                                                                                     |       | 187,769            |       | 184,121               |       |
| Accrued interest                                                                                                                                                                                                                                |       | 21,197             |       | 24,177                |       |
| Deferred financing costs                                                                                                                                                                                                                        |       | 42,258             |       | 44,381                |       |
| Deferred costs                                                                                                                                                                                                                                  |       | 1,696              |       | 2,271                 |       |
| Other assets                                                                                                                                                                                                                                    |       | 50,709             |       | 42,877                |       |
| Total assets                                                                                                                                                                                                                                    |       | $                  | 4,129,721  |                  | $          | 4,205,078 |   |
| ** **                                                                                                                                                                                                                                      | ** ** | ** **         | ** ** | ** **            | ** ** |
| **Liabilities and Stockholders’ Equity:**                                                                                                                                                                                                  | ** ** | ** **         | ** ** | ** **            | ** ** |
| Repurchase agreements                                                                                                                                                                                                                           |       | $                  | 166,777    |                  | $          | 200,197 |   |
| Credit facility                                                                                                                                                                                                                                 |       | 50,000             |       | —                |       |
| Collateralized debt obligations                                                                                                                                                                                                                 |       | 2,721,700          |       | 2,735,145             |       |
| Mortgage notes payable                                                                                                                                                                                                                          |       | 153,624            |       | 153,624               |       |
| Management fees payable                                                                                                                                                                                                                         |       | 3,239              |       | 2,852                 |       |
| Incentive fee payable                                                                                                                                                                                                                           |       | 2,496              |       | 2,765                 |       |
| Dividends payable                                                                                                                                                                                                                               |       | 24,280             |       | 93,992                |       |
| Accounts payable and accrued expenses                                                                                                                                                                                                           |       | 21,921             |       | 35,188                |       |
| Derivative instruments, at fair value                                                                                                                                                                                                           |       | 116,148            |       | 72,495                |       |
| Other liabilities                                                                                                                                                                                                                               |       | 12,432             |       | 10,085                |       |
| Junior subordinated  deferrable interest debentures held by trusts that issued trust preferred  securities                                                                                                                                      |       | 150,000            |       | 150,000               |       |
| Total liabilities                                                                                                                                                                                                                               |       | 3,422,617          |       | 3,456,343             |       |
|                                                                                                                                                                                                                                            |       |               |       |                  |       |
| Commitments and contingencies                                                                                                                                                                                                                   |       | —             |       | —                |       |
| ** **                                                                                                                                                                                                                                      | ** ** | ** **         | ** ** | ** **            | ** ** |
| **Stockholders’ Equity:**                                                                                                                                                                                                                  | ** ** | ** **         | ** ** | ** **            | ** ** |
| Common stock,  par value $0.001, 100,000,000 shares authorized, 34,853,911 and 34,850,577  shares issued and outstanding at March 31, 2008 and December 31,  2007, respectively                                                       |       | 34                 |       | 34                    |       |
| Series A  cumulative redeemable preferred stock, par value $0.001, liquidation  preference $115,000, 4,600,000 shares authorized, 4,600,000 shares issued and  outstanding at March 31, 2008 and December 31, 2007, respectively |       | 111,205            |       | 111,205               |       |
| Additional paid-in-capital                                                                                                                                                                                                                      |       | 687,426            |       | 685,958               |       |
| Accumulated other comprehensive loss                                                                                                                                                                                                            |       | (108,859           | )          | (65,658               | )          |
| Retained earnings                                                                                                                                                                                                                               |       | 17,298             |       | 17,196                |       |
| Total  stockholders’ equity                                                                                                                                                                                                                |       | 707,104            |       | 748,735               |       |
| Total liabilities and stockholders’ equity                                                                                                                                                                                                 |       | $                  | 4,129,721  |                  | $          | 4,205,078 |   |

 

The accompanying notes are an integral part of these financialstatements.

 

1

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**Gramercy Capital Corp.**

**Consolidated Statements of Income**

**(Unaudited,amounts in thousands, except per share data)**

 
| ** **                                                                                           | ** ** | **Three Months Ended  March 31,** | ** ** |
|------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                                           | ** ** | **2008**                                         | ** ** | **2007** | ** ** |
| **Revenues**                                                                                         | ** ** | ** **                                       | ** ** | ** ** | ** ** |
| Investment  income                                                                                   |       | $                                                | 74,595     |   | $ | 59,969 |   |
| Rental revenue,  net                                                                                 |       | 3,699                                            |       | 1,736 |   |
| Gain on sales  and other income                                                                      |       | 7,797                                            |       | 6,429 |   |
| Total revenues                                                                                       |       | 86,091                                           |       | 68,134 |   |
| ** **                                                                                           | ** ** | ** **                                       | ** ** | ** ** | ** ** |
| **Expenses**                                                                                         | ** ** | ** **                                       | ** ** | ** ** | ** ** |
| Interest expense                                                                                     |       | 41,443                                           |       | 36,461 |   |
| Management fees                                                                                      |       | 7,145                                            |       | 4,839 |   |
| Incentive fee                                                                                        |       | 2,496                                            |       | 2,817 |   |
| Depreciation and  amortization                                                                       |       | 1,830                                            |       | 671 |   |
| Marketing,  general and administrative                                                               |       | 2,804                                            |       | 3,820 |   |
| Provision for  loan loss                                                                             |       | 8,000                                            |       | 1,248 |   |
| Total expenses                                                                                       |       | 63,718                                           |       | 49,856 |   |
| Income before  equity in net income (loss) of unconsolidated joint ventures and provision  for taxes |       | 22,373                                           |       | 18,278 |   |
| Equity in net  income (loss) of unconsolidated joint ventures                                        |       | 3,109                                            |       | (695 | ) |
| Income before  provision for taxes                                                                   |       | 25,482                                           |       | 17,583 |   |
|                                                                                                 |       |                                             |       |   |   |
| Provision for  taxes                                                                                 |       | (11                                              | )          | (534 | ) |
| Net income                                                                                           |       | 25,471                                           |       | 17,049 |   |
| Preferred stock  dividends                                                                           |       | 2,336                                            |       | — |   |
| Net income  available to common stockholders                                                         |       | $                                                | 23,135     |   | $ | 17,049 |   |
|                                                                                                 |       |                                             |       |   |   |
| **Basic earnings per share:**                                                                        | ** ** | ** **                                       | ** ** | ** ** | ** ** |
| Net income  available to common stockholders                                                         |       | $                                                | 0.66       |   | $ | 0.66 |   |
| ** **                                                                                           | ** ** | ** **                                       | ** ** | ** ** | ** ** |
| **Diluted earnings per share:**                                                                      | ** ** | ** **                                       | ** ** | ** ** | ** ** |
| Net income  available to common stockholders                                                         |       | $                                                | 0.66       |   | $ | 0.62 |   |
|                                                                                                 |       |                                             |       |   |   |
| Dividends per  common share                                                                          |       | $                                                | 0.63       |   | $ | 0.56 |   |
|                                                                                                 |       |                                             |       |   |   |
| Basic weighted  average common shares outstanding                                                    |       | 34,854                                           |       | 26,027 |   |
| Diluted weighted  average common shares and common share equivalents outstanding                     |       | 35,015                                           |       | 27,472 |   |

 

Theaccompanying notes are an integral part of these financial statements.

 

2

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**GramercyCapital Corp.**

**Consolidated Statement of Stockholders’ Equity**

**(Unaudited,amounts in thousands, except share data)**

 
| ** **                                                                                             | ** ** | **Common** | ** ** | ** **        | ** ** | ** **           | ** ** | **Accumulated** | ** ** | ** **        | ** ** | ** **   | ** ** | ** ** | ** ** |
|--------------------------------------------------------------------------------------------------------|------------|------------|------------|-------------------|------------|----------------------|------------|-----------------|------------|-------------------|------------|--------------|------------|------------|------------|
| ** **                                                                                             | ** ** | **Stock**  | ** ** | **Series A** | ** ** | **Additional ** | ** ** | **Other**       | ** ** | ** **        | ** ** | ** **   | ** ** | ** ** | ** ** |
| ** **                                                                                             | ** ** | ** ** | ** ** | **Par**           | ** ** | **Preferred**        | ** ** | **Paid-**       | ** ** | **Comprehensive** | ** ** | **Retained** | ** ** | ** ** | ** ** | **Comprehensive** | ** ** |
| ** **                                                                                             | ** ** | **Shares** | ** ** | **Value**         | ** ** | **Stock**            | ** ** | **In-Capital**  | ** ** | **Loss**          | ** ** | **Earnings** | ** ** | **Total**  | ** ** | **Income** | ** ** |
| **Balance  at December 31, 2007**                                                                 |       | 34,850     |       | $                 | 34         |                 | $          | 111,205         |       | $                 | 685,958    |         | $          | (65,658    | )          | $ | 17,196 |   | $ | 748,735 |   |   |   |
| Net income                                                                                             |       |       |       |              |       |                 |       |            |       |              |       | 25,471       |       | 25,471     |       | $ | 25,471 |   |
| Change in net  unrealized loss on derivative instruments                                               |       |       |       |              |       |                 |       |            |       | (43,348           | )          |         |       | (43,348    | )          | (43,348 | ) |
| Change in net  unrealized loss on commercial mortgage-backed securities previously available  for sale |       |       |       |              |       |                 |       |            |       | 147               |       |         |       | 147        |       | 147 |   |
| Stock-based  compensation – fair value                                                            |       |       |       |              |       |                 |       | 1,160           |       |              |       |         |       | 1,160      |       |   |   |
| Deferred  compensation plan, net                                                                       |       | 4          |       |              |       |                 |       | 308             |       |              |       |         |       | 308        |       |   |   |
| Dividends  declared on common stock                                                                    |       |       |       |              |       |                 |       |            |       |              |       | (23,033      | )          | (23,033    | )          |   |   |
| Dividends  declared on preferred stock                                                                 |       |       |       |              |       |                 |       |            |       |              |       | (2,336       | )          | (2,336     | )          |   |   |
| **Balance at March 31, 2008**                                                                     |       | 34,854     |       | $                 | 34         |                 | $          | 111,205         |       | $                 | 687,426    |         | $          | (108,859   | )          | $ | 17,298 |   | $ | 707,104 |   | $ | (17,730 | ) |

 

The accompanying notesare an integral part of these financial statements

 

3

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**GramercyCapital Corp.**

**ConsolidatedStatements of Cash Flows**

**(Unaudited,amounts in thousands)**

 
| ** **                                                             | ** ** | **Three Months Ended March 31,** | ** ** |
|------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                             | ** ** | **2008**                              | ** ** | **2007** | ** ** |
| **Operating  Activities**                                              | ** ** | ** **                            | ** ** | ** ** | ** ** |
| Net income                                                             |       | 25,471                                |       | 17,049 |   |
| Adjustments to  net cash provided by / (used in) operating activities: |       |                                  |       |   |   |
| Depreciation and  amortization                                         |       | 4,795                                 |       | 2,722 |   |
| Amortization of  discount, premium and other fees on investments       |       | (5,125                                | )          | (5,777 | ) |
| Deferred rents  receivable                                             |       | (2,480                                | )          | (1,736 | ) |
| Equity in net  (income) loss of unconsolidated joint ventures          |       | (3,109                                | )          | 695 |   |
| Gain on extinguishment  of debt                                        |       | (3,690                                | )          | — |   |
| Amortization of  stock compensation                                    |       | 1,468                                 |       | 1,836 |   |
| Provision for  loan loss                                               |       | 8,000                                 |       | 1,248 |   |
| Unrealized gain  on derivative instruments                             |       | 147                                   |       | (66 | ) |
| Net realized  gain on loans held for sale                              |       | (10                                   | )          | (2,686 | ) |
| Changes in operating assets and liabilities:                           |       |                                  |       |   |   |
| New investments  in loans held for sale                                |       | —                                |       | (92,238 | ) |
| Proceeds from  sale of loans, loan commitments and loans held for sale |       | —                                |       | 175,246 |   |
| Accrued interest                                                       |       | 2,980                                 |       | 61 |   |
| Other assets                                                           |       | (7,832                                | )          | 64 |   |
| Management fees  payable                                               |       | 387                                   |       | 32 |   |
| Incentive fee  payable                                                 |       | (269                                  | )          | 1,622 |   |
| Settlement of  derivative instruments                                  |       | —                                |       | (460 | ) |
| Accounts  payable, accrued expenses and other liabilities              |       | (10,920                               | )          | (4,112 | ) |
| Net cash provided by operating activities                              |       | 9,812                                 |       | 93,500 |   |
| **Investing  Activities**                                              |       |                                  |       |   |   |
| New investment originations and funded commitments                     |       | (145,954                              | )          | (726,833 | ) |
| Principal collections on investments                                   |       | 140,233                               |       | 381,405 |   |
| Proceeds from loan syndications                                        |       | 85,132                                |       | — |   |
| Investment in commercial real estate                                   |       | (1,828                                | )          | 157 |   |
| Investment in commercial mortgage backed securities                    |       | (43,379                               | )          | — |   |
| Investment in joint venture                                            |       | (517                                  | )          | 93 |   |
| Change in restricted cash from investing activities                    |       | 2,539                                 |       | 8,015 |   |
| Deferred investment costs                                              |       | (441                                  | )          | 733 |   |
| Net cash provided by (used in) investing activities                    |       | 35,785                                |       | (336,430 | ) |
| **Financing  Activities**                                              |       |                                  |       |   |   |
| Proceeds from repurchase facilities                                    |       | 22,867                                |       | 471,079 |   |
| Repayments of repurchase facilities                                    |       | (56,287                               | )          | (502,213 | ) |
| Proceeds from unsecured revolving credit facility                      |       | 50,000                                |       | 75,000 |   |
| Change in restricted cash from financing activities                    |       | 57,871                                |       | 210,880 |   |
| Repurchase of collateralized debt obligations                          |       | (9,810                                | )          | — |   |
| Proceeds from stock options exercised                                  |       | —                                |       | 414 |   |
| Deferred financing costs and other liabilities                         |       | (636                                  | )          | (694 | ) |
| Dividends paid                                                         |       | (95,081                               | )          | (14,420 | ) |
| Net cash (used in) provided by financing activities                    |       | (31,076                               | )          | 240,046 |   |
| Net increase (decrease) in cash and cash equivalents                   |       | 14,521                                |       | (2,884 | ) |
| Cash and cash equivalents at beginning of period                       |       | 293,126                               |       | 19,314 |   |
| Cash and cash equivalents at end of period                             |       | $                                     | 307,647    |   | $ | 16,430 |   |
| **Non-cash  activity**                                                 | ** ** | ** **                            | ** ** | ** ** | ** ** |
| Deferred losses  and other non-cash activity related to derivatives    |       | $                                     | (43,348    | ) | $ | (1,832 | ) |
| **Supplemental  cash flow disclosures**                                | ** ** | ** **                            | ** ** | ** ** | ** ** |
| Interest paid                                                          |       | $                                     | 45,837     |   | $ | 34,756 |   |
| Income taxes  paid                                                     |       | $                                     | 313        |   | $ | 834 |   |

 

Theaccompanying notes are an integral part of these financial statements.

 

4

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**Gramercy Capital Corp.**

**Notes ToConsolidated Financial Statements**

**(Unaudited, amounts in thousands,except share and per share data)**

**March 31,2008**

 

**1.  Organization**

** **

GramercyCapital Corp. (the “Company” or “Gramercy”) is a commercial real estate specialtyfinance company that focuses on the direct origination and acquisition of wholeloans, subordinate interests in whole loans, mezzanine loans, preferred equity,and net lease investments involving commercial properties throughout the UnitedStates.  The Company also established areal estate securities business that focuses on the acquisition, trading andfinancing of commercial mortgage-backed securities, or CMBS, and other realestate related securities.  When evaluatingtransactions, the Company assesses its risk-adjusted return and targettransactions with yields that seek to provide excess returns for the risksbeing taken.

 

Substantiallyall of the Company’s operations are conducted through GKK Capital LP, aDelaware limited partnership, or the Operating Partnership.  The Company, as the sole general partner of,and currently the holder of 100% of the common units of, the OperatingPartnership, have responsibility and discretion in the management and controlof the Operating Partnership, and the limited partners of the OperatingPartnership, in such capacity, have no authority to transact business for, orparticipate in the management activities of, the Operating Partnership.  Accordingly, the Company consolidates theaccounts of our Operating Partnership.

 

TheCompany is externally managed and advised by GKK Manager LLC, or the Manager, amajority-owned subsidiary of SL Green Realty Corp., or SL Green.  At March 31, 2008, SL Green ownedapproximately 22% of the outstanding shares of the Company’s common stock. TheCompany qualified as a real estate investment trust, or REIT, under theInternal Revenue Code commencing with its taxable year ended December 31,2004 and the Company expects to qualify for the current fiscal year.  To maintain the Company’s tax status as aREIT, the Company plans to distribute at least 90% of taxable income.

 

Asof March 31, 2008, the Company held loans and other lending investmentsand CMBS of $3,389,832 net of fees, discounts, and unfunded commitments with anaverage spread to LIBOR of 407 basis points for its floating rate investments,and an average yield of 6.95% for its fixed rate investments.  As of March 31, 2008, the Company alsoheld interests in three credit tenant net lease investments, or CTLinvestments, two interests in fee positions on properties subject to long-termground leases and a 100% fee interest in a property subject to a long-termground lease.

 

**On April 1, 2008 the Companycompleted the acquisition of American Financial Realty Trust (NYSE: AFR), orAmerican Financial, in a transaction with a total value of approximately $3.3billion, including the assumption of approximately $1.3 billion of AmericanFinancial’s secured debt.  Theacquisition combines the existing operating platforms of American Financial andthe Company, creates integrated commercial real estate finance and operatingcompany, and transforms the Company from a pure specialty finance company intoa $7.5 billion diversified enterprise with complementary business linesconsisting of commercial real estate finance and property investments. As aresult of the acquisition, the Company has added approximately 29.2 millionsquare feet of commercial real estate in 38 states and the District of Columbiato its $4.1 billion of loans and other lending investments, CMBS, net leaseproperties and other assets.**

** **

**Basisof Quarterly Presentation**

** **

The accompanyingfinancial statements have been prepared in accordance with accountingprinciples generally accepted in the United States for interim financial informationand with the instructions to Form 10-Q and Article 10 of RegulationS-X.  Accordingly, it does not includeall of the information and footnotes required by accounting principlesgenerally accepted in the United States, or GAAP, for complete financialstatements.  In management’s opinion, alladjustments (consisting of normal recurring accruals) considered necessary forfair presentation have been included. The 2008 operating results for the period presented are not necessarilyindicative of the results that may be expected for the year ending December 31,2008.  These financial statements should be read in conjunction with thefinancial statements and accompanying notes included in the Company’s AnnualReport on Form 10-K for the year ended December 31, 2007.

 

Thebalance sheet at December 31, 2007 has been derived from the auditedfinancial statement at that date, but does not include all the information andfootnotes required by GAAP for complete financial statements.

 

5

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**2.  SignificantAccounting Policies**

** **

**Principles of Consolidation**

** **

Theconsolidated financial statements include the Company’s accounts and those ofthe Company’s subsidiaries which are wholly-owned or controlled by the Company,or entities which are variable interest entities in which the Company is theprimary beneficiary under FASB Interpretation No. 46, or FIN 46, “Consolidationof Variable Interest Entities.”  FIN 46requires a variable interest entity, or VIE, to be consolidated by its primarybeneficiary.  The primary beneficiary isthe party that absorbs a majority of the VIE’s anticipated losses and/or amajority of the expected returns.  TheCompany has evaluated its investments for potential classification as variableinterests by evaluating the sufficiency of the entities’ equity investment atrisk to absorb losses, and determined that the Company is not the primarybeneficiary for any of its investments. Entities which the Company does not control and entities which are VIE’s,but where the Company is not the primary beneficiary, are accounted for underthe equity method.  All significantintercompany balances and transactions have been eliminated.

 

**VariableInterest Entities**

 

The Company’s ownership of the subordinated classes of CMBS from a singleissuer may provide us with the right to control the foreclosure/workout processon the underlying loans.  There arecertain exceptions to the scope of FIN 46R, one of which provides that aninvestor that holds a variable interest in a qualifying special-purpose entity(“QSPE”) does not consolidate that entity unless the investor has theunilateral ability to cause the entity to liquidate. FASB Statement No. 140, or SFAS 140, “Accountingfor Transfers and Servicing of Financial Assets and Extinguishments ofLiabilities,” providesthe requirements for an entity to qualify as a QSPE. To maintain the QSPEexception, the special-purpose entity must initially meet the QSPE criteria andmust continue to satisfy such criteria in subsequent periods. A special-purposeentity’s QSPE status can be affected in future periods by activities by itstransferors or other involved parties, including the manner in which certainservicing activities are performed. To the extent that the Company’s CMBSinvestments were issued by a special-purpose entity that meets the QSPErequirements, the Company records those investments at the purchase price paid.To the extent the underlying special-purpose entities do not satisfy the QSPErequirements, the Company follows the guidance set forth in FIN 46R as thespecial-purpose entities would be determined to be VIEs.

 

The Company has analyzed thepooling and servicing agreements governing each of its controllingclass CMBS investments and the Company believes that the terms of thoseagreements conform to industry standards and are consistent with the QSPEcriteria. However, there is uncertainty with respect to QSPE treatment due toongoing review by accounting standard setters, potential actions by variousparties involved with the QSPE (discussed in the paragraph above), as well asvarying and evolving interpretations of the QSPE criteria under SFAS 140.  Additionally, the standard setters continueto review the FIN 46R provisions related to the computations used to determinethe primary beneficiary of a VIE.

 

At March 31, 2008, theCompany owned securities of three controlling class CMBS trusts with a carryingvalue of $38,508.  The total par amountsof CMBS issued by the three CMBS trusts was $921,654.  Using the fair value approach to calculateexpected losses or residual returns, the Company has concluded that it wouldnot be the primary beneficiary of any of the underlying special-purposeentities.   At March 31, 2008, theCompany’s maximum exposure to loss as a result of its investment in these QSPEstotaled $38,508, which equals the book value of these investments as of March 31,2008.

 

The financing structures that theCompany offers to the borrowers on certain of our real estate loans involve thecreation of entities that could be deemed VIEs and therefore, could be subjectto FIN 46R.  The Company’smanagement has evaluated these entities and has concluded that none of suchentities are VIEs that are subject to the consolidation rules ofFIN 46R.

 

**Cash andCash Equivalents**

 

TheCompany considers all highly liquid investments with maturities of three monthsor less when purchased to be cash equivalents.

** **

**Restricted Cash**

** **

**Restrictedcash at March 31, 2008 consists primarily of $64,581**on deposit with the trustee of the Company’scollateralized debt obligations, or CDOs, representing the proceeds ofrepayments from loans serving as collateral in our CDOs, which will be used tofund investments to replace those trust assets which are repaid or sold by thetrust, interest payments received by the trustee on investments that serve ascollateral for our CDOs, which are remitted to the Company on a quarterlybasis, and future funding obligations on certain investments.  The remaining balance consists of interestreserves held on behalf of borrowers and $1,271 representing the Company’s 

 

6

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proportionateshare of the reserves of 55 Corporate Drive.

 

**Loans and Investments and Loans Held for Sale**

** **

Loansheld for investment are intended to be held to maturity and, accordingly, arecarried at cost, net of unamortized loan origination fees, discounts,repayments, sales of partial interests in loans, and unfunded commitmentsunless such loan or investment is deemed to be impaired.  Loans held for sale are carried at the lowerof cost or market value using available market information obtained throughconsultation with dealers or other originators of such investments.  The Company may originate or acquirepreferred equity interests that allow it to participate in a percentage of theunderlying property’s cash flows from operations and proceeds from a sale orrefinancing.  Should the Company makesuch a preferred equity investment, the Company must determine whether thatinvestment should be accounted for as a loan, joint venture or as an interestin real estate.

 

Specific valuationallowances are established for possible loan losses based on the fair value ofcollateral on an individual loan basis and the consideration of guarantees orother recourse.  The fair value of thecollateral is determined by selecting the most appropriate valuationmethodology, or methodologies, among several generally available and accepted  in the commercial real estate industry.  The determination of the most appropriatevaluation methodology is based on the key characteristics of the collateraltype.  These methodologies include theevaluation of operating cash flow from the property during the projectedholding period, and the estimated sales value of the collateral computed byapplying an expected capitalization rate to the stabilized net operating incomeof the specific property, less selling costs, all of which are discounted atmarket discount rates.  Because thedetermination of estimated value is based upon projections of future economicevents, which are inherently subjective, amounts ultimately realized from loansand investments may differ materially from the carrying value at the balancesheet date.

 

If upon completion of thevaluation, the estimated fair value of the underlying collateral securing theloan is less than the net carrying value of the loan, an allowance is createdwith a corresponding charge to the provision for possible loan losses.  The allowance for each loan is maintained ata level the Company believes is adequate to absorb possible losses.  Impairment losses are recognized as a directwrite-down of the loan investment with a corresponding charge-off to theallowance.  The Company maintained areserve of $16,658 and $8,658 at March 31, 2008 and December 31,2007, respectively.  There were nocharge-offs for the three months ended March 31, 2008.  During the year ended December 31, 2007,charge-offs totaled $3,200.

 

#### **Commercial Mortgage-Backed Securities**

#### ** **

The Company designatesits CMBS investments pursuant to FASB Statement of Financial AccountingStandards No. 115, or SFAS 115, on the date of acquisition of theinvestment.  Held to maturity investmentsare stated at cost plus the amortization of any premiums or discounts and anypremiums or discounts are amortized through the consolidated statements ofincome using the level yield method. CMBS securities that the Company does nothold for the purpose of selling them in the near-term but may dispose of priorto maturity, are designated as available-for-sale and are carried at estimatedfair value with the net unrealized gains or losses recorded as a component ofaccumulated other comprehensive income (loss) in stockholders equity.  Unrealized losses on securities that in thejudgment of management are other than temporary are charged against earnings asa loss on the income statement.  In November 2007,subsequent to financing the Company’s CMBS investments in its CDOs, the Companyredesignated all of its available-for-sale CMBS investments with a book valueof approximately $43.6 million to held to maturity. As of March 31, 2008and December 31, 2007, the unrealized loss on the redesignated CMBSinvestments included in other comprehensive income was $5,428 and $5,575,respectively.

 

The Company accounts forCMBS (other than those of high credit quality or sufficiently collateralized toensure that the possibility of credit loss is remote) under Emerging IssuesTask Force 99-20, “Recognition of Interest Income and Impairment on Purchasedand Retained Beneficial Interests in Securitized Financial Assets,” or EITF99-20.   Accordingly, on a quarterlybasis, when significant changes in estimated cash flows from the cash flowspreviously estimated occur due to actual prepayment and credit loss experience,and the present value of the revised cash flow is less then the present valuepreviously estimated, an other then temporary impairment is deemed to haveoccurred.  The security is written downto fair value with the resulting change against earnings and a new cost basisis established.   The Company calculatesa revised yield based on the current amortized cost of the investment(including any other-than-temporary impairments recognized to date) and the revisedyield is then applied prospectively to recognize interest income.

 

TheCompany determines the fair value of CMBS based on the types of securities inwhich the Company has invested.  Forliquid, investment-grade securities, the Company consults with dealers of suchsecurities to periodically obtain updated market pricing for the same orsimilar instruments.  For non-investmentgrade securities, the Company actively monitors the performance of theunderlying 

 

7

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propertiesand loans and update the Company’s pricing model to reflect changes inprojected cash flows.  The value of thesecurities is derived by applying discount rates to such cash flows based oncurrent market yields.  The yieldsemployed are obtained from the Company’s own experience in the market, advicefrom dealers and/or information obtained in consultation with other investorsin similar instruments.  Because fairvalue estimates may vary to some degree, the Company must make certain judgmentsand assumptions about the appropriate price to use to calculate the fair valuesfor financial reporting purposes. Different judgments and assumptions could result in differentpresentations of value.

 

In accordance with SFAS 115,when the estimated fair value of the security classified as available-for-salehas been below amortized cost for a significant period of time and the Companyconcludes that it no longer has the ability or intent to hold the security forthe period of time over which the Company expects the values to recover to amortizedcost, the investment is written down to its fair value, and this loss isrealized and charged against earnings. The determination of other than temporary impairment is a subjectiveprocess, and different judgments and assumptions could affect the timing ofloss realization.

 

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

#### ** **

ConsolidatedCTL investments are recorded at cost less accumulated depreciation.  Costs directly related to the acquisition ofsuch investments are capitalized. Certain improvements are capitalized when they are determined toincrease the useful life of the building. Capitalized items are depreciated using the straight-line method overthe shorter of the useful lives of the capitalized item or 40 years forbuildings 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-line rent adjustments are no longer recordedand historic results are reclassified as Discontinued Operations.

 

In accordance with FASB No. 141,or SFAS 141, “Business Combinations,” the Company allocates the purchase priceof real estate to land and building and, if determined to be material,intangibles, such as the value of above, below and at-market leases andorigination costs associated with the in-place leases.  The Companydepreciates the amount allocated to building and other intangible assets overtheir estimated useful lives, which generally range from three to 40years.  The values of the above and below-market leases are amortized andrecorded as either an increase (in the case of below-market leases) or adecrease (in the case of above-market leases) to rental income over theremaining 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 tothe contractual termination of the lease and no rental payments are being madeon the lease, any unamortized balance of the related intangible will be writtenoff.  The tenant improvements and origination costs are amortized as anexpense over the remaining life of the lease (or charged against earnings ifthe lease is terminated prior to its contractual expiration date).  TheCompany assesses fair value of the leases based on estimated cash flowprojections that utilize appropriate discount and capitalization rates andavailable market information.  Estimates of future cash flows are based ona number of factors including the historical operating results, known trends,and market/economic conditions that may affect the property.

 

**Investmentsin Unconsolidated Joint Ventures**

 

#### **The Companyaccounts for its investments in unconsolidated joint ventures under the equitymethod of accounting since it exercises significant influence, but does notunilaterally control, the entities and are not considered to be the primarybeneficiary under FIN 46.  In the joint ventures, the rights of the otherinvestor are protective and participating. Unless the Company is determined tobe the primary beneficiary, these rights preclude it from consolidating theinvestments.  The investments are recorded initially at cost as aninvestment in unconsolidated joint ventures, and subsequently are adjusted forequity in net income (loss) and cash contributions and distributions.  Anydifference between the carrying amount of the investments on our balance sheetand the underlying equity in net assets is amortized as an adjustment to equityin net income (loss) of unconsolidated joint ventures over the lesser of thejoint venture term or 40 years.  None of the joint venture debt isrecourse to the Company.  As of March 31,2008 and December 31, 2007, the Company had investments of $53,066 and$49,440 in unconsolidated joint ventures, respectively.**

 

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**Valuationof Financial Instruments**

 

The Company measuresderivatives at fair value.  Investmentsin loans and other lending investments and loans held for sale are held atlower of cost or fair value and lower of cost or fair value less cost tosell.  CMBS are classified as held tomaturity and therefore recorded at the fair value at the date of redesignation.

 

#### **Effective January 1,2008, the Company adopted FASB Statement No. 157, Fair Value Measurements,or SFAS 157, which among other things requires additional disclosures aboutfinancial instruments carried at fair value. SFAS 157 establishes a hierarchaldisclosure framework associated with the level of pricing observabilityutilized in measuring financial instruments at fair value.  Considerable judgment is necessary tointerpret market data and develop estimated fair value.  Accordingly, fair values are not necessarilyindicative of the amounts the Company could realize on disposition of thefinancial instruments.  Financialinstruments with readily available active quoted prices or for which fair valuecan be measured from actively quoted prices generally will have a higher degreeof pricing observability and a lesser degree of judgment utilized in measuringfair value. Conversely, financial instruments rarely traded or not quoted willgenerally have less, or no, pricing observability and a higher degree ofjudgment utilized in measuring fair value. The use of different market assumptions and/or estimation methodologiesmay have a material effect on estimated fair value amounts.**

#### ** **

#### **SFAS 157defines fair value as the price that would be received to sell an asset or paidto transfer a liability in an orderly transaction between market participantsat the measurement date, or an exit price. The level of pricing observability generally correlates to the degree ofjudgment utilized in measuring the fair value of financial instruments.  The less judgment utilized in measuring fairvalue financial instruments such as with readily available active quoted pricesor for which fair value can be measured from actively quoted prices in activemarkets generally have more pricing observability.  Conversely, financial instruments rarelytraded or not quoted have less observability and are measured at fair valueusing valuation models that require more judgment.  Impacted by a number of factors, pricingobservability is generally affected by such items as including the type offinancial instrument, whether the financial instrument is new to the market andnot yet established, the characteristics specific to the transaction andoverall market conditions.**

#### ** **

#### **The threebroad levels defined by the SFAS 157 hierarchy are as follows:**

#### ** **

*Level I*– This level is comprised of financial instruments that have quoted priceswhich are available in active markets for identical assets or liabilities. Thetype of financial instruments included in this category are highly liquidinstruments with quoted prices.

 

*Level II*– This level is comprised of financial instruments that have pricing inputsother than quoted prices in active markets, which are either directly orindirectly observable. The nature of these financial instruments includeinstruments for which quoted prices are available but traded less frequentlyand instruments that are fair valued using other financial instruments, theparameters of which can be directly observed.  Instruments which are generally included in this category are interestrate swaps.

 

*Level III*– This level is comprised of financial instruments that have little to nopricing observability as of the reported date. These financial instruments donot have active markets and are measured using the manager’s best estimate offair value, where the inputs into the determination of fair value requiresignificant management judgment and assumptions.  Instruments which are generally included inthis category are whole loans, subordinate interests in whole loans andmezzanine loans.

 

For afurther discussion regarding the measurement of financial instruments see Note13, “Fair Value of Financial Instruments.”

 

#### **Revenue Recognition**

#### ** **

Interestincome on debt investments is recognized over the life of the investment usingthe effective interest method and recognized on the accrual basis.  Fees received in connection with loancommitments are deferred until the loan is funded and are then recognized overthe term of the loan using the effective interest method.  Anticipated exit fees, whose collection isexpected, are also recognized over the term of the loan as an adjustment toyield.  Fees on commitments that expireunused are recognized at expiration. Fees received in exchange for the credit enhancement of another lender,either subordinate or senior to us, in the form of a guarantee are recognizedover the term 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 the opinion of theManager, a full recovery of income and principal becomes doubtful.  Income recognition is resumed when the loanbecomes contractually current and performance is demonstrated to be resumed.

 

9

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The Company designates loans as non-performing atsuch time as: (1) the loan becomes 90 days delinquent or (2) the loanhas a maturity default.  Allnon-performing loans are placed on non-accrual status and income is recognizedonly upon actual cash receipt.    At March 31,2008, the Company had one first mortgage loan with a carrying value of $10,411and one 40% participation interest in a first mortgage loan with a carryingvalue of $21,000 which were classified as non-performing loans.   At December 31, 2007, the Company hadone non-performing loan with a carrying value of $29,058 which was subsequentlyrepaid in full on March 14, 2008, along with accrued interest andsubstantially all other fees and charges due to the Company.

 

The Company classifies loans as sub-performing ifthey are not performing in accordance with their terms, in all materialrespects, but they do not qualify as non-performing loans.  The specific facts and circumstances of theseloans may cause them to ripen into non-performing loans should certain eventsoccur.  At March 31, 2008, two firstmortgage loans with a total carrying value of $69,755, one second lien loanwith a carrying value of $45,000 and one third lien loan with a carrying valueof $6,764 were classified as sub-performing. In April 2008, the first lien lenders filed notices of default andacceleration with respect to the collateral supporting the second lien andthird lien loans classified as sub-performing loans as of March 31,2008.  The first and second lien loans are secured byland, which is intended primarily for residential development.  Given the ongoing correction in the UnitedStates residential real estate markets, and the fact that the debt structureunderlying this land consists of several tranches with several largeinstitutional lenders in each tranche, we believe that the debt restructuringof these loans will be more complicated and take longer than a more customaryrestructuring.  Therefore, there is moreuncertainty surrounding the possible outcome of these loans.  The Company and its co-lenders are currently evaluating their options toprotect their interests.  At December 31,2007, one first mortgage loan with a carrying value of $10,403, and one 40%participation interest in a first mortgage loan with a carrying value of$22,000, were classified as sub-performing.

 

Insome instances the Company may sell all or a portion of its investments to athird party.  To the extent the fairvalue received for an investment exceeds the amortized cost of that investmentand FASB Statement No. 140, or SFAS 140, “Accounting for Transfers andServicing of Financial Assets and Extinguishments of Liabilities,” criteria ismet, under which control of the asset that is sold is surrendered making it a “truesale,” a gain on the sale will be recorded through earnings as otherincome.  To the extent an investment thatis sold has a discount or fees, which were deferred at the time the investmentwas made and were being recognized over the term of the investment, theunamortized portion of the discount or fees are recognized at the time of saleand recorded as a gain on the sale of the investment through other income.  For the three months ended March 31,2008 and 2007, the Company recognized $10 and $2,686 in net gains from the saleof debt investments or commitments.

 

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. The Company 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 the Company’s CTL investmentsalso pay all operating costs of owned property including real estate taxes.

 

#### **Reserve for Possible Loan Losses**

#### ** **

Specific valuationallowances are established for possible loan losses on loans in instances whereit is deemed possible that the Company will be unable to collect all amounts ofprincipal and interest due according to the contractual terms of the loan.  The Company considers the estimated value ofthe collateral securing the loan, and compares it to the carrying value of theloan.  The estimated value of thecollateral is determined by selecting the most appropriate valuationmethodology, or methodologies, among several generally available andaccepted  in the commercial real estateindustry.  The determination of the mostappropriate valuation methodology is based on the key characteristics of thecollateral type, collateral location, quality of the sponsor, and otherfactors.  These methodologies include theevaluation of operating cash flow from the property during the projectedholding period, and the estimated sales value of the collateral computed byapplying an expected capitalization rate to the stabilized net operating incomeof the specific property, less selling costs, all of which are discounted atmarket discount rates.  Because thedetermination of estimated value is based upon projections of future economicevents, which are inherently subjective, amounts ultimately realized from loansand investments may differ materially from the carrying value at the balancesheet date.

 

If, upon completion ofthe valuation, the estimated value of the underlying collateral securing theloan is less than the net carrying value of the loan, an allowance is createdwith a corresponding charge to the provision for possible loan losses.  The allowance for 

 

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each loan is maintainedat a level the Company believes is adequate to absorb possible losses.  Impairment losses are recognized as a directwrite-down of the loan investment with a corresponding charge-off to theallowance.  During the three months endedMarch 31, 2008, no charge-offs were incurred.  During the year ended December 31, 2007,the Company incurred a charge-off totaling $3,200 related to a defaulted loanwhich had a carrying value of $19,155 at December 31, 2007 and is recordedin other assets.  The Company maintaineda reserve for possible loan losses of $16,658 against investments with acarrying value of $205,414 as of March 31, 2008, and a reserve forpossible loan losses of $8,658 against investments with a carrying value of $264,612as of December 31, 2007.

 

**Deferred Costs**

** **

Deferred costs consist offees and direct costs incurred to originate new investments and are amortizedusing the effective yield method over the related term of the investment.

 

**DeferredFinancing Costs**

 

Deferred financing costsrepresent commitment fees, legal and other third party costs associated withobtaining commitments for financing which result in a closing of suchfinancing.  These costs are amortizedover the terms of the respective agreements and the amortization is reflectedin interest expense.  Unamortizeddeferred financing costs are expensed when the associated debt is refinanced orrepaid before maturity.  Costs incurredin seeking financing transactions, which do not close, are expensed in theperiod in which it is determined that the financing will not close.

 

**Stock Based Compensation Plans**

** **

TheCompany has a stock-based compensation plan, described more fully in Note14.  The Company accounts 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.”

 

TheBlack-Scholes option-pricing model was developed for use in estimating the fairvalue of traded options, which have no vesting restrictions and are fullytransferable.  In addition, optionvaluation models require the input of highly subjective assumptions includingthe expected stock price volatility. Because the Company’s plan has characteristics significantly differentfrom those of traded options and because changes in the subjective inputassumptions can materially affect the fair value estimate, in the Company’sopinion, the existing models do not necessarily provide a reliable singlemeasure of the fair value of the Company’s stock options.

 

Compensationcost for stock options, if any, is recognized ratably over the vesting periodof the award.  The Company’s policy is togrant options with an exercise price equal to the quoted closing market priceof its stock on the business day preceding the grant date.  Awards of stock or restricted stock areexpensed as compensation on a current basis over the benefit period.

 

Thefair value of each stock option granted is estimated on the date of grant forawards to co-leased employees, and quarterly for options issued tonon-employees, using the Black-Scholes option pricing model with the followingweighted average assumptions for grants in 2008 and 2007.

 

| ** **                      | ** ** | **2008**  | ** ** | **2007**  | ** ** |
|---------------------------------|------------|-----------|------------|-----------|------------|
| Dividend yield                  |       | 8.5       | %          | 7.9       | %          |
| Expected life of option         |       | 5.5 years |       | 5.9 years |       |
| Risk-free interest rate         |       | 3.5       | %          | 4.32      | %          |
| Expected stock price volatility |       | 35.0      | %          | 28.0      | %          |

#### ** **

**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, or FFO, plus certainaccounting gains (as defined in the partnership agreement of the OperatingPartnership) exceed the product of the Company’s weighted average stockholdersequity (as defined in the partnership agreement of the Operating Partnership)multiplied by 9.5% (divided by 4 to adjust for quarterly calculations). TheCompany records any distributions on the Class B limited partner interestsas an incentive distribution expense in the period when earned and when paymentof such amounts has become probable and reasonably estimable in accordance withthe partnership agreement.  These cashdistributions will reduce the amount of cash available for distribution to thecommon unit holders in the Operating Partnership and to the Company’s commonstockholders.  The Company incurredapproximately $2,496 and $2,817 with respect to such Class B limitedpartner interests for the three months 

 

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ended March 31, 2008and 2007, respectively.

 

##### **Derivative Instruments**

#### ** **

**In thenormal course of business, the Company uses a variety of commonly usedderivative instruments that are considered**conventional, or “plain vanilla” derivatives, includinginterest rate swaps, caps, collars and floors, to manage, or hedge, interestrate risk.  The Company requires that hedgingderivative instruments be effective in reducing the interest rate risk exposurethat they are designated to hedge.  Thiseffectiveness is essential for qualifying for hedge accounting.  Some derivative instruments are associatedwith an anticipated transaction.  Inthose cases, hedge effectiveness criteria also require that it be probable thatthe underlying transaction occurs. Instruments that meet these hedging criteria are formally designated ashedges at the inception of the derivative contract.  The Company expressly prohibits the use ofunconventional derivative instruments and using derivative instruments fortrading or speculative purposes. Further, the Company has a policy of only entering into contracts withmajor financial institutions based upon their credit ratings and other factors.

** **

**Todetermine the fair value of derivative instruments, the Company uses a varietyof methods and assumptions that are based on market conditions and risksexisting at each balance sheet date. For the majority of financial instrumentsincluding most derivatives, long-term investments and long-term debt, standardmarket conventions and techniques such as discounted cash flow analysis,option-pricing models, replacement cost, and termination cost are used to determinefair 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, the Company is exposed to the effect of interest rate changes andlimits these risks by following established risk management policies andprocedures including the use of derivatives. To address exposure to interest rates, the Company uses derivativesprimarily to hedge the mark-to-market risk of its liabilities with respect to certainof the Company’s assets.   The Companymay also use derivatives to hedge variability in sales proceeds to be receivedupon the sale of loans held for sale.

 

**FASB No. 133,or SFAS 133, “Accounting for Derivative Instruments and Hedging Activities,” asamended by FASB No. 149, requires the Company to recognize all derivativeson the balance sheet at fair value. Derivatives that are not hedges must be adjusted to fair value throughincome.  If a derivative is a hedge,depending on the nature of the hedge, changes in the fair value of thederivative will either be offset against the change in fair value of the hedgedasset, liability, or firm commitment through earnings, or recognized in othercomprehensive income until the hedged item is recognized in earnings.  The ineffective portion of a derivative’schange in fair value will be immediately recognized in earnings.  SFAS 133 may increase or decrease reportednet income and stockholders’ equity prospectively, depending on future levelsof 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.**

** **

The Company may employswaps, forwards or purchased options to hedge qualifying forecastedtransactions.  Gains and losses relatedto these transactions are deferred and recognized in net income as interestexpense or other income in the same period or periods that the underlyingtransaction occurs expires or is otherwise terminated.

 

All hedges held by theCompany are deemed to be effective in meeting the hedging objectivesestablished by the Company’s corporate policy governing interest rate riskmanagement.  The effect of the Company’sderivative instruments on its financial statements is discussed more fully inNote 17.

 

**Income Taxes**

 

TheCompany elected to be taxed as a REIT, under Sections 856 through 860 of theInternal Revenue Code, beginning with taxable year ended December 31,2004.  To qualify as a REIT, the Companymust meet certain organizational and operational requirements, including arequirement to distribute at least 90% of its ordinary taxable income tostockholders.  As a REIT, the Companygenerally will not be subject to federal income tax on taxable income that theCompany distributes to its stockholders. If the Company fails to qualify as a REIT in any taxable year, it willthen be subject to federal income taxes on taxable income at regular corporaterates and will not be permitted to qualify for treatment as a REIT for federalincome tax purposes for four years following the year during whichqualification is lost unless the Internal Revenue Service grants the Companyrelief under certain statutory provisions. Such an event could materially adversely affect the Company’s net incomeand net cash available for distributions to stockholders.  However, the Company believes that it will beorganized and operate in such a manner as to qualify for treatment as a REITand the Company intends to operate in the foreseeable future in such a mannerso that it will qualify as a REIT for federal income tax purposes.  The Company may, however, be subject tocertain state and local taxes.

 

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The Company’s taxable REITsubsidiaries individually referred to as a TRS, are subject to federal, stateand local taxes.

 

**UnderwritingCommissions and Costs**

 

**Underwriting commissions andcosts incurred in connection with**the Company’sstockofferings are reflected as a reduction of additional paid-in-capital.

** **

**EarningsPer Share**

 

The Company presents bothbasic and diluted earnings per share, or EPS. Basic EPS excludes dilution and is computed by dividing net incomeavailable to common stockholders by the weighted average number of commonshares outstanding during the 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.

 

**Use ofEstimates**

 

Thepreparation of financial statements in conformity with GAAP requires managementto make estimates and assumptions that affect the amounts reported in thefinancial statements and accompanying notes. Actual results could differ fromthose estimates.

 

**Concentrationsof Credit Risk**

 

**Financial instruments that potentially subject the Company toconcentrations of credit risk consist primarily of cash investments, debtinvestments and accounts receivable.  TheCompany places its cash investments in excess of insured amounts with highquality financial institutions.  TheManager performs ongoing analysis of credit risk concentrations in the Company’sloan and other lending investment portfolio by evaluating exposure to variousmarkets, underlying property types, investment structure, term, sponsors,tenants and other credit metrics.  Sixinvestments accounted for more than 21% of the total carrying value of theCompany’s loan and other lending investments as of March 31, 2008 and December 31,2007.  Four investments accounted forapproximately 20% of the revenue earned on the Company’s loan and other lendinginvestments for the three months ended March 31, 2008, compared to four**investments which accounted for approximately24% of the revenue earned on the Company’s loan and other lending investmentsfor the three months ended March 31, 2007. The largestsponsor accounted for approximately 4.2% of the revenue earned on the Company’sloan and other lending investments for the three months ended March 31,2008, compared to approximately 4.6%of the revenue earned on the Company’s loan and other lending investments forthe three months ended March 31, 2007.

** **

**Recently Issued AccountingPronouncements**

** **

**In June 2006, the FASB issued Interpretation No. 48, or FIN48, “**Accounting for Uncertainty in Income Taxes.” This interpretation, clarifies theaccounting for uncertainty in income taxes recognized in an enterprise’sfinancial statements in accordance with SFAS 109.  This interpretation prescribes a recognitionthreshold and measurement attribute for the financial statement recognition andmeasurement of a tax position taken or expected to be taken in a taxreturn.  FIN 48 also provides guidance onderecognition, classification, disclosure, and transition.  This interpretation was effective January 1,2007 for the Company.  The adoption ofFIN 48 did not have a material impact on the Company’s financial results forthe year ended December 31, 2007.

** **

**In February 2007,the FASB issued Statement No. 159, or SFAS 159, ‘‘The Fair Value Optionfor Financial Assets and Financial Liabilities.’’  SFAS 159 permits entities to choose tomeasure many financial instruments and certain other items, at fair value. SFAS159 also establishes presentation and disclosure requirements designed tofacilitate comparisons between entities that choose different measurementattributes for similar types of assets and liabilities. SFAS 159 applies toreporting periods beginning after November 15, 2007.  The Company did not elect SFAS 159 forany of its financial assets and financial liabilities as of March 31,2008.**

** **

**In June 2007,the American Institute of Certified Public Accountants, or AICPA, issuedStatement of Position (“SOP”) 07-01**

 

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**“Clarificationof the Scope of the Audit and Accounting Guide for Investment Companies andAccounting by Parent Companies and Equity Method Investors for Investments inInvestment Companies” SOP 07-1.  SOP 07-1clarifies the scope of accounting for investment companies and providesguidance for determining whether an entity is within the scope of the AICPAAudit and Accounting Guide for Investment Companies or the Guide.  For those entities that are investmentcompanies under SOP 07-1, the specialized industry accounting principles of theGuide (referred to as Investment Company accounting) should be retained by aparent company when it consolidates its interest in the investment company orby an equity method investor when it records its interest in the investmentcompany.  The SOP also provides forcertain disclosure requirements for parent companies and equity methodinvestors in investment companies that continue investment company accountingin the parent’s consolidated financial statements or the financial statementsof the equity method investor.  The SOPwas to be effective for fiscal years beginning on or after December 15,2007; however in a meeting on October 17, 2007, the FASB voted toindefinitely defer the effective date and add to the FASB’s technical agenda,consideration of amending certain provisions of the SOP.   The Company maintains an exemption from theInvestment Company Act of 1940, as amended, and is therefore not regulated asan investment company and as a REIT; the Company is not subject to the AICPA’sInvestment Company Accounting and Auditing Guide.   The Company continues to monitor the FASB’sdevelopments with respect to SOP 07-1.**

** **

**In December 2007,the FASB issued Statement No. 141 (revised), “Business Combinations”, orSFAS 141(R), which attempts to improve the relevance, representationalfaithfulness, and comparability of the information that a reporting entityprovides in its financial reports about a business combination and its effects.This Statement replaces SFAS 141, “Business Combinations”. SFAS 141(R) retainsthe fundamental requirements in Statement 141 that the acquisition method ofaccounting (which Statement 141 called the purchase method) be used for allbusiness combinations and for an acquirer to be identified for each businesscombination. This Statement also retains the guidance in SFAS 141 foridentifying and recognizing intangible assets separately from goodwill. Themost significant changes in SFAS 141(R) are: (1) acquisition andrestructuring would be now expensed; (2) stock consideration will bemeasured based on the quoted market price as of the acquisition date instead ofthe date the deal is announced; (3) contingent consideration arising fromcontractual and noncontractual contingencies that meet the more-likely-than-notrecognition threshold will be measured and recognized as an asset or liabilityat fair value at the acquisition date using a probability-weighted discountedcash flows model, with subsequent changes in fair value reflected in earnings.Noncontractual contingencies that do not meet the more-likely-than-not criteriawill continue to be recognized when they are probable and reasonably estimable;and (4) acquirer records 100% step-up to fair value for all assets &liabilities, including the minority interest portion and goodwill is recordedas if a 100% interest was acquired. SFAS 141(R) is effective for fiscalyears beginning after December 15, 2008. The Company is currentlyevaluating the effect, if any, that this pronouncement will have on its futurefinancial position or results of operations.**

** **

**In February 2008,the FASB issued Staff Position No. 140-3, or FSP 140-3, “Accounting forTransfers of Financial Assets and Repurchase Financing Transactions.” FSP 140-3provides guidance on the accounting for a purchase of a financial asset from acounterparty and contemporaneous financing of the acquisition throughrepurchase agreements with the same counterparty.   Under this guidance, the purchase andrelated financing are linked, unless all of the following conditions are met atthe inception of the transaction: (1) the purchase and correspondingfinancing are not contractually contingent; (2) the repurchase financingprovides recourse; (3) the financial asset and repurchase financing arereadily obtainable in the marketplace and are executed at market rates; and (4) thematurity of financial asset and repurchase are not conterminous.   A linked transaction would require adetermination under FAS 140 to conclude if the transaction meets therequirements for sale accounting.  If thelinked transaction does not meet sale accounting requirements, the netinvestment in the linked transaction is to be recorded as a derivative with thecorresponding change in fair value of the derivative being recorded throughearnings.  The value of the derivativewould reflect changes in the value of the underlying debt investments andchanges in the value of the underlying credit provided by the counterparty.  The Company currently presents thesetransactions gross, with the acquisition of the financial assets in totalassets and the related repurchase agreements as financing in total liabilitieson the consolidated balance sheets and the interest income earned on the debtinvestments and interest expense incurred on the repurchase obligations arereported gross on the consolidated income statements.    FAS 140-3 is effective for financialstatements issued for fiscal years beginning after November 15, 2008.   The Company is currently evaluating theeffect, if any, that this pronouncement will have on its future financialposition or results of operations.**

** **

**In March 2008,the FASB issued SFAS No. 161, Disclosures about Derivative Instruments andHedging Activities—an amendment of FASB Statement No. 133, or  SFAS 161. SFAS 161 is intended toimprove financial reporting about derivative instruments and hedging activitiesby requiring enhanced disclosures to enable investors to better understand howand why an entity uses derivative instruments and their effects on an entity’sfinancial position, financial performance and cash flows. SFAS 161 iseffective for financial statements issued for fiscal years and interim periodsbeginning after November 15, 2008 with early application encouraged. TheCompany is currently evaluating the effect, if any, that this pronouncementwill have on its future financial position or results of operations.**

 

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**3.  Loansand Other Lending Investments**

 

**Theaggregate carrying values, allocated by product type and weighted averagecoupons of the Company’s loans and other lending investments  and CMBS as of March 31, 2008 and December 31,2007 were as follows:**

** **
| ** **                                           | ** ** | **Carrying Value (1)** | ** ** | **Allocation by  Investment Type** | ** ** | **Fixed Rate:  Average Yield** | ** ** | **Floating Rate:  Average Spread over LIBOR (2)** | ** ** |
|------------------------------------------------------|------------|------------------------|------------|------------------------------------|------------|--------------------------------|------------|---------------------------------------------------|------------|
| ** **                                           | ** ** | **2008**               | ** ** | **2007**                           | ** ** | **2008**                       | ** ** | **2007**                                          | ** ** | **2008** | ** ** | **2007** | ** ** | **2008** | ** ** | **2007** | ** ** |
| Whole loans,  floating rate                          |       | $                      | 1,565,300  |                               | $          | 1,594,338                      |       | 61                                                | %          | 60 | % | — |   | — |   | 337 bps |   | 332 bps |   |
| Whole loans, fixed rate                              |       | 155,250                |       | 204,192                            |       | 6                              | %          | 8                                                 | %          | 7.15 | % | 7.79 | % | — |   | — |   |
| Subordinate  interests in whole loans, floating rate |       | 142,917                |       | 146,901                            |       | 6                              | %          | 6                                                 | %          | — |   | — |   | 471 bps |   | 447 bps |   |
| Subordinate  interests in whole loans, fixed rate    |       | 43,314                 |       | 61,890                             |       | 2                              | %          | 2                                                 | %          | 8.31 | % | 8.78 | % | — |   | — |   |
| Mezzanine loans,  floating rate                      |       | 411,757                |       | 413,813                            |       | 16                             | %          | 16                                                | %          | — |   | — |   | 603 bps |   | 607 bps |   |
| Mezzanine loans,  fixed rate                         |       | 223,504                |       | 203,753                            |       | 9                              | %          | 8                                                 | %          | 8.99 | % | 8.91 | % | — |   | — |   |
| Preferred  equity, fixed rate                        |       | 11,868                 |       | 11,858                             |       | —                         |       | —                                            |       | 10.09 | % | 10.09 | % | — |   | — |   |
| Subtotal/  Weighted average                          |       | $                      | 2,553,910  |                               | $          | 2,636,745                      |       | 100                                               | %          | 100 | % | 8.30 | % | 8.45 | % | 398 bps |   | 395 bps |   |
|                                                 |       |                   |       |                               |       |                           |       |                                              |       |   |   |   |   |   |   |   |   |
| CMBS, floating rate                                  |       | 54,261                 |       | 23,817                             |       | 7                              | %          | 3                                                 | %          | — |   | — |   | 783 bps |   | 593 bps |   |
| CMBS, fixed rate                                     |       | 781,661                |       | 768,166                            |       | 93                             | %          | 97                                                | %          | 6.21 | % | 6.13 | % | — |   | — |   |
| Subtotal/  Weighted average                          |       | 835,922                |       | 791,983                            |       | 100                            | %          | 100                                               | %          | 6.21 | % | 6.13 | % | 783 bps |   | 593 bps |   |
|                                                 |       |                   |       |                               |       |                           |       |                                              |       |   |   |   |   |   |   |   |   |
| Total                                                |       | $                      | 3,389,832  |                               | $          | 3,428,728                      |       | 100                                               | %          | 100 | % | 6.95 | % | 7.02 | % | 407 bps |   | 397 bps |   |

 

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**(1)  Loansand other lending investments and CMBS are presented after scheduledamortization payments and prepayments, and are net of unamortized fees,discounts, asset sales and unfunded commitments.**

** **

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

 

As of March 31,2008, the Company’s loans and other lending investments and CMBS had thefollowing maturity characteristics:

 
| **Year of Maturity** | ** ** | **Number of  Investments  Maturing** | ** ** | **Current  Carrying Value  (In thousands)** | ** ** | **% of Total** | ** ** |
|--------------------------------|------------|-------------------------------------------|------------|-------------------------------------------------------|------------|--------------------------|------------|
| 2008                           |       | 24                                        |       | $                                                     | 687,372    |                     | 20         | % |
| 2009                           |       | 33                                        |       | 994,444                                               |       | 29                       | %          |
| 2010                           |       | 18                                        |       | 453,298                                               |       | 14                       | %          |
| 2011                           |       | 3                                         |       | 63,734                                                |       | 2                        | %          |
| 2012                           |       | 4                                         |       | 109,025                                               |       | 3                        | %          |
| Thereafter                     |       | 25                                        |       | 1,081,959                                             |       | 32                       | %          |
| Total                          |       | 107                                       |       | $                                                     | 3,389,832  |                     | 100        | % |
|                           |       |                                      |       |                                                  |       |                     |       |
| Weighted average  maturity (1) |       |                                      |       | 3.9 years                                             |       |                     |       |

 

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(1)          The calculation of weighted average maturity is based upon the remaininginitial term of the investment and does not include option or extension periodsor the ability to prepay the investment after a negotiated lock-out period,which may be available to the borrower.

 

For the three monthsended March 31, 2008 and 2007 the Company’s investment income from loanand other lending and CMBS investments was generated by the followinginvestment types:

 
| ** **                            | ** ** | **Three months ended  March 31, 2008** | ** ** | **Three months ended  March 31, 2007** | ** ** |
|---------------------------------------|------------|---------------------------------------------|------------|---------------------------------------------|------------|
| **Investment Type**              | ** ** | **Investment  Income**                      | ** ** | **% of  Total**                        | ** ** | **Investment  Income** | ** ** | **% of  Total** | ** ** |
| Whole loans                           |       | $                                           | 41,721     |                                        | 56         | % | $ | 33,317 |   | 56 | % |
| Subordinate  interests in whole loans |       | 2,712                                       |       | 4                                           | %          | 6,261 |   | 10 | % |
| Mezzanine loans                       |       | 16,562                                      |       | 22                                          | %          | 19,192 |   | 32 | % |
| Preferred equity                      |       | 313                                         |       | —                                      |       | 1,199 |   | 2 | % |
| CMBS                                  |       | 13,287                                      |       | 18                                          | %          | — |   | — |   |
| Total                                 |       | $                                           | 74,595     |                                        | 100        | % | $ | 59,969 |   | 100 | % |

 

15

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At March 31, 2008and December 31, 2007, the Company’s loans and other lending investmentsand CMBS portfolio had the following geographic diversification:

 

| ** **   | ** ** | **2008**            | ** ** | **2007**             | ** ** |
|--------------|------------|---------------------|------------|----------------------|------------|
| **Region**   | ** ** | **Carrying  Value** | ** ** | **% of  Total** | ** ** | **Carrying  Value** | ** ** | **% of  Total** | ** ** |
| Northeast    |       | $                   | 1,119,703  |                 | 33         | % | $ | 1,130,799 |   | 43 | % |
| West         |       | 665,084             |       | 20                   | %          | 714,045 |   | 27 | % |
| South        |       | 360,151             |       | 11                   | %          | 405,410 |   | 15 | % |
| Midwest      |       | 50,277              |       | 1                    | %          | 79,750 |   | 3 | % |
| Southwest    |       | 100,667             |       | 3                    | %          | 103,217 |   | 4 | % |
| Mid-Atlantic |       | 129,286             |       | 4                    | %          | 150,300 |   | 6 | % |
| Various      |       | 964,664             |       | 28                   | %          | 53,224 |   | 2 | % |
| Total        |       | $                   | 3,389,832  |                 | 100        | % | $ | 2,636,745 |   | 100 | % |

 

At March 31, 2008and December 31, 2007, the Company’s loans and other lending investments,excluding CMBS, by property type are as follows:

 

| ** **             | ** ** | **2008**            | ** ** | **2007**             | ** ** |
|------------------------|------------|---------------------|------------|----------------------|------------|
| **Property Type** | ** ** | **Carrying  Value** | ** ** | **% of  Total** | ** ** | **Carrying  Value** | ** ** | **% of  Total** | ** ** |
| Office                 |       | $                   | 1,017,511  |                 | 40         | % | $ | 970,362 |   | 37 | % |
| Hotel (1)              |       | 423,632             |       | 17                   | %          | 468,604 |   | 18 | % |
| Multifamily            |       | 362,269             |       | 14                   | %          | 366,665 |   | 14 | % |
| Retail(3)              |       | 217,241             |       | 8                    | %          | 217,223 |   | 8 | % |
| Land-commercial        |       | 199,306             |       | 8                    | %          | 200,445 |   | 7 | % |
| Land-residential (2)   |       | 111,321             |       | 4                    | %          | 138,771 |   | 5 | % |
| Condominium            |       | 131,142             |       | 5                    | %          | 126,771 |   | 5 | % |
| Mixed-use              |       | 22,691              |       | 1                    | %          | 80,784 |   | 3 | % |
| Industrial             |       | 51,254              |       | 2                    | %          | 50,730 |   | 2 | % |
| Other                  |       | 17,543              |       | 1                    | %          | 16,390 |   | 1 | % |
| Total                  |       | $                   | 2,553,910  |                 | 100        | % | $ | 2,636,745 |   | 100 | % |

 

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(1)  Two first mortgage loans with an aggregate carrying value of$69,755 secured by hotel properties controlled by the same sponsor group wereclassified as sub-performing as of March 31, 2008.  Subsequent to December 31, 2007, anon-monetary, technical event of default was triggered with respect to one ofthe loans, which automatically triggered a cross-default provision with theother loan.  Both loans were subject to aforbearance agreement, and both properties were being operated by anindependent, national hotel management company pursuant to a court order soughtby the Company.

 

(2)  All of the loans secured by residential land are secured byfirst mortgages or first deeds of trust, except for two mezzanine loans to thesame sponsor with an aggregate carrying value of $51,764.  These loans, which were classified assub-performing as of March 31,2008, were subsequently amended to waive certain defaults and permit thedeferral of interest, and precluding the first mortgage lenders from exercisingtheir rights and remedies (including acceleration and foreclosure) until April 2008.A subsequent proposal to recapitalize the borrower was recently rejected by thesenior lenders. In April 2008, the first lien lenders filed notices of defaultand acceleration with respect to the collateral supporting the second lien andthird lien loans classified as sub-performing loans as of March 31,2008.  The first and second lien loansare secured by land, which is intended primarily for residentialdevelopment.  Given the ongoingcorrection in the United States residential real estate markets, and the factthat the debt structure underlying this land consists of several tranches withseveral large institutional lenders in each tranche, we believe that the debtrestructuring of these loans will be more complicated and take

 

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longerthan a more customary restructuring. Therefore, there is more uncertainty surrounding the possible outcome ofthese loans. The Company and its co-lenders are currently evaluating theiroptions to protect their interests. Absent a new recapitalization proposal acceptable to the first mortgagelenders, the Company expects these loans are likely to be classified asnon-performing during the second quarter of 2008.

 

(3)  In April 2008, the borrower under afirst mortgage loan with a carrying value of $101,853 filed legal action inconnection with a rebalancing notice delivered by the Company to the borrower.The Company believes the borrower’s claim is without merit. The Company hasfiled a counterclaim and is considering further action to enforce its rights.

 

The following is a summary of the Company’s CMBS investments atMarch 31, 2008:
| **Description**     | ** ** | **Number of  Securities** | ** ** | **Face Value** | ** ** | **Book  Value** | ** ** | **Gross  Unrealized  Gain** | ** ** | **Gross  Unrealized  Loss** | ** ** | **Fair Value** | ** ** |
|---------------------|------------|--------------------------------|------------|---------------------|------------|-----------------|------------|-----------------------------|------------|-----------------------------|------------|---------------------|------------|
|                |       |                           |       |                |       |            |       |                        |       |                        |       |                |       |
| Held to maturity:   |       |                           |       |                |       |            |       |                        |       |                        |       |                |       |
|                |       |                           |       |                |       |            |       |                        |       |                        |       |                |       |
| Floating rate  CMBS |       | 7                              |       | $                   | 58,664     |            | $          | 54,261                      |       | $                           | 584        |                | $          | (8,890 | ) | $ | 45,955 |   |
| Fixed rate CMBS     |       | 54                             |       | 810,578             |       | 781,661         |       | 383                         |       | (153,944                    | )          | 628,100             |       |
| Total               |       | 61                             |       | $                   | 869,242    |            | $          | 835,922                     |       | $                           | 967        |                | $          | (162,834 | ) | $ | 674,055 |   |

 

The following is asummary of the underlying credit rating of the Company’s CMBS investments at March 31,2008:

** **
| ** ** | ** ** | **Book Value** | ** ** | **Percentage** | ** ** |
|------------|------------|---------------------|------------|----------------|------------|
| AAA        |       | $                   | 768,100    |           | 92         | % |
| AA         |       | 29,314              |       | 4              |       |
| BBB-       |       | 11,807              |       | 1              |       |
| BB+        |       | 7,412               |       | 1              |       |
| BB         |       | 4,642               |       | 1              |       |
| B+         |       | 4,639               |       | —         |       |
| B          |       | 4,058               |       | —         |       |
| B-         |       | 4,988               |       | 1              |       |
| Not rated  |       | 962                 |       | —         |       |
| Total      |       | $                   | 835,922    |           | 100        | % |

** **

**The Company recorded provisions for loan losses of $8,000and $1,248 for the three months ended March 31, 2008, and 2007,respectively.  These provisions representincreases in loan loss reserves based on management’s estimates consideringdelinquencies, loss experience and collateral quality by individual asset orcategory of asset.**

** **

**There were no charge-offs for the three months ended March 31,2008.  During the year ended December 31,2007, the Company incurred a charge-off totaling $3,200, relating to onedefaulted loan which had a carrying value of $19,608 and $19,155 at March 31,2008 and December 31, 2007, respectively.**

** **

**Changesin the reserve for possible loan losses were as follows:**

 
| Reserve for possible loan losses, December 31,  2006 |   | $      | 2,460  |   |
|-----------------------------------------------------------|--------|--------|--------|--------|
| Additional provision for loan losses                      |   | 9,398  |   |
| Charge-offs                                               |   | (3,200 | )      |
| Reserve for possible loan losses, December 31,  2007 |   | 8,658  |   |
| Additional provision for loan losses                      |   | 8,000  |   |
| Charge-offs                                               |   | — |   |
| Reserve for possible loan losses, March 31,  2008    |   | $      | 16,658 |   |

** **

TheCompany evaluates CMBS investments to determine if there has been another-than-temporary impairment.  Certainof the Company’s CMBS investments have an unrealized loss as the carrying valueis in excess of the market value.  Theseunrealized losses are primarily the result of market factors other than creditimpairment which is generally indicated by significant change in estimated cashflows from the cash flows previously estimated due to actual prepayments andcredit loss experience.  The Company’sCMBS 

 

17

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investmentshave been in a continuous loss for less than 12 months.  The Company believes the carrying value ofthe securities are fully recoverable over their expected holding period.  The Company possesses both the intent and theability to hold the securities until it has recovered the amortized costs.  Accordingly, the Company does not believe anyof the securities are other than temporarily impaired.

 

Inconnection with a preferred equity investment, which was repaid in October 2006,the Company has guaranteed a portion of the outstanding principal balance ofthe first mortgage loan that is a financial obligation of the entity in whichthe Company has invested in the event of a borrower default under suchloan.  The loan matures in 2032.  This guarantee is considered to be anoff-balance-sheet arrangement and will survive until the repayment of the firstmortgage loan.  As compensation, theCompany received a credit enhancement fee of $125 from the borrower, which isrecognized as the fair value of the guarantee and has been recorded on itsbalance sheet as a liability. The liability will be amortized over the life ofthe guarantee using the straight-line method and corresponding fee income willbe recorded.  The Company’s maximumexposure under this guarantee is approximately $1,420 as of March 31,2008.  Under the terms of the guarantee,the investment sponsor is required to reimburse us for the entire amount paidunder the guarantee until the guarantee expires.

 

**4.  Property Acquisitions**

** **

***55 CorporateDrive***

** **

**In June 2006, the Companyclosed on the acquisition of a 49.75% TIC interest in 55 Corporate Drive,located in Bridgewater, New Jersey, with a 0.25% interest to be acquired in thefuture.  The property is comprised ofthree buildings totaling 670,000 square feet which is 100% net leased to anentity whose obligations are guaranteed by Sanofi-Aventis Group through April 2023.The transaction was valued at $236,000 and was financed with a $190,000,10-year, fixed-rate first mortgage loan. The remaining 50% of the property is owned as a TIC interest by anaffiliate of SL Green.   Upon closing theacquisition of the property, the $90,000 whole loan previously held by theCompany was repaid in full using proceeds from the new mortgage financing.  The Company** recorded its pro rata share of net (loss) income ofthe property of $(83) and $74 for the three months ended March 31, 2008and 2007, respectively.

** **

***292 Madison***

** **

**In July 2007, the Company acquired a 100% fee interestin the property located at 292 Madison Avenue, New York, NY, from an affiliateof SL Green for $71,871.   The purchasecontract was negotiated directly between SL Green and the third party, and wetook an assignment of the purchase contract at closing.  The Company entered into a 70-year groundlease with the unaffiliated third party which negotiated the purchase contractwith the third party then simultaneously purchased from SL Green, the Class Boffice building situated on the property. The Company’s acquisition of the fee interest was financed with a$59,099 ten-year fixed rate mortgage loan. The Company recorded operating income on the property of $754 for thethree months ended March 31, 2008.**

** **

**5.Disposition of Security Interests in Property**

** **

***200 FranklinSquare Drive***

** **

In September 2005,the Company closed on the acquisition of a 100% fee interest in 200 FranklinSquare Drive, located in Somerset, New Jersey. The property is a 200,000 squarefoot building which is 100% net leased to Philips Holding USA Inc., awholly-owned subsidiary of Royal Philips Electronics, through December 2021.  The property was acquired for a purchaseprice of $50,250, excluding closing costs, and financed with a $41,000,ten-year, fixed-rate first mortgage loan.

 

In March 2006,following the conversion of the entity that owns 200 Franklin Square Drive intoa Delaware statutory trust, or DST, the Company sold approximately 29.3% of itssecurity interests in the DST to a third party. Subsequently, the Company sold an additional 45.7% of its securityinterests in the DST to the same party, reducing the Company’s final ownershipinterest to 25.0%.  The Company receivedtotal cash consideration of $12,800 for these interests and the buyer assumed75% of the DST’s underlying mortgage debt. The disposition resulted in a net gain of $4,530, after transactioncosts.  As a result of the disposition,this investment is now classified as an investment in joint venture andaccounted for using the equity method. As of March 31, 2008 and 2007 the investment has a carrying valueof $2,207 and $2,457, respectively.  TheCompany recorded its pro rata share of net income of the joint venture of $31and $31 for the three months ended March 31, 2008 and 2007, respectively.

 

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**6. Investments in Unconsolidated Joint Ventures**

** **

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

** **

**In April 2005, the Companyclosed on a $57,503 initial investment in a joint venture with SL Green toacquire, own and operate the South Building located at One Madison Avenue, NewYork, New York, or the South Building. The joint venture is owned 45% by a wholly-owned subsidiary and 55% by awholly-owned subsidiary of SL Green.  Thejoint venture interests are *pari passu*.  The joint venture completed the acquisitionof the South Building from Metropolitan Life Insurance Company for the purchaseprice of approximately $802,800 plus closing costs, financed in part through a$690,000 first mortgage loan on the South Building.  The first mortgage was non-recourse to theCompany.  The South Building comprisesapproximately 1.2 million square feet and is almost entirely net leased toCredit Suisse Securities (USA) LLC, or CS, pursuant to a lease with a 15-yearremaining term.**In July 2007,the Company entered into an agreement to sell its entire investment in the OneMadison Avenue joint venture to SL Green for approximately $147.0 million,subject to an external appraisal, which was to be approved by the board ofdirectors of both parties. In August 2007, an affiliate of SL Green loanedapproximately $147.0 million to the Operating Partnership. This loan was to berepaid with interest at an annual rate of 5.80% on the earlier of September 1,2007 or the closing of the sale of the Company’s 45% interest in One MadisonAvenue to SL Green. The sale transaction closed on August 17, 2007, atwhich time the Company realized a gain of $92,235 and simultaneously repaid theentire loan amount with interest due through such date.  As of March 31, 2007 the investment had a carrying value of$54,832.  The Company recorded its prorata share of net losses of the joint venture of $335 for the three monthsended March 31, 2007.  Since theinvestment was sold during August 2007, the investment had no impact onthe balance sheet or income statement of the Company for the three month periodending March 31, 2008.

** **

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

** **

**In November 2005, theCompany closed on the purchase of a 50% interest in an office building inPasadena, CA.  The Company also acquiredan interest in certain related assets as part of the transaction. The 345,000square foot office property, which is net leased to Bank of America through September 2015,assuming the exercise of options, and related collateral were acquired for$52,000 plus closing costs, using a non-recourse, $50,000, ten-year fixed-ratefirst mortgage loan.  For the threemonths ended March 31, 2008 and 2007, the Company recorded its pro ratashare of net losses of the joint ventures of $357 and $390, respectively.**

** **

***2 HeraldSquare, New York, New York***

** **

In April 2007, theCompany purchased for $103,200 a 45% TIC interest to acquire the fee interestin a parcel of land located at 2 Herald Square, located along 34th Street inNew York, New York. The acquisition was financed with a $86,063 ten-year fixedrate mortgage loan. The property is subject to a long-term ground lease with anunaffiliated third party for a term of 70 years. The remaining TIC interest isowned by a wholly-owned subsidiary of SL Green. The TIC interests are paripassu. As of March 31, 2008, the investment had a carrying value of$22,074. The Company recorded its pro rata share of net income of $1,504 forthe three months ended March 31, 2008.

 

***885 ThirdAvenue, New York, New York***

** **

In July 2007, theCompany purchased for $144,240 an investment in a 45% TIC interest to acquire a79% fee interest and 21% leasehold interest in the fee position in a parcel ofland located at 885 Third Avenue, on which is situated The Lipstick Building.The transaction was financed with a $120,443 ten-year fixed-rate mortgage loan.The property is subject to a 70-year leasehold ground lease with anunaffiliated third party. The remaining TIC interest is owned by a wholly-ownedsubsidiary of SL Green. The TIC interests are *paripassu.*As of March 31, 2008, the investment had a carryingvalue of $30,694. The Company recorded its *prorata*share of net income of $1,931 for the three months ended March 31,2008.

 

**7.  Junior Subordinated Debentures**

** **

**In January 2006, May 2005and August 2005, the Company completed issuances of $50,000 each inunsecured trust preferred securities through three DST’s, Gramercy CapitalTrust I, or GCTI, Gramercy Capital Trust II, or GCTII, and Gramercy CapitalTrust II, or GCT III, that are also wholly-owned subsidiaries of the OperatingPartnership.  The securities issued in January 2006bear interest at a fixed rate of 7.65% for the first ten years ending January 2016,with an effective rate of 7.43% when giving effect to the swap arrangementpreviously entered into in contemplation of this financing.  Thereafter the rate will float based on thethree-month LIBOR plus 270 basis points. The securities issued in May 2005 bear interest at a fixed rate of7.57% for the first ten years ending June 2015 and the securities issuedin August 2005 bear interest at a fixed rate of 7.75% for the first tenyears ending October 2015. Thereafter the rates will float based on the**

 

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three-month LIBOR plus 300 basis points.

 

Allissuances of trust preferred securities require quarterly interestdistributions; however, payments may be deferred while the interest expense isaccrued for a period of up to four consecutive quarters if the OperatingPartnership exercises its right to defer such payments, which it may elect todo on more than one occasion.  The trustpreferred securities are redeemable, at the option of the OperatingPartnership, in whole or in part, with no prepayment premium any time after June 30,2010, October 30, 2010 or January 30, 2011 for the securities issuedby GCTI, GCTII and GCTIII, respectively.

 

GCTI,GCTII and GCTIII each issued $1,550 aggregate liquidation amount of commonsecurities, representing 100% of the voting common stock of those entities tothe Operating Partnership for a total purchase price of $4,650.  GCTI, GCTII and GCTIII used the proceeds fromthe sale of the trust preferred securities and the common securities topurchase the Operating Partnership’s junior subordinated notes.  The terms of the junior subordinated notesmatch the terms of the trust preferred securities.  The notes are subordinate and junior in rightof payment to all present and future senior indebtedness and certain other ofour financial obligations.  The Companyrealized net proceeds from each offering of approximately $48,956.

 

TheCompany’s interests in GCTI, GCTII and GCTIII are accounted for using theequity method and the assets and liabilities of those entities are notconsolidated into its financial statements. Interest on the junior subordinated notes is included in interestexpense on the Company’s consolidated income statements while the value of thejunior subordinated notes, net of the Company’s investment in the trusts thatissued the securities, are presented on the consolidated balance sheet.

 

**8.  Collateralized Debt Obligations**

 

During2005 the Company issued approximately $1,000,000 of CDOs through two indirectsubsidiaries, Gramercy Real Estate CDO 2005-1 Ltd., or the 2005 Issuer,and Gramercy Real Estate CDO 2005-1 LLC, or the 2005 Co-Issuer. The CDOconsists of $810,500 of investment grade notes, $84,500 of non-investment gradenotes, which were co-issued by the 2005 Issuer and the 2005 Co-Issuer, and$105,000 of preferred shares, which were issued by the 2005 Issuer.  The investment grade notes were issued withfloating rate coupons with a combined weighted average rate of three-monthLIBOR plus 0.49%.  The Company incurredapproximately $11,957 of costs related to Gramercy Real Estate CDO 2005-1,which are amortized on a level- yield basis over the average life of the CDO.

 

During2006 the Company issued an additional approximately $1,000,000 of CDOs throughtwo newly-formed indirect subsidiaries, Gramercy Real Estate CDO 2006-1Ltd., or the 2006 Issuer, and Gramercy Real Estate CDO 2006-1 LLC, or the 2006Co-Issuer. The CDO consists of $903,750 of investment grade notes, $38,750 ofnon-investment grade notes, which were co-issued by the 2006 Issuer and the2006 Co-Issuer, and $57,500 of preferred shares, which were issued by the 2006Issuer.  The investment grade notes wereissued with floating rate coupons with a combined weighted average rate ofthree-month LIBOR plus 0.37%. The Company incurred approximately $11,364 ofcosts related to Gramercy Real Estate CDO 2006-1, which are amortized on alevel-yield basis over the average life of the CDO.

 

In August 2007,the Company issued $1,100,000 of CDOs through two newly-formed indirectsubsidiaries, Gramercy Real Estate CDO 2007-1 Ltd., or the 2007 Issuer,and together with the 2005 Issuer and the 2006 Issuer, the Issuers, andGramercy Real Estate CDO 2007-1 LLC, or the 2007 Co-Issuer, and together withthe 2005 Co-Issuer and the 2006 Co-Issuer, the Co-Issuers. The CDO consists of$1,045,550 of investment grade notes, $22,000 of non-investment grade notes,which were co-issued by the 2007 Issuer and the 2007 Co-Issuer, and $32,450 ofpreferred shares, which were issued by the 2007 Issuer.  The investment grade notes were issued withfloating rate coupons with a combined weighted average rate of three-monthLIBOR plus 0.46%. The Company incurred approximately $16,816 of costs relatedto Gramercy Real Estate CDO 2007-1, which are amortized on a level-yield basisover the average life of the CDO.

 

The Company retained all non-investment grade securities, the preferredshares and the common shares in the Issuers and Co-Issuers of each CDO.  The Issuer in each CDO holds assets,consisting primarily of whole loans, subordinate interests in whole loans,mezzanine loans and preferred equity investments and CMBS, which serve ascollateral for the CDO.  Each 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.  The financial statements ofthe Issuer of each CDO are consolidated in our financial statements. Theinvestment grade notes are treated as a secured financing, and are non-recourseto the Company. Proceeds from the sale of the investment grade notes issued ineach CDO were used to repay substantially all outstanding debt under ourrepurchase agreements and to fund additional investments. In January 2008,the Company repurchased $4,000 of Class B notes in the 2005 Issuer and$9,500 of Class B notes in the

 

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2007 Issuer at a dollar price of approximately $0.79 and $0.70, respectively.  The Company recorded a net gain of $3,499 inconnection with the repurchase of notes of such Issuers.

 

**9.  Debt Obligations**

** **

#### **Repurchase Facilities**

#### ** **

**The Company has two repurchasefacilities, one with Wachovia Capital Markets, LLC or one or more of itsaffiliates, or Wachovia, and one with Goldman Sachs Mortgage Company, orGoldman.**

** **

Therepurchase facility with Wachovia is a $500,000 facility.  This facility was initially established as a$250,000 facility, was increased to $350,000 from $250,000 effective January 2005,and was subsequently increased to $500,000 effective April 2005. In June 2007,the Company modified the facility by further reducing the credit spreads.  As a result of the modifications, the$500,000 facility bears interest at spreads of 0.65% to 2.50% over one-monthLIBOR and, based on its expected investment activities, provides for advancerates that vary from 60% to 95% based upon the collateral provided under aborrowing base calculation.  In October 2006,the Company extended the facility’s maturity date until October 2009.  The lender has a consent right with respectto the inclusion of investments in this facility, determines periodically themarket value of the investments, and has the right to require additionalcollateral, a partial repayment of the facility (margin call), or a reductionin unused availability under the facility, sufficient to rebalance the facilityif the estimated market value of the included investments declines.  The Company had no accrued interest and borrowingsof $121,867 at a weighted average spread to LIBOR of 1.33% as of March 31,2008, and no accrued interest and borrowings of $165,286 at a weighted averagespread to LIBOR of 1.33% as of December 31, 2007.

 

Borrowingsunder the Wachovia facility at March 31, 2008 and December 31, 2007were secured by the following investments:

 

| ** **               | ** ** | **Carrying Value** | ** ** |
|--------------------------|------------|--------------------|------------|
| **Investment Type** | ** ** | **2008**           | ** ** | **2007** | ** ** |
| Whole loans              |       | $                  | 306,874    |   | $ | 276,869 |   |
| Mezzanine loans          |       | 149,160            |       | 148,164 |   |
| Total                    |       | $                  | 456,034    |   | $ | 425,033 |   |

** **

TheCompany also has a repurchase facility with Goldman.  In October 2006 the Company increasedthis facility from $200,000 to $400,000 and extended its maturity date until September 2009.  In June 2007, it modified the facilityby further reducing the credit spreads. As a result of the modifications, the facility bears interest at spreadsof 1.00% to 1.50% over one-month LIBOR and, based on its expected investmentactivities, provides for advance rates that vary from 70% to 90% based upon thecollateral provided under a borrowing base calculation.  As with the Wachovia facility, the lender hasa consent right to the inclusion of investments in this facility, determinesperiodically the market value of the investments, and has the right to requireadditional collateral, a partial repayment of the facility (margin call), or areduction in unused availability under the facility, sufficient to rebalancethe facility if the estimated market value of the included investmentsdeclines.  The Company had accruedinterest of $128 and borrowings of $44,910 at a weighted average spread toLIBOR of 1.18% as of March 31, 2008, and accrued interest of $189 andborrowings of $34,911 at a weighted average spread to LIBOR of 1.07% under thisfacility at December 31, 2007.

 

Borrowingsunder the Goldman facility at March 31, 2008 and December 31, 2007were secured by the following investments:

 

| ** **               | ** ** | **Carrying Value** | ** ** |
|--------------------------|------------|--------------------|------------|
| **Investment Type** | ** ** | **2008**           | ** ** | **2007** | ** ** |
| Whole loans              |       | $                  | 152,805    |   | $ | 151,679 |   |
| Mezzanine loans          |       | —             |       | — |   |
| Total                    |       | $                  | 152,805    |   | $ | 151,679 |   |

 

The terms of the Company’srepurchase facilities (together with any related guarantees) include covenantsthat****(a) limit our maximumtotal indebtedness to no more than 85% of total assets, (b) require us tomaintain minimum liquidity of at least $15,000, (c) require our fixedcharge coverage ratio to be at no time less than 1.25 to 1.00, (d) requirethe Company’s minimum interest coverage ratio to be at no time less than 1.35to 1.00, and (e) require the Company to maintain minimum tangible networth of not less than (i) $400,000, plus 

 

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(ii) 75% of the netproceeds of the Company’s subsequent equity issuances following the date of theJune 2007 amendments. The covenants also restrict the Company from makingannual distributions in excess of a maximum of 100% of our FFO (as definedtherein) for the previous four quarters under the Wachovia facility, exceptthat we may in any case pay distributions necessary to maintain the Company’sREIT status.  An event of default can be triggered on the Company’s repurchasefacilities if, among other things, GKK Manager LLC is terminated as theManager.  As of March 31, 2008 and December 31,2007, the Company was in compliance with all such covenants.

 

The repurchase facilitiesrequire that the Company pay down borrowings under these facilities asprincipal payments on the loans and investments pledged to these facilities arereceived.  Assets pledged as collateral under thesefacilities may include stabilized and transitional whole loans, subordinateinterests in whole loans, mezzanine loans, and rated CMBS or commercial realestate CDO securities originated or acquired by the Company.

 

#### **UnsecuredRevolving Credit Facility**

 

In May 2006, theCompany closed on a $100,000 senior unsecured revolving credit facility withKeyBank National Association, or KeyBank, with an initial term of three yearsand a one-year extension option.  Theinitial facility was supported by a negative pledge of an identified asset base(involving substitution rights) with advance rates that vary from 30% to 90% ofthe asset value provided under a borrowing base calculation.  The lender also had consent rights to theinclusion of assets in the borrowing base calculation.  The facility bore interest at 1.90% overone-month LIBOR to the extent the Company’s leverage ratio, defined as totalliabilities to total assets, including the Company’s proportionate share of theliabilities and assets of the Company’s unconsolidated subsidiaries, is lessthan 80% and 2.10% over one-month LIBOR to the extent the Company’s leverageratio is equal to or greater than 80%. In June 2007 the facility wasincreased to $175,000 and interest spreads on the facility were reduced.  The facility is supported by a negativepledge of an identified asset base with advance rates that vary from 30% to 90%of the asset value provided under a borrowing base calculation.  The lender also has consent rights to theinclusion of assets in the borrowing base calculation. Following themodifications in June 2007, the facility bears interest at 1.65% overone-month LIBOR. The Company had accrued interest of $6 and borrowings of$50,000 as of March 31, 2008, and no accrued interest and borrowings underthis facility at December 31, 2007.

 

The terms of theunsecured revolving credit facility include covenants that****(a) limit our maximum totalindebtedness to no more than 85% of total assets, (b) require the Company’sfixed charge coverage ratio to be at no time less than 1.30, and (c) requireus to maintain minimum tangible net worth of not less than $450,000 plus 75% ofthe net proceeds from equity offerings completed following the date of the June 2007amendment.  The covenants also restrictthe Company from making annual distributions in excess of a maximum of 100% of ourFFO (as defined by the National Association of Real Estate Investment Trusts,or NAREIT) for the previous four quarters, except that the Company may in anycase pay distributions necessary to maintain the Company’s REITqualification.  An event of default can be triggered on our unsecured revolving creditfacility if, among other things, GKK Manager LLC is terminated as theManager.  As of March 31, 2008 and December 31,2007, the Company was in compliance with all such covenants.

 

#### **Mortgage Loans**

#### ** **

The Company has twoconsolidated interest-only mortgage loans related to 55 Corporate Drive and 292Madison Avenue. The mortgage loan that financed the acquisition of 55 CorporateDrive in June 2006 has an outstanding principal balance of $190,000, ofwhich the Company has consolidated its ownership percentage of 49.75% or$94,525. This loan has an effective interest rate of 5.75% and a term of tenyears. Interest on this mortgage was capitalized for a portion of the yearended December 31, 2006 as the property was redeveloped. Capitalizedinterest was $1,841 for the year ended December 31, 2006. The mortgageloan that financed the acquisition of 292 Madison Avenue in July 2007 hasan outstanding balance of $59,099, with an effective interest rate of 6.17% anda term of ten years.

 

Combinedaggregate principal maturities of the Company’s consolidated CDOs, repurchasefacilities, trust preferred securities, proportionately consolidated mortgagenote payable related to its TIC interest in 55 Corporate Drive, and unsecuredrevolving credit facility as of March 31, 2008 are as follows:

 

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| ** ** | ** ** | **CDOs**  | ** ** | **Repurchase  Facilities** | ** ** | **Trust  Preferred  Securities** | ** ** | **Mortgage  Note  Payable** | ** ** | **Unsecured  Revolving  Credit  Facility** | ** ** | **Total** | ** ** |
|------------|------------|-----------|------------|----------------------------|------------|----------------------------------|------------|-----------------------------|------------|--------------------------------------------|------------|-----------|------------|
| 2008       |       | $         | —     |                       | $          | —                           |       | $                           | —     |                                       | $          | —    |       | $ | — |   | $ | — |   |
| 2009       |       | —    |       | 166,777                    |       | —                           |       | —                      |       | 50,000                                     |       | 216,777   |       |
| 2010       |       | —    |       | —                     |       | —                           |       | —                      |       | —                                     |       | —    |       |
| 2011       |       | —    |       | —                     |       | —                           |       | —                      |       | —                                     |       | —    |       |
| 2012       |       | —    |       | —                     |       | —                           |       | —                      |       | —                                     |       | —    |       |
| Thereafter |       | 2,721,700 |       | —                     |       | 150,000                          |       | 153,624                     | (1)        | —                                     |       | 3,025,324 |       |
| Total      |       | $         | 2,721,700  |                       | $          | 166,777                          |       | $                           | 150,000    |                                       | $          | 153,624   |       | $ | 50,000 |   | $ | 3,242,101 |   |

 

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(1) The Company has a 49.75% interest in the mortgage notefor $94,525 and a 100% interest in the $59,099 note.

 

**10. **Operating Partnership Agreement / Manager

** **

At March 31,2008, the Company owned all of the Class A limited partnership interestsin the Operating Partnership.  At March 31,2008, the majority of the Class B limited partnership interests were ownedby the Manager and SL Green Operating Partnership, L.P. Interests were alsoheld by certain officers and employees of SL Green, including some of whom arethe Company’s executive officers, certain of which interests are subject toperformance thresholds.

 

At March 31, 2008,the majority of the interests in the Manager were held by SL Green OperatingPartnership, L.P. Interests were also held by certain officers and employees ofSL Green, including some of whom are the Company’s executive officers, certainof which interests are subject to performance thresholds.

 

**11.  Related Party Transactions**

** **

In connection with its initial public offering, theCompany entered into a management agreement with the Manager, which wassubsequently amended and restated in April 2006.  The management agreement provides for a termthrough December 2009 with automatic one-year extension options and issubject to certain termination rights. The Company pays the Manager an annual management fee equal to 1.75% ofour gross stockholders equity (as defined in the management agreement)inclusive of the Company’s trust preferred securities.  The Company incurred expense to the Managerunder this agreement of an aggregate of $7,145 and $4,839 for the three monthsended March 31, 2008 and 2007, respectively.

 

To provide an incentive to enhance the value of theCompany’s common stock, the holders of the Class B limited partnerinterests of the Operating Partnership are entitled to an incentive returnequal to 25% of the amount by which FFO plus certain accounting gains andlosses (as defined in the partnership agreement of the Operating Partnership)exceed the product of the weighted average stockholders equity (as defined inthe partnership agreement of the Operating Partnership) multiplied by 9.5%(divided by four to adjust for quarterly calculations).  The Company will record any distributions onthe Class B limited partner interests as an incentive distribution expensein the period when earned and when payments of such amounts have becomeprobable and reasonably estimable in accordance with the partnershipagreement.  The Company incurred $2,496and $2,817 with respect to such Class B limited partner interests for thethree months ended March 31, 2008 and 2007.

 

The Company is obligated to reimburse the Manager forits costs incurred under an asset servicing agreement between the Manager andan affiliate of SL Green Operating Partnership, L.P. and a separate outsourceagreement between the Manager and SL 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 the Company of 0.05% of the book valueof all credit tenant lease assets and non-investment grade bonds and 0.15% ofthe 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 the Company.  At March 31, 2008, the outsourceagreement provides for an annual fee payable by the Company, which fee iscurrently $1,366 per year, increasing 3% annually over the prior year on theanniversary date of the outsource agreement in August of each year.  For the three months ended March 31,2008 and 2007, the Company realized expense of $341 and $332, respectively, tothe Manager under the outsource agreement. For the three months ended March 31, 2008 and 2007, we realizedexpense of $1,324 and $769, respectively, to the Manager under the assetservicing agreement.  Payments under theoutsource agreement will increase subsequent to the closing of the AmericanFinancial merger to reflect higher costs resulting from the increased size andnumber of assets of the combined company.

 

In connection with the closing of the Company’s first CDO in July 2005,the 2005 Issuer entered into a collateral management agreement with theManager. Pursuant to the collateral management agreement, the Manager hasagreed to provide certain advisory and administrative services in relation tothe collateral debt securities and other eligible investments securing the CDOnotes.  The collateral management agreementprovides 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 a subordinatecollateral 

 

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managementfee, payable quarterly in accordance with the priority of payments as set forthin the indenture, equal to 0.25% per annum of the net outstanding portfoliobalance.  Net outstanding portfoliobalance is the sum of the (i) aggregate principal balance of thecollateral 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 underthe first CDO, the Board of Directors has allocated to the Manager thesubordinate collateral management fee paid on the CDO notes not held by theCompany.  At March 31, 2008 and December 31,2007 the Company owned all of the non-investment grade bonds, preferred equityand equity in the 2005  CDO.  The senior collateral management fee and balance of the subordinatecollateral management fee is allocated to the Company.  For the three months ended March 31,2008 and 2007, the Company realized expense of $512 and $507, respectively, tothe Manager under such collateral management agreement.

 

Exceptfor the 2005 CDO, fees payable in connection with CDOs or other securitizationvehicles are governed by the management agreement.  Pursuant to that agreement, if a collateralmanager is retained as part of the formation of a CDO or other securitization vehicle,the Manager or an affiliate will be the collateral manager and will receive thefollowing fees:  (i) 0.25% per annum of the principal amountoutstanding of bonds issued by a managed transitional CDO that are owned bythird-party investors unaffiliated with the Company or the Manager, which CDOis structured to own loans secured by transitional properties, (ii) 0.15%per annum of the book value of the principal amount outstanding of bonds issuedby a managed non-transitional CDO that are owned by third-party investorsunaffiliated with the Company or the Manager, which CDOs structured to ownloans secured by non-transitional properties, (iii) 0.10% per annum of theprincipal amount outstanding of bonds issued by a static CDO that are owned bythird party investors unaffiliated with the Company or the Manager, which CDOis structured to own non-investment grade bonds, and (iv) 0.05% per annumof the principal amount outstanding of bonds issued by a static CDO that areowned by third-party investors unaffiliated with the Company or the Manager,which CDO is structured to own investment grade bonds.  For the purposes of the management agreement,a “managed transitional” CDO means a CDO that is actively managed, has areinvestment period and is structured to own debt collateral secured primarilyby non-stabilized real estate assets that are expected to experiencesubstantial net operating income growth, and a “managed non-transitional” CDOmeans a CDO that is actively managed, has a reinvestment period and isstructured to own debt collateral secured primarily by non-stabilized realestate assets that are expected to experience substantial net operating incomegrowth, and a “managed non-transitional” CDO means a CDO that is activelymanaged, has a reinvestment period and is structured to own debt collateralsecured primarily by stabilized real estate assets that are not expected toexperience substantial net operating income growth.  Both “managed transitional” and “managednon-transitional” CDOs may at any given time during the reinvestment period ofthe respective vehicles invest in and own non-debt collateral (in limitedquantity) as defined by the respective indentures.  If any fees are paid to the collateralmanager in excess of the fee structure provided for above, such fees are paidto the Company.  For the three months ended March 31,2008 and 2007, the Company realized expense of $571 and $565, respectively, tothe Manager under this agreement.  Withrespect to the CDO which closed in August 2007, the Company realizedexpense of $216 to the Manager for the three months ended March 31, 2008.

 

**In April 2005, the Companyclosed on a $57,503 initial investment in a joint venture with SL Green toacquire, own and operate the South Building located at One Madison Avenue, NewYork, New York, or the South Building. The joint venture, which was owned 45% by a wholly-owned subsidiary ofthe Company and 55% by a wholly-owned subsidiary of SL Green was created toacquire, own and operate the South Building. The joint venture interests were *paripassu*.  The joint venturecompleted the acquisition of the South Building from Metropolitan LifeInsurance Company for the purchase price of approximately $802,800 plus closingcosts, financed in part through a $690,000 first mortgage loan on the SouthBuilding.  The South Building comprisesapproximately 1.2 million square feet and is almost entirely net leased toCredit Suisse Securities (USA) LLC (“CS”) pursuant to a lease with a 15-yearremaining term.  In August 2007 the Companysold its entire investment in the joint venture to SL Green for approximately$147.0 million and realized a gain of $92,235. In August 2007, an affiliate of SL Green loaned approximately$147.0 million to the Operating Partnership. This loan was to be repaid with interest at an annual rate of 5.80% onthe earlier of September 1, 2007 or the closing of the sale of the Company’s45% interest in One Madison Avenue to SL Green. As a result of the sale of the Company’s interest in August 2007,the loan was repaid with interest on such date.**

** **

**In June 2006, the Company closed on theacquisition of a 49.75% TIC interest in 55 Corporate Drive, located inBridgewater, New Jersey with a 0.25% interest to be acquired in thefuture.  The remaining 50% of the propertyis owned as a TIC interest by an affiliate of SL Green Operating Partnership,L.P.  The property is comprised of threebuildings totaling approximately six hundred and seventy thousand square feetwhich is 100% net leased to an entity whose obligations are guaranteed bySanofi-Aventis Group through April 2023. The transaction was valued at$236,000 and was financed with a $190,000, ten-year, fixed-rate first mortgageloan.**

** **

Commencingin May 2005 the Company is party to a lease agreement with SLG GraybarSublease LLC, an affiliate of SL Green, for 

 

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the Company’s corporate offices at 420 Lexington Avenue, New York, NewYork.  The lease is for approximately5,000 square feet with an option to lease an additional approximately 2,000square feet and carries a term of ten years with rents on the entire seventhousand square feet of approximately $249 per annum for year one rising to$315 per annum in year ten.  For thethree months ended March 31, 2008 and 2007, the Company paid $62 and $63under this lease, respectively.

 

**In July 2005, the Company closedon the purchase from an SL Green affiliate of a $40,000 mezzanine loan whichbears interest at 11.20%.  As part ofthat sale, the seller retained an interest-only participation.  The Company has determined that the yield onits mezzanine loan after giving effect to the interest-only participationretained by the seller is at market.  Themezzanine loan is secured by the equity interests in an office property in NewYork, New York.**

** **

**In February 2006, the Companyclosed on the purchase of a $90,000 whole loan, which bears interest at threemonth LIBOR plus 2.15%, to a joint venture in which SL Green is an equityholder.  The loan is secured by 55Corporate Drive in Bridgewater, New Jersey. The loan was repaid in full in June 2006 with the proceeds from newmortgage financing obtained in connection with the sale of the property, 49.75%of which is now owned by the Company through a TIC structure.**

** **

**In March 2006, the Company closedon the purchase of a $25,000 mezzanine loan, which bears interest at one-monthLIBOR plus 8.00%, to a joint venture in which SL Green is an equityholder.  The mezzanine loan was repaid infull on May 9, 2006, when the Company originated a $90,287 whole loan, whichbears interest at one-month LIBOR plus 2.75%, to the joint venture.  The whole loan is secured by office andindustrial properties in northern New Jersey and has a book value of $90,477and $90,389 as of March 31, 2008 and December 31, 2007, respectively.**

** **

**In August 2006, the Companyacquired from a financial institution a 50% pari-passu interest in a $65,000preferred equity investment secured by an office property in New York, NewYork.  An affiliate of SL Green simultaneouslyacquired and owns the other 50% pari-passu interest. The investment bearsinterest at a blended fixed rate of 10.52%.**

** **

**In December 2006, the Companyacquired from a financial institution a pari-passu interest of $125,000 in a$200,000 mezzanine loan, which bears interest at 6.384% and is secured by amulti-family portfolio in New York, New York. An affiliate of SL Green simultaneously acquired the remaining $75,000pari-passu interest in the mezzanine loan.**

** **

**In January 2007, the Companyoriginated two mezzanine loans totaling $200,000. The $150,000 loan was securedby a pledge of cash flow distributions and partial equity interests in aportfolio of multi-family properties and bore interest at one-month LIBOR plus6.00%. The $50,000 loan was initially secured by cash flow distributions andpartial equity interests in an office property. On March 8, 2007 the $50,000loan was increased by $31,000 when the existing mortgage loan on the propertywas defeased, upon which event the Company’s loan became secured by a firstmortgage lien on the property and was reclassified as a whole loan. The wholeloan currently bears interest at one-month LIBOR plus 6.00% for the initialfunding and one-month LIBOR plus 1.00% for the subsequent funding. At closing,an affiliate of SL Green acquired from the Company and held a 15.15% pari-passuinterest in the mezzanine loan and the whole loan. As of March 31, 2008 andDecember 31, 2007, the Company’s interest in the whole loan had a carryingvalue of $65,066 and $65,033, respectively. The investment in the mezzanineloan was repaid in full in September 2007.**

** **

**In March 2007,the Company closed on the acquisition of a $62,500 pari-passu interest in onetranche of a multiple-level mezzanine structure primarily secured by pledges ofequity and rights to cash distributions, which was used to fund the acquisitionof a large office portfolio.  Theinvestment bears interest at one-month LIBOR plus 2.85%.  At closing, an affiliate of SL Greensimultaneously acquired a $62,500 pari-passu interest in the same tranche ofthe mezzanine structure.  The investmentwas repaid in full in May 2007.**

** **

**In April 2007, the Companypurchased for $103,200 a 45% TIC interest to acquire the fee interest in aparcel of land located at 2 Herald Square, located along 34th Streetin New York, New York.  The acquisitionwas financed with a $86,063 ten-year fixed rate mortgage loan.  The property is subject to a long-term groundlease with an unaffiliated third party for a term of 70 years.  The remaining TIC interest is owned by awholly-owned subsidiary of SL Green. The TIC interests are *pari passu*.  As of March 31, 2008 and December 31, 2007,the investment had a carrying value of $22,074 and $20,390, respectively.  The Company recorded its *pro rata*share of net income of $1,504 for the three months ended March 31, 2008.**

** **

**In July 2007, the Companypurchased for $144,240 an investment in a 45% TIC interest to acquire a 79% feeinterest and 21% leasehold interest in the fee position in a parcel of landlocated at 885 Third Avenue, on which is situated The Lipstick Building.  The transaction was financed with a $120,443ten-year fixed rate mortgage loan.  Theproperty is subject to a 70-year leasehold ground lease with an unaffiliatedthird party. The remaining TIC interest is owned by a wholly-owned subsidiaryof SL Green.  The TIC interests are *pari passu*.  As of March 31, 2008 and December 31, 2007,the investment had a carrying value of $30,694 and $28,332, respectively.  The Company**

 

25

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recorded its *pro rata* shareof net income of $1,931 for the three months ended March 31, 2008.

 

**In July 2007, the Companyacquired for $71,871 a 100% fee interest in the property located at 292 MadisonAvenue, New York, New York, purchased from SL Green.  The Company entered into a 70-year groundlease with an unaffiliated third party which simultaneously purchased from SLGreen the Class B office building situated on the property.  The Company’s acquisition of the fee interestwas financed with a $59,099 ten -year fixed rate mortgage loan.**

 

**In August 2007, the Companyclosed on the purchase from a financial institution of a $12,500 mezzanine loanon a substantially complete residential condominium project in the upper eastside of Manhattan.  The investment bearsinterest at the current pay rate of 11% over LIBOR, and a 19% look-backinternal rate of return at maturity.  Atclosing, an affiliate of SL Green simultaneously acquired a $12,500 pari-passuinterest in the same tranche of the capital structure.**

** **

**In September 2007, the Companyacquired a 50% interest in a $25,000 senior mezzanine loan from SL Green.  Immediately thereafter the Company, alongwith SL Green, sold all of its interests in the loan to an unaffiliated thirdparty.  Additionally, the Companyacquired from SL Green a 100% interest in a $25,000 junior mezzanine loanassociated with the same properties as the preceding senior mezzanine loan.Immediately thereafter the Company participated 50% of its interest in the loanback to SL Green.  In October 2007, theCompany acquired a 50% *pari-passu*interest in $57,795 of two additional tranches in the senior mezzanine loanfrom an unaffiliated third party.  Atclosing, an affiliate of SL Green simultaneously acquired the other 50%pari-passu interest in the two tranches.**

** **

**In September 2007, the Managerearned a $1,000 collateral selection fee payable by Nomura Internationalplc.   The Company purchased $18,000 of par bonds of the samesecurities to which the collateral selection fee was related and was earned. As part of the closing on the securities purchased, the Company collected andimmediately remitted the fee due to the Manager.**

** **

**In November 2007, the Companyacquired from a syndicate comprised of financial institutions a $25,000interest in a $100,000 junior mezzanine investment secured by a hotel portfolioand franchise headquarters.  An affiliateof SL Green simultaneously acquired and owns another $25,000 interest in theinvestment.  The investment was purchasedat a discount and bears interest at an effective spread to one-month LIBOR of9.50%.**

** **

**In December 2007, the Companyacquired a $52,000 interest in a senior mezzanine loan from a financialinstitution.  Immediately thereafter theCompany participated 50% of its interest in the loan to an affiliate of SLGreen.  The investment, which is securedby a retail property in New York, New York, was purchased at a discount andbears interest at an effective spread to one-month LIBOR of 5.00%.**

** **

**In December 2007, the Companyacquired a 50% interest in a $200,000 senior mezzanine loan from a financialinstitution.  Immediately thereafter theCompany participated 50% of our interest in the loan to an affiliate of SLGreen.  The investment was purchased at adiscount and bears interest at an effective spread to one-month LIBOR of 6.50%.**

** **

**Bright Star Couriers LLC, orBright Star, provides messenger services to the Company.  Bright Star is owned by Gary Green, a son ofStephen L. Green, the Company’s Chairman. The aggregate amount of fees paid by the Company for such services forthe three months ended March 31, 2008 and 2007, was less than $1 and less than $1,respectively.**

** **

**12.  Deferred Costs**

 

Deferredcosts at March 31, 2008 and December 31, 2007 consisted of the following:

 

| ** **                    | ** ** | **2008** | ** ** | **2007** | ** ** |
|-------------------------------|------------|----------|------------|----------|------------|
| Deferred financing            |       | $        | 59,387     |     | $          | 59,294 |   |
| Deferred acquisition          |       | 3,726    |       | 4,320    |       |
|                          |       | 63,113   |       | 63,314   |       |
| Less accumulated amortization |       | (19,159  | )          | (16,962  | )          |
|                          |       | $        | 43,954     |     | $          | 46,652 |   |

 

Deferredfinancing costs relate to the Company’s existing repurchase facilities withWachovia and Goldman, the Company’s unsecured revolving credit facility withKeyBank, the Company’s CDOs, the proportionately consolidated mortgagenote payable related to our TIC interest in 55 Corporate Drive and the trust preferred securities.  These costs are amortized on a straight-linebasis to interest expense based on the remaining term of the related financing.

 

26

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Deferredacquisition costs consist of fees and direct costs incurred to originate theCompany’s investments and are amortized using the effective yield methodover the related term of the investment.

 

**13.  FairValue of Financial Instruments**

 

Effective January 1,2008, the Company adopted SFAS 157, which among other things, requiresadditional disclosures about financial instruments carried at fair value. SFAS157 establishes a hierarchal disclosure framework associated with the level ofpricing observability utilized in measuring financial instruments at fairvalue. The followingdiscussion of fair value was determined by the Manager, using available marketinformation and appropriate valuation methodologies.  Considerable judgment is necessary tointerpret market data and develop estimated fair value.  Accordingly, fair values are not necessarilyindicative of the amounts the Company could realize on disposition of thefinancial instruments.  Financialinstruments with readily available active quoted prices or for which fair valuecan be measured from actively quoted prices generally will have a higher degreeof pricing observability and a lesser degree of judgment utilized in measuringfair value. Conversely, financial instruments rarely traded or not quoted willgenerally have less, or no, pricing observability and a higher degree ofjudgment utilized in measuring fair value. The use of different market assumptions and/or estimation methodologiesmay have a material effect on estimated fair value amounts.

 

**Fair Value on a Recurring Basis**

 

TheCompany does not measure any assets at fair value on a recurring basis.  Liabilities measured at fair value on arecurring basis are categorized in the table below based upon the lowest levelof significant input to the valuations.

 

| **At March 31, 2008** | ** ** | **Total** | ** ** | **Level I** | ** ** | **Level II** | ** ** | **Level III** | ** ** |
|--------------------------------------|------------|-----------|------------|------------------|------------|-------------------|------------|--------------------|------------|
|                                 |       |      |       |             |       |              |       |               |       |
| Financial Liabilities:               |       |      |       |             |       |              |       |               |       |
| Derivative  instruments              |       | $         | 116,148    |             | $          | —            |       | $                  | 116,148    |   | $ | — |   |
|                                      |            |           |            |                  |            |                   |            |                    |            |  |  |  |  |

 

**Fair Value on a Non-RecurringBasis**

 

The Company usesfair value measurements on a nonrecurring basis in its assessment of assetsclassified as loans and other lending investments , which are reported at costand have been written down to fair value as a result of valuation allowancesestablished for possible loan losses, and loans held for sale, which arereported at lower of cost or fair value less costs to sell.The following tableshows the fair value hierarchy for those assets measured at fair value on anon-recurring basis based upon the lowest level of significant input to the valuationsfor which a non-recurring change in fair value has been recorded during thethree months ended March 31, 2008:

 

| **At March 31, 2008** | ** ** | **Total** | ** ** | **Level I** | ** ** | **Level II** | ** ** | **Level III** | ** ** |
|--------------------------------------|------------|-----------|------------|------------------|------------|-------------------|------------|--------------------|------------|
| Financial Assets:                    |       |      |       |             |       |              |       |               |       |
| Lending  investments                 |       | $         | 63,533     |             | $          | —            |       | $                  | —     |   | $ | 63,533 |   |
| Loans held for  sale                 |       | $         | 195,178    |             | $          | —            |       | $                  | —     |   | $ | 195,178 |   |

 

The total change in fair value of financial instruments forwhich a fair value adjustment has been included in the consolidated statementsof income for the three months ended March 31, 2008 was $8,000.

 

The valuations derived from pricing models overall valuationprocess may include adjustments to the financial instruments.  These adjustments may be made when, inmanagement’s judgment, either the size of the position in the financialinstrument or other features of the financial instrument such as itscomplexity, or the market in which the financial instrument is traded (such ascounterparty, credit, concentration or liquidity) require that an adjustment bemade to the value derived from the pricing models.   Additionally, an adjustment from the pricederived from a model typically reflects management’s judgment that otherparticipants in the market for the 

 

27

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financial instrument being measured at fair value would alsoconsider such an adjustment in pricing that same financial instrument.

 

Financial assets and liabilities presented at fair value andcategorized as Level III are generally those that are marked to model usingrelevant empirical data to extrapolate an estimated fair value. The models’inputs reflect assumptions that market participants would use in pricing theinstrument in a current period transaction and outcomes from the modelsrepresent an exit price and expected future cash flows.  The parameters and inputs are adjusted forassumptions about risk and current market conditions. Changes to inputs invaluation models are not changes to valuation methodologies; rather, the inputsare modified to reflect direct or indirect impacts on asset classes fromchanges in market conditions. Accordingly, results from valuation models in one period may not beindicative of future period measurements.

 

**14.  Stockholders’ Equity**

** **

TheCompany’s authorized capital stock consists of 125,000,000 shares, $0.001 parvalue, of which the Company has 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 March 31, 2008, 34,853,911 shares of common stock and4,600,000 shares of preferred stock were issued and outstanding.

 

**PreferredStock**

 

**In April 2007,the Company issued 4,600,000 shares of its 8.125% Series A cumulativeredeemable preferred stock (including the underwriters’ over-allotment optionof 600,000 shares) with a mandatory liquidation preference of $25.00 per share.Holders of the Series A cumulative redeemable preferred shares receiveannual dividends of $2.03125 per share paid on a quarterly basis and dividendsare cumulative, subject to certain provisions. On or after April 18, 2012,the Company may at its option redeem the Series A cumulative redeemablepreferred stock at par for cash. Net proceeds (after deducting underwritingfees and expenses) from the offering were approximately $111,205.**

** **

**Common Stock**

 

Asof the date of our formation, April 12, 2004, the Company had 500,000shares of common stock outstanding valued at approximately $200.  On August 2, 2004 the Company completedits initial public offering of 12,500,000 shares of common stock resulting innet proceeds of approximately $172,900, which was used to fund investments andcommence operations.  As of March 31,2008, 594,333 restricted shares had also been issued under the Company’s 2004Equity Incentive Plan, or the Equity Incentive Plan.  These shares have a vesting period of two tofour years.

 

InDecember 2004, the Company sold 5,500,000 shares of our common stock, at aprice of $17.27 per share, resulting in net proceeds of approximately $93,740under a private placement exemption from the registration requirements of Section 5of the Securities Act of 1933, as amended, or the Securities Act.  The Company subsequently registered theseshares for resale under the Securities Act in August 2005.  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 up to a 25% ownership interest in the Company’s outstandingshares of common stock.  Of the 5,500,000shares sold, 2,000,000 shares were settled in December 2004 and theremaining 3,500,000 shares were settled in January 2005.

 

InSeptember 2005, the Company sold 3,833,333 shares of common stock, at aprice of $25.80 per share, resulting in net proceeds of approximately$97,830.  A total of 2,875,000 shareswere sold through a public offering and an additional 958,333 shares were soldto SL Green Operating Partnership, L.P. pursuant to its contractual right tochoose to maintain up to a 25% ownership interest in the Company’s outstandingshares of common stock.  Net proceedswere used for loan acquisitions and originations, repayment of outstandingprincipal under one of the Company’s repurchase facilities and general corporatepurposes.

 

InMay 2006, the Company sold 3,000,000 shares of common stock, at a price of$26.75 per share, resulting in net proceeds of approximately $79,787.  A total of 2,250,000 shares were sold througha public offering and an additional 750,000 shares were sold to SL GreenOperating Partnership, L.P. pursuant to its contractual right to choose tomaintain up to a 25% ownership interest in the Company’s outstanding shares ofcommon stock.  Net proceeds were used forloan acquisitions and originations, repayment of outstanding principal underthe Company’s repurchase facilities and general corporate purposes.

 

28

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In May 2007, theCompany’s new $500,000 shelf registration statement was declared effective bythe Securities and Exchange Commission, or SEC. This registration statementprovides the Company with the ability to issue common and preferred stock,depository shares and warrants. The Company currently has $373,344 availableunder the shelf.

 

InSeptember 2007, the Company sold 4,825,000 shares of common stock, at apublic offering price of $26.25 per share, resulting in net proceeds ofapproximately $124,451.  A total of3,618,750 shares were sold through a public offering and an additional 1,206,250shares were sold directly to SL Green Operating Partnership, L.P. pursuant toits contractual right to choose to maintain up to a 25% ownership interest inthe Company’s outstanding shares of common stock.  After this offering, SL Green Operating Partnership,L.P. owned 7,624,583 shares of the Company’s common stock.  Net proceeds were used to retire borrowingsunder the Company’s unsecured facility and to create additional fundingcapacity for opportunistic investments.

 

InNovember 2007, the Company sold, through a private placement, 3,809,524shares of common stock at a price of $26.25 to an affiliate of Morgan StanleyReal Estate Special Situations Fund III, a global diversified fund managed byMorgan Stanley Real Estate, raising gross proceeds of approximately $100,000.The shares were not registered under the Securities Act of 1933 or any statesecurities laws, and were sold in a private transaction under Regulation D ofthe Securities Act.  Subsequent to thisoffering, SL Green’s ownership percentage was approximately 22% of theoutstanding shares of our common stock at March 31, 2008.

 

**EquityIncentive Plan**

 

As part of the Company’s initial public offering, theCompany instituted its Equity Incentive Plan. The Equity Incentive Plan, as amended, authorizes (i) the grant ofstock options that qualify as incentive stock options under Section 422 ofthe Internal 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 options will be determined by thecompensation committee, but may not be less than 100% of the fair market valueof the shares of common stock on the date of grant.  At March 31, 2008, approximately1,134,431 shares of common stock were available for issuance under the EquityIncentive Plan.

 

Management and outsourcefees paid to our Manager and SL Green Operating Partnership, L.P. aresufficient to reimburse the Manager and SL Green Operating Partnership, L.P.for the applicable compensation, including payroll taxes, of the employees whoprovide services to Gramercy pursuant to the confirmatory addendum to theManagement Agreement between Gramercy, the Manager and the OperatingPartnership.  These awardees areconsidered 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 inthree to four annual installments commencing one year from the date of grant.  In some instances, options may be grantedunder the Equity Incentive Plan to persons who provide significant services tothe Company or its affiliates, but are not considered co-leased employeesbecause compensation for their services is not covered by the managementagreement or outsource agreement. Options granted to recipients that are not co-leased employees have thesame terms as those issued to co-leased employees except as it relates to anyperformance-based provisions within the grant. To the extent there are performance provisions associated with a grantto a recipient who is not a co-leased employee, an estimated expense related tothese options is recognized over the vesting period and the final expense isreconciled at the point performance has been met, 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.

 

A summary of the statusof the Company’s stock options as of March 31, 2008 and December 31,2007 are presented below:

** **

| ** **                     | ** ** | **March 31, 2008**  | ** ** | **December 31, 2007**             | ** ** |
|--------------------------------|------------|--------------------------|------------|----------------------------------------|------------|
| ** **                     | ** ** | **Options  Outstanding** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Options  Outstanding** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
| Balance at beginning of period |       | 1,428,169                |       | $                                      | 22.82      |   | 830,001 |   | $ | 18.02 |   |
| Granted                        |       | 35,000                   |       | $                                      | 24.30      |   | 770,500 |   | $ | 27.76 |   |
| Exercised                      |       | —                   |       | —                                 |       | (103,330 | ) | $ | 19.44 |   |
| Lapsed or cancelled            |       | 31,916                   |       | $                                      | 26.20      |   | (69,002 | ) | $ | 25.29 |   |
| Balance at end of period       |       | 1,431,253                |       | $                                      | 22.67      |   | 1,428,169 |   | $ | 22.82 |   |

 

Forthe three months ended March 31, 2008, all options were granted within aprice range of $23.10 to $25.90.  Theremaining 

 

29

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weightedaverage contractual life of the options was 7.9 years.  Compensation expense of $1,343 will berecorded over the course of the next 12 months, representing the remainingweighted average vesting period of the option awards as of March 31,2008.  Compensation expense of $263 and$190 was recorded for the three months ended March 31, 2008 and 2007,respectively, related to the issuance of stock options.

 

ThroughMarch 31, 2008, 594,333 restricted shares had been issued under the EquityIncentive Plan, of which 75% have vested.  The vested and unvested shares are currently entitled to receivedistributions declared by the Company on its common stock.    Holders of restricted shares are prohibitedfrom selling such shares until they vest but are provided the ability to votesuch shares beginning on the date of grant. Compensation expense of $1,258 will be recorded over the course of thenext 6 months, representing the remaining weighted average vesting period ofthe restricted stock awards as of March 31, 2008.  Compensation expense of $559 and $1,223 wasrecorded for the three months ended March 31, 2008 and 2007, respectively,related to the issuance of restricted shares.

 

**EmployeeStock Purchase Plan**

 

InJanuary 2008, the Company’s board of directors adopted, subject tostockholder approval, the 2008 Employee Stock Purchase Plan, or ESPP, toencourage its employees to increase their efforts to make the Company’sbusiness more successful by providing equity-based incentives to eligibleemployees.  The ESPP is intended to qualify as an “employee stock purchaseplan” under Section 423 of the Internal Revenue Code of 1986, as amended,and has been adopted by the board to enable the Company’s eligible employees topurchase its shares of common stock through payroll deductions.  The ESPPbecame effective on January 1, 2008 with a maximum of 250,000 shares ofthe common stock available for issuance, subject to adjustment upon a merger,reorganization, stock split or other similar corporate change.  TheCompany filed a registration statement on Form S-8 with the Securities andExchange Commission with respect to the ESPP. The common stock will be offered for purchase through a series ofsuccessive offering periods.  Eachoffering period will be three months in duration and will begin on the firstday of each calendar quarter, with the first offering period having commencedon January 1, 2008.  The ESPPprovides for eligible employees to purchase the common stock at a purchaseprice equal to 85% of the lesser of (1) the market value of the commonstock on the first day of the offering period or (2) the market value ofthe common stock on the last day of the offering period. The ESPP will besubmitted to the Company’s stockholders for approval at its 2008 annual meetingof stockholders.

 

**OutperformancePlan**

 

InJune 2005, the compensation committee of the board of directors approved along-term incentive compensation program, the 2005 Outperformance Plan.  Participants in the 2005 Outperformance Plan,all of whom are co-leased employees, will share in a “performance pool” if theCompany’s total return to stockholders for the period from June 1, 2005through May 31, 2008 exceeds a cumulative total return to stockholders of30% during the measurement period over a base share price of $20.21 pershare.  The size of the pool will be 10%of the outperformance amount in excess of the 30% benchmark, subject to amaximum limit equal to the lesser of 4% of the Company’s outstanding shares andunits of limited partnership interest as of the end of the performance period,or 1,200,000 shares.  If the Company’stotal return to stockholders from June 1, 2005 to any subsequent dateexceeds 80% and remains at that level or higher for 30 consecutive days, then aminimum performance pool will be established. In the event the potential performance pool reaches the maximum dilutioncap before May 31, 2008 and remains at that level or higher for 30consecutive days, the performance period will end early and the pool will beformed on the last day of such 30-day period. Each participant’s award under the 2005 Outperformance Plan isdesignated as a specified percentage of the aggregate performance pool to beallocated to such participant assuming the 30% benchmark is achieved.  Individual awards under the 2005Outperformance Plan will be made in the form of partnership units, or LTIPUnits, that may ultimately become exchangeable for shares of the Company’scommon stock or cash, at its election. Under the 2005 Outperformance Plan, LTIP Units have been granted andadditional LTIP Units may be granted in the future prior to the determinationof the performance pool; however, these LTIP Units will only vest uponsatisfaction of performance and other thresholds, and will not be entitled todistributions until after the performance pool, or minimum performance pool, isestablished.  The 2005 OutperformancePlan provides that if a pool is established, each participant will also beentitled to the distributions that would have been paid on the number of LTIPUnits earned, had they been issued at the beginning of the performance period.  Those distributions will be paid in the formof additional LTIP Units.  Once aperformance pool has been established, the earned LTIP Units will receiveregular quarterly distributions on a per unit basis equal to the dividends pershare paid on the Company’s common stock, whether or not they are vested.  Any LTIP Units that are not earned upon theestablishment of the performance pool will be automatically forfeited, and theLTIP Units that are earned will be subject to time-based vesting, with 50% ofthe LTIP Units earned vesting in May 2009 and the balance vesting one yearlater based on continued employment with the Manager or SL Green.   The Company will record the expense of therestricted stock award in accordance with FASB Statement No. 123(R).  Compensation expense of $308 and $383 wasrecorded for the three months ended March 31, 2008 and 2007, respectively,related to the 2005 Outperformance Plan. The measurement date under the Company’s2005 Outperformance Plan will occur on May 31, 2008

 

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and,absent any material increase in the price of the Company’s common stock on theNYSE, the Company expects that its 2005 Outperformance Plan will expire with novalue to any of the plan participants.

 

**DeferredStock Compensation Plan for Directors**

 

Under the Company’sIndependent Director’s Deferral Program, which commenced April 2005, the Company’sindependent directorsmay elect to defer up to 100% of their annual retainer fee, chairman fees andmeeting fees.  Unless otherwise elected by a participant, fees deferredunder the program shall be credited in the form of phantom stock units. The phantom stock units are convertible into an equal number of shares ofcommon stock upon such directors’ termination of service from the Board ofDirectors or a change in control by the Company, as defined by theprogram.  Phantom stock units are credited to each independent directorquarterly using the closing price of the Company’s common stock on theapplicable dividend record date for the respective quarter.  Eachparticipating independent director who elects to receive fees in the form ofphantom stock units has the option to have their account credited for anequivalent amount of phantom stock units based on the dividend rate for eachquarter or have dividends paid in cash.

 

As of March 31,2008, there were approximately 38,713 phantom stock units outstanding, of which26,713 units are vested.

 

**Earningsper Share**

** **

Earningsper share for the three months ended March 31, 2008 and 2007 is computedas follows:

 
| ** **                                   | ** ** | **Three Months Ended  March 31,** | ** ** |
|----------------------------------------------|------------|----------------------------------------|------------|
| **Numerator (Income)**                       | ** ** | **2008**                               | ** ** | **2007** | ** ** |
| Basic Earnings:                              |       |                                   |       |   |   |
| Net income  available to common stockholders |       | $                                      | 23,135     |   | $ | 17,049 |   |
| Effect of dilutive securities                |       | —                                 |       | — |   |
| Diluted Earnings:                            |       |                                   |       |   |   |
| Net income  available to common stockholders |       | $                                      | 23,135     |   | $ | 17,049 |   |
|                                         |       |                                   |       |   |   |
| **Denominator (Weighted Average Shares)**    | ** ** | ** **                             | ** ** | ** ** | ** ** |
| Basic                                        |       |                                   |       |   |   |
| Shares available  to common stockholders     |       | 34,854                                 |       | 26,027 |   |
| Effect of Diluted Securities:                |       |                                   |       |   |   |
| Stock-based  compensation plans              |       | 122                                    |       | 1,422 |   |
| Phantom stock  units                         |       | 39                                     |       | 23 |   |
| Diluted Shares                               |       | 35,015                                 |       | 27,472 |   |

** **

**15.Benefit Plans**

** **

**At March 31,2008, the Company did not maintain a defined benefit pension plan,post-retirement health and welfare plan, 401(k) plan or other benefitsplans as the Company did not have any employees.  At March 31, 2008, these benefits areprovided to its employees by the Manager, a majority-owned subsidiary of SLGreen.**

** **

**16.**       Commitments and Contingencies

** **

TheCompany and the Operating Partnership are not presently involved in anymaterial litigation nor, to the Company’s knowledge, is any material litigationthreatened against the Company or its investments, other than routinelitigation arising in the ordinary course of business.  Management believes the costs, if any,incurred by the Operating Partnership and the Company related to litigationwill not materially affect its financial position, operating results orliquidity.

 

TheCompany’s corporate offices at 420 Lexington Avenue, New York, New York aresubject to an operating lease agreement with SLG Graybar Sublease LLC, anaffiliate of SL Green, effective May 1, 2005.  The lease is for approximately five thousandsquare feet with an option to lease an additional approximately two thousandsquare feet and carries a term of ten years with rents on the entire seventhousand square feet of approximately $249 per annum for year one rising to$315 per annum in year ten.

 

Thefollowing is a schedule of future minimum lease payments under the Company’soperating lease as of March 31, 2008.

 

31

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| ** **                    | ** ** | **Operating  Lease** | ** ** |
|-------------------------------|------------|----------------------|------------|
| 2008                          |       | $                    | 196        |   |
| 2009                          |       | 265                  |       |
| 2010                          |       | 283                  |       |
| 2011                          |       | 297                  |       |
| 2012                          |       | 302                  |       |
| Thereafter                    |       | 752                  |       |
| Total minimum  lease payments |       | $                    | 2,095      |   |

 

**17.  Financial Instruments:Derivatives and Hedging**

** **

FASB No. 133,or SFAS 133, “Accounting for Derivative Instruments and Hedging Activities,”which became effective January 1, 2001, requires Gramercy to recognize allderivatives on the balance sheet at fair value. Derivatives that are not hedges must be adjusted to fair value throughincome.  If a derivative is a hedge,depending on the nature of the hedge, changes in the fair value of thederivative will either be offset against the change in fair value of the hedgedasset, liability, or firm commitment through earnings, or recognized in othercomprehensive income until the hedged item is recognized in earnings.  The ineffective portion of a derivative’schange in fair value will be immediately recognized in earnings.  SFAS 133 may increase or decrease reportednet income and stockholders’ equity prospectively, depending on future levelsof 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 followingtable summarizes the notional and fair value of the Company’s derivativefinancial instrument at March 31, 2008. The notional value is an indication of the extent of the Company’sinvolvement in this instrument at that time, but does not represent exposure tocredit, interest rate or market risks:

 
| ** **         | ** ** | **Benchmark Rate** | ** ** | **Notional  Value** | ** ** | **Strike  Rate** | ** ** | **Effective  Date** | ** ** | **Expiration  Date** | ** ** | **Fair  Value** | ** ** |
|--------------------|------------|--------------------|------------|---------------------|------------|------------------|------------|---------------------|------------|----------------------|------------|-----------------|------------|
| Interest Rate Swap |       | 1 month LIBOR      |       | $                   | 3,462      |             | 4.280      | %                   | 7/2005     |                 | 12/2009    |            | $          | (113 | ) |
| Interest Rate Swap |       | 3 month LIBOR      |       | 3,465               |       | 5.178            | %          | 4/2006              |       | 3/2010               |       | (175            | )          |
| Interest Rate Swap |       | 3 month LIBOR      |       | 14,650              |       | 4.425            | %          | 11/2007             |       | 7/2015               |       | (701            | )          |
| Interest Rate Swap |       | 3 month LIBOR      |       | 12,000              |       | 3.063            | %          | 1/2008              |       | 7/2010               |       | (146            | )          |
| Interest Rate Swap |       | 3 month LIBOR      |       | 12,000              |       | 9.850            | %          | 8/2006              |       | 8/2011               |       | (871            | )          |
| Interest Rate Swap |       | 3 month LIBOR      |       | 2,000               |       | 3.073            | %          | 1/2008              |       | 7/2010               |       | (25             | )          |
| Interest Rate Swap |       | 3 month LIBOR      |       | 347,526             |       | 5.408            | %          | 8/2007              |       | 5/2017               |       | (32,354         | )          |
| Interest Rate Swap |       | 3 month LIBOR      |       | 699,441             |       | 5.331            | %          | 8/2007              |       | 1/2018               |       | (73,866         | )          |
| Interest Rate Swap |       | 1 month LIBOR      |       | 42,718              |       | 4.990            | %          | 1/2007              |       | 1/2017               |       | (4,210          | )          |
| Interest Rate Swap |       | 1 month LIBOR      |       | 24,143              |       | 5.114            | %          | 2/2008              |       | 1/2017               |       | (2,137          | )          |
| Interest Rate Swap |       | 1 month LIBOR      |       | 16,412              |       | 5.203            | %          | 2/2008              |       | 5/2017               |       | (1,550          | )          |
| Total              |       |               |       | $                   | 1,177,817  |             |       |                |       |                 |       |            | $          | (116,148 | ) |

 

AtMarch 31, 2008, derivative instruments were reported at their fair valueas a net liability of $116,148. Offsetting adjustments are represented as deferred losses in AccumulatedOther Comprehensive Income of $43,348. For the three months ended March 31, 2008, the Company recognizedno increase to interest expense attributable to any ineffective component ofits derivative instruments designated as cash flow hedges.  For the same period the Company recognized nodecrease to earnings attributable to the change in value of undesignatedderivatives. Currently, all derivative instruments are designated as cash flowhedging instruments.  Over time, therealized 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.

 

The Company is hedging exposure to variability in futureinterest payments on our debt facilities and cash flows for future transactionsexcept in the case of swaps the Company may enter into from time to time,including total rate of return swaps, or TROR swaps, which are tied to theLehman Brothers CMBS index and are intended to hedge the Company’s exposure tovariability in the rate of return in excess of anticipated future interestpayments on that portion of the Company’s debt facilities used to fund fixedrate mortgage loan assets held as available for sale.

 

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**18.  IncomeTaxes**

 

TheCompany has elected to be taxed as a REIT, under Sections 856 through 860 ofthe Internal Revenue Code beginning with its taxable year ended December 31,2004.  To qualify as a REIT, the Companymust meet certain organizational and operational requirements, including arequirement to distribute at least 90% of its ordinary taxable income tostockholders.  As a REIT, the Companygenerally will not be subject to federal income tax on taxable income that itdistributes to its stockholders.  If theCompany fails to qualify as a REIT in any taxable year, it will then be subjectto federal income taxes on taxable income at regular corporate rates and willnot be permitted to qualify for treatment as a REIT for federal income taxpurposes for four years following the year during which qualification is lostunless the Internal Revenue Service grants the Company relief under certainstatutory provisions.  Such an eventcould materially adversely affect the Company’s net income and net cash availablefor distributions to stockholders. However, the Company believes that it is organized and will operate insuch a manner as to qualify for treatment as a REIT and the Company intends tooperate in the foreseeable future in such a manner so that it will qualify as aREIT for federal income tax purposes. The Company may, however, be subject to certain state and local taxes.

 

For the threemonths ended March 31, 2008 and 2007, the Company recorded $11 and $534 ofincome tax expense, respectively, in income from continuing operations forincome attributable to its wholly-owned TRSs. The Company has assumed aneffective tax rate for the three months ended March 31, 2008 of 44% takinginto consideration the anticipated applicable U.S. federal statutory tax rateat March 31, 2008 of 34% and state and local taxes.

 

**19.  Environmental Matters**

** **

**The Company’s management believesthe Company is in compliance in all material respects with applicable Federal,state and local ordinances and regulations regarding environmental issues.  Its management is not aware of anyenvironmental liability that it believes would have a materially adverse impacton the Company’s financial position, results of operations or cash flows.**

** **

**20.  Segment Reporting**

** **

**Statement of Financial AccountingStandard No. 131, or SFAS 131, establishes standards for the way thatpublic entities report information about operating segments in their annualfinancial statements.  As of March 31,2008, the Company was a REIT focused primarily on originating and acquiringloans and securities related to real estate and under the provisions of SFAS 131operated in only one segment.**

** **

**21.  Supplemental Disclosure of Non-Cash Investingand Financing Activities**

** **

The following table represents non-cash activitiesrecognized in other comprehensive income for the three months ended March 31,2008 and 2007:

 

| ** **                                                                  | ** ** | **2008** | ** ** | **2007** | ** ** |
|-----------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Deferred gains/(losses) and other non-cash activity  related to derivatives |       | $        | (43,348    | )        | $          | (62,973 | ) |
|                                                                             |            |          |            |          |            |  |  |

** **

**22.  SubsequentEvents**

** **

**On April 1, 2008, the Companycompleted the acquisition of American Financial Realty Trust (NYSE: AFR) orAmerican Financial, in a transaction with a total value of approximately $3.3billion, including the assumption of approximately $1.3 billion of AmericanFinancials secured debt.  The acquisitioncombines the existing operating platforms of American Financial and theCompany, creates an integrated commercial real estate finance and operatingcompany, and transforms the Company from a pure specialty finance company intoa $7.5 billion diversified enterprise with complementary business linesconsisting of commercial real estate finance and property investments. As aresult of the acquisition, the Company has added approximately 29.2 millionsquare feet of commercial real estate in 38 states and the District of Columbiato its $4.1 billion of debt investments, commercial real estate securitiesinvestments, net lease properties and other assets.**

** **

**Each common share of beneficialinterest of American Financial was converted into the right to receiveapproximately $5.50 in cash, additional cash consideration in an amount equalto approximately $0.2419 in cash resulting from the Company’s $2.00 per sharespecial dividend declared in December 2007 and paid in January 2008,and 0.12096 of a share of the Company’s common stock. The cash considerationwas not increased in respect of any additional value payment described in themerger agreement. Upon closing,**

 

33

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**American Financial’s stockholdersown approximately 31% of the Company’s outstanding shares.**

** **

**In April 2008, an affiliate of SL Green was granted 644,787 sharesof the Company’s common stock as a result of the merger of American** Financial Realty Trust (NYSE:AFR).

** **

In April 2008, the firstlien lenders filed notices of default and acceleration with respect to thecollateral supporting a second lien loan with a carrying value of $45,000 and athird lien loan with a carrying value of $6,764.  The second lien loan and third lien loan wereclassified as sub-performing as of March 31, 2008.** **The first and second lien loans are secured byland, which is intended primarily for residential development.  Given the ongoing correction in the UnitedStates residential real estate markets, and the fact that the debt structureunderlying this land consists of several tranches with several largeinstitutional lenders in each tranche, we believe that the debt restructuringof these loans will be more complicated and take longer than a more customary restructuring.  Therefore, there is more uncertaintysurrounding the possible outcome of these loans.

 

In April 2008, Hugh F.Hall resigned as the Company’s chief operating officer and as one of its Class Idirectors.  Robert R. Foley wassubsequently promoted to chief operating officer of the Company and steppeddown from his previous position as chief financial officer on such date.Additionally, John B. Roche was appointed as chief financial officer of theCompany.

 

34

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

**(Amounts in thousands,except for share and per share amounts)**

** **

**Overview**

** **

Gramercy Capital Corp. isa commercial 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. We have also established areal estate securities business that focuses on the acquisition, trading andfinancing of commercial mortgage backed securities, or CMBS, and other realestate related securities.  Whenevaluating transactions, we assess our risk-adjusted return and targettransactions with yields that seek to provide excess returns for the risksbeing taken.  We conduct substantiallyall of our operations through our operating partnership, GKK Capital LP, or ourOperating Partnership.  We are externallymanaged and advised by GKK Manager LLC, or our Manager, a majority-ownedsubsidiary of SL Green Realty Corp. (NYSE: SLG), or SL Green.  We have elected to be taxed as a real estateinvestment trust, or REIT, under the Internal Revenue Code and generally willnot be subject to federal income taxes to the extent we distribute our incometo our stockholders.  We have in the pastestablished, and may in the future establish, taxable REIT subsidiaries, orTRSs, to effect various taxable transactions. Those TRSs would incur federal, state and local taxes on the taxableincome from their activities.  Unless thecontext requires otherwise, all references to “we,” “our” and “us” meanGramercy 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 the direct origination of wholeloans, the ownership of which permits a wide variety of financing, syndication,and securitization executions to achieve excess returns for the risks beingtaken.  By providing a single source offinancing for developers and sponsors, we streamline the lending process,provide greater certainty for borrowers, and retain the high yield debtinstruments that we manufacture.  Byoriginating, rather than buying, whole loans, subordinate interests in wholeloans, mezzanine debt and preferred equity, we strive to deliver superiorreturns to our stockholders.

 

Since our inception, wehave completed transactions in a variety of markets and secured by a variety ofproperty types.  Until recently, themarket for commercial real estate debt exhibited high relative returns and significantinflows of capital.  Commercial realestate debt has continued to demonstrate low rates of default in comparisonwith historical levels.  However, thismay change as the credit markets become increasingly illiquid, or as theeconomy slows.  Consequently, the marketfor debt instruments had for several years until recently evidenced decliningyields and more flexible credit standards and loan structures.  In particular, “conduit” originators whopackaged whole loans for resale to investors drove debt yields lower whilemaintaining substantial liquidity because of the then-strong demand for theresulting securities.  Because of reducedprofits in the most liquid sectors of the mortgage finance business, severallarge institutions began originating large bridge loans for the purpose of generatinginterest income, rather than the typical focus on trading profits.  In response to those developments, we havefocused on areas where we have comparative advantages rather than competing forproduct merely on the basis of yield or structure.  This has particularly included whole loanorigination in markets and transactions where we have an advantage due to (i) knowledgeor relationships we have, (ii) knowledge or relationships of our largeststockholder, SL Green, and (iii) where we have an ability to better assessand manage risks over time.  Whenconsidering investment opportunities in secondary market transactions intranched debt, we often avoid first loss risk in larger transactions due to thehigh recent valuations of the underlying real estate relative to historicvaluation levels.  Because of thesignificant increase in the value of institutional quality assets relative tohistoric norms, we focus on positions in which a property sale or conventionalrefinancing at loan maturity would provide for a complete return of ourinvestment.

 

We have carefully managed our exposure to interest rate changes thatcould affect our liquidity.  We generallymatch our assets and liabilities in terms of base interest rate (generallyone-month LIBOR) and, to the extent possible, expected duration. We have raisedliabilities and equity in several different capital markets to improve thediversity of our funding sources, maintain liquidity, and achieve ourmatch-funding objectives. We have been active in the equity and debt marketssince 2004 to take advantage of cost effective sources of capital, maintainliquidity and attractively finance our business.  The proceeds of these offerings were used tofund loan acquisitions and originations, repay outstanding principal amountsunder our repurchase facilities or unsecured revolving credit facilities, andfor general corporate purposes. In addition, we have an unsecured creditfacility which was increased in June 2007 to $175,000 from $100,000 andits term was extended to June 2010. The facility is available for funding investments and general corporatepurposes.

 

**On April 1, 2008 we completedthe acquisition of American Financial Realty Trust (NYSE: AFR), or AmericanFinancial, in a transaction with a total value of approximately $3.3 billion,including the assumption of approximately $1.3 billion of American Financialssecured debt.  The acquisition combinesthe existing operating platforms of American Financial and our company, creates**

 

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**an integrated commercial realestate finance and operating company, and transforms us from a pure specialtyfinance company into a $7.5 billion diversified enterprise with complementarybusiness lines consisting of commercial real estate finance and propertyinvestments. As a result of the acquisition, we have added approximately 29.2million square feet of commercial real estate in 38 states and the District ofColumbia to our $4.1 billion of loans and other lending investments, CMBS,net lease properties and other assets.**

** **

**Each common share of beneficialinterest of American Financial was converted into the right to receiveapproximately $5.50 in cash, additional cash consideration in an amount equalto approximately $0.2419 in cash resulting from our $2.00 per share specialdividend declared in December 2007 and paid in January 2008, and0.12096 of a share of our common stock. The cash consideration was notincreased in respect of any additional value payment described in the merger agreement.Upon closing, American Financial’s stockholders own approximately 31% of ouroutstanding shares.**

** **

Asof March 31, 2007, we held loans and other lending investments of$3,389,832 net of fees, discounts, and unfunded commitments with an averagespread to LIBOR of 407 basis points for our floating rate investments and anaverage yield of 6.95% for our fixed rate investments.  As of March 31, 2008, we also heldinterests in three credit tenant net lease investments, or CTL investments, twointerests in fee positions on properties subject to long-term ground leases anda 100% fee interest in a property subject to a long-term ground lease.

 

The aggregate carryingvalues, allocated by product type and weighted average coupons of our loans andother lending investments  and CMBS as ofMarch 31, 2008 and December 31, 2007 were as follows:

** **
| ** **                                           | ** ** | **Carrying Value (1)** | ** ** | **Allocation by  Investment Type** | ** ** | **Fixed Rate:  Average Yield** | ** ** | **Floating Rate:  Average Spread over LIBOR (2)** | ** ** |
|------------------------------------------------------|------------|------------------------|------------|------------------------------------|------------|--------------------------------|------------|---------------------------------------------------|------------|
| ** **                                           | ** ** | **2008**               | ** ** | **2007**                           | ** ** | **2008**                       | ** ** | **2007**                                          | ** ** | **2008** | ** ** | **2007** | ** ** | **2008** | ** ** | **2007** | ** ** |
| Whole loans, floating rate                           |       | $                      | 1,565,300  |                               | $          | 1,594,338                      |       | 61                                                | %          | 60 | % | — |   | — |   | 337 bps |   | 332 bps |   |
| Whole loans, fixed rate                              |       | 155,250                |       | 204,192                            |       | 6                              | %          | 8                                                 | %          | 7.15 | % | 7.79 | % | — |   | — |   |
| Subordinate  interests in whole loans, floating rate |       | 142,917                |       | 146,901                            |       | 6                              | %          | 6                                                 | %          | — |   | — |   | 471 bps |   | 447 bps |   |
| Subordinate  interests in whole loans, fixed rate    |       | 43,314                 |       | 61,890                             |       | 2                              | %          | 2                                                 | %          | 8.31 | % | 8.78 | % | — |   | — |   |
| Mezzanine loans,  floating rate                      |       | 411,757                |       | 413,813                            |       | 16                             | %          | 16                                                | %          | — |   | — |   | 603 bps |   | 607 bps |   |
| Mezzanine loans,  fixed rate                         |       | 223,504                |       | 203,753                            |       | 9                              | %          | 8                                                 | %          | 8.99 | % | 8.91 | % | — |   | — |   |
| Preferred equity, fixed rate                         |       | 11,868                 |       | 11,858                             |       | —                         |       | —                                            |       | 10.09 | % | 10.09 | % | — |   | — |   |
| Subtotal/  Weighted average                          |       | $                      | 2,553,910  |                               | $          | 2,636,745                      |       | 100                                               | %          | 100 | % | 8.30 | % | 8.45 | % | 398 bps |   | 395 bps |   |
| ** **                                           | ** ** | ** **             | ** ** | ** **                         | ** ** | ** **                     | ** ** | ** **                                        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| CMBS, floating rate                                  |       | 54,261                 |       | 23,817                             |       | 7                              | %          | 3                                                 | %          | — |   | — |   | 783 bps |   | 593 bps |   |
| CMBS, fixed rate                                     |       | 781,661                |       | 768,166                            |       | 93                             | %          | 97                                                | %          | 6.21 | % | 6.13 | % | — |   | — |   |
| Subtotal/  Weighted average                          |       | 835,922                |       | 791,983                            |       | 100                            | %          | 100                                               | %          | 6.21 | % | 6.13 | % | 783 bps |   | 593 bps |   |
|                                                 |       |                   |       |                               |       |                           |       |                                              |       |   |   |   |   |   |   |   |   |
| Total                                                |       | $                      | 3,389,832  |                               | $          | 3,428,728                      |       | 100                                               | %          | 100 | % | 6.95 | % | 7.02 | % | 407 bps |   | 397 bps |   |

 

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**(1)**          Loan andother lending investments are presented after scheduled amortization paymentsand prepayments, 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.

** **

**The followingdiscussion related to our consolidated financial statements should be read inconjunction with the financial statements appearing in item 1 of this quarterlyreport on form 10-Q.**

 

**Critical Accounting Policies**

 

Our discussion and analysis of financial condition and results ofoperations is based on our financial statements, which have been prepared inaccordance with accounting principles generally accepted in the United States,known as GAAP. These accounting principles require us to make some complex andsubjective decisions and assessments. Our most critical accounting policies involve decisions and assessments,which could significantly affect our reported assets, liabilities andcontingencies, as well as our reported 

 

36

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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 thesedecisions and assessments on an ongoing basis. Actual results may differ from these estimates under differentassumptions or conditions.  We haveidentified our most critical accounting policies to be the following:

 

**VariableInterest Entities**

 

Our ownership of the subordinated classes of CMBS from a single issuer mayprovide us with the right to control the foreclosure/workout process on theunderlying loans.  There are certainexceptions to the scope of FIN 46R, one of which provides that an investorthat holds a variable interest in a qualifying special-purpose entity, or QSPE,does not consolidate that entity unless the investor has the unilateral abilityto cause the entity to liquidate.  FASB Statement of Financial AccountingStandards No. 140, or SFAS 140, “Accounting for Transfers and Servicing ofFinancial Assets and Extinguishments of Liabilities,” provides the requirements for an entity toqualify as a QSPE. To maintain the QSPE exception, the special-purpose entitymust initially meet the QSPE criteria and must continue to satisfy suchcriteria in subsequent periods. A special-purpose entity’s QSPE status can beaffected in future periods by activities by its transferors or other involvedparties, including the manner in which certain servicing activities areperformed. To the extent that our CMBS investments were issued by aspecial-purpose entity that meets the QSPE requirements, we record thoseinvestments at the purchase price paid. To the extent the underlyingspecial-purpose entities do not satisfy the QSPE requirements, we follow theguidance set forth in FIN 46R as the special-purpose entities would bedetermined to be VIEs.

 

We have analyzed the pooling andservicing agreements governing each of our controlling class CMBSinvestments and we believe that the terms of those agreements conform toindustry standards and are consistent with the QSPE criteria. However, there isuncertainty with respect to QSPE treatment due to ongoing review by accountingstandard setters, potential actions by various parties involved with the QSPE(discussed in the paragraph above), as well as varying and evolvinginterpretations of the QSPE criteria under SFAS 140.  Additionally, the standard setters continueto review the FIN 46R provisions related to the computations used to determinethe primary beneficiary of a VIE.

 

At March 31, 2008, we ownedsecurities of three controlling class CMBS trusts with a carrying value of$38,508.  The total par amounts of CMBSissued by the three CMBS trusts was $921,654. Using the fair value approach to calculate expected losses or residualreturns, we have concluded that we would not be the primary beneficiary of anyof the underlying special-purpose entities.  At March 31, 2008, our maximum exposure to loss as a result of itsinvestment in these QSPEs totaled $38,508, which equals the book value of theseinvestments as of March 31, 2008.

 

The financing structures that weoffer to the borrowers on certain of our real estate loans involve the creationof entities that could be deemed VIEs and therefore, could be subject toFIN 46R.  Our management hasevaluated these entities and has concluded that none of such entities are VIEsthat are subject to the consolidation rules of FIN 46R.

 

**Loans and Investments and Loans Held for Sale**

** **

Loansheld for investment are intended to be held to maturity and, accordingly, arecarried at cost, net of unamortized loan origination fees, discounts,repayments, sales of partial interests in loans, and unfunded commitmentsunless such loan or investment is deemed to be impaired.  Loans held for sale are carried at the lowerof cost or market value using available market information obtained throughconsultation with dealers or other originators of such investments.  We may originate or acquire preferred equityinterests that allow it to participate in a percentage of the underlyingproperty’s cash flows from operations and proceeds from a sale orrefinancing.  Should we make such apreferred equity investment, we must determine whether that investment shouldbe accounted for as a loan, joint venture or as an interest in real estate.

 

Specific valuationallowances are established for possible loan losses based on the fair value ofcollateral on an individual loan basis and the consideration of guarantees orother recourse.  The fair value of thecollateral is determined by selecting the most appropriate valuationmethodology, or methodologies, among several generally available andaccepted  in the commercial real estateindustry.  The determination of the mostappropriate valuation methodology is based on the key characteristics of thecollateral type.  These methodologies includethe evaluation of operating cash flow from the property during the projectedholding period, and the estimated sales value of the collateral computed byapplying an expected capitalization rate to the stabilized net operating incomeof the specific property, less selling costs, all of which are discounted atmarket discount rates.  Because thedetermination of estimated value is based upon projections of future economicevents, which are inherently subjective, amounts ultimately realized from loansand investments may differ materially from the carrying value at the balance sheetdate.

 

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If upon completion of thevaluation, the estimated fair value of the underlying collateral securing theloan is less than the net carrying value of the loan, an allowance is createdwith a corresponding charge to the provision for possible loan losses.  The allowance for each loan is maintained ata level we believe is adequate to absorb probable losses.  Impairment losses are recognized as a directwrite-down of the loan investment with a corresponding charge-off to theallowance.  We maintained a reserve of$16,658 and $8,658 at March 31, 2008 and December 31, 2007,respectively.  There were no charge-offsfor the three months ended March 31, 2008. During the year ended December 31, 2007, charge-offs totaled$3,200.

 

#### **Commercial Mortgage-Backed Securities**

#### ** **

We designate our CMBSinvestments pursuant to FASB Statement of Financial Accounting Standards No. 115,or SFAS 115, on the date of acquisition of the investment.  Held to maturity investments are stated atcost plus the amortization of any premiums or discounts and any premiums ordiscounts are amortized through the consolidated statements of income using thelevel yield method. CMBS securities that we do not hold for the purpose ofselling them in the near-term but may dispose of prior to maturity, aredesignated as available-for-sale and are carried at estimated fair value withthe net unrealized gains or losses recorded as a component of accumulated othercomprehensive income (loss) in stockholders equity.  Unrealized losses on securities that in thejudgment of management are other than temporary are charged against earnings asa loss on the income statement.  In November 2007,subsequent to financing our CMBS investments in our CDOs, we redesignated allof our available-for-sale CMBS investments with a book value of approximately$43.6 million to held to maturity.  As ofMarch 31, 2008 and December 31, 2007, the unrealized loss on theredesignated CMBS investments included in other comprehensive income was $5,428and $5,575, respectively.

 

We account for CMBS(other than those of high credit quality or sufficiently collateralized toensure that the possibility of credit loss is remote) under Emerging IssuesTask Force 99-20, “Recognition of Interest Income and Impairment on Purchasedand Retained Beneficial Interests in Securitized Financial Assets,” or EITF99-20.   Accordingly, on a quarterlybasis, when significant changes in estimated cash flows from the cash flowspreviously estimated occur due to actual prepayment and credit loss experience,and the present value of the revised cash flow is less then the present valuepreviously estimated, an other then temporary impairment is deemed to haveoccurred.  The security is written downto fair value with the resulting change against earnings and a new cost basisis established.   We calculate a revisedyield based on the current amortized cost of the investment (including anyother-than-temporary impairments recognized to date) and the revised yield isthen applied prospectively to recognize interest income.

 

Wedetermine the fair value of CMBS based on the types of securities in which wehave invested.  For liquid,investment-grade securities, we consult with dealers of such securities toperiodically obtain updated market pricing for the same or similarinstruments.  For non-investment gradesecurities, we actively monitor the performance of the underlying propertiesand loans and update our pricing model to reflect changes in projected cash flows.  The value of the securities is derived byapplying discount rates to such cash flows based on current market yields.  The yields employed are obtained from our ownexperience in the market, advice from dealers and/or information obtained inconsultation with other investors in similar instruments.  Because fair value estimates may vary to somedegree, we must make certain judgments and assumptions about the appropriateprice to use to calculate the fair values for financial reportingpurposes.  Different judgments andassumptions could result in different presentations of value.

 

In accordance with SFAS 115,when the estimated fair value of the security classified as available-for-salehas been below amortized cost for a significant period of time and we concludethat we no longer have the ability or intent to hold the security for theperiod of time over which we expect the values to recover to amortized cost,the investment is written down to its fair value, and this loss is realized andcharged against earnings.  Thedetermination of other than temporary impairment is a subjective process, anddifferent judgments and assumptions could affect the timing of lossrealization.

 

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

 

ConsolidatedCTL investments are recorded at cost less accumulated depreciation.  Costs directly related to the acquisition ofsuch investments are capitalized. Certain improvements are capitalized when they are determined toincrease the useful life of the building. Capitalized items are depreciated using the straight-line method overthe shorter of the useful lives of the capitalized item or 40 years forbuildings 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.

 

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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-line rent adjustments are no longer recordedand historic results are reclassified as 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 allocatedto building and other intangible assets over their estimated useful lives,which generally range from three to 40 years.  The values of the above andbelow-market leases are amortized and recorded as either an increase (in thecase of below-market leases) or a decrease (in the case of above-market leases)to rental income over the remaining term of the associated lease.  Thevalue associated with in-place leases and tenant relationships are amortizedover the expected term of the relationship, which includes an estimatedprobability of the lease renewal, and its estimated term.  If a tenantvacates its space prior to the contractual termination of the lease and norental payments are being made on the lease, any unamortized balance of therelated 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 offuture cash flows are based on a number of factors including the historicaloperating results, known trends, and market/economic conditions that may affectthe property.

 

**Investmentsin Unconsolidated Joint Ventures**

 

#### **We account for our investments inunconsolidated joint ventures under the equity method of accounting since weexercise significant influence, but do not unilaterally control, the entitiesand are not considered to be the primary beneficiary under FIN 46.  In thejoint ventures, the rights of the other investor are protective andparticipating. Unless we are determined to be the primary beneficiary, theserights preclude us from consolidating the investments.  The investmentsare recorded initially at cost as an investment in unconsolidated jointventures, and subsequently are adjusted for equity in net income (loss) andcash 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.  As of March 31, 2008 and December 31,2007, we had investments of $53,066 and $49,440 in unconsolidated jointventures, respectively.**

#### ** **

#### **RevenueRecognition**

#### ** **

Interestincome on debt investments is recognized over the life of the investment usingthe effective interest method and recognized on the accrual basis.  Fees received in connection with loancommitments are deferred until the loan is funded and are then recognized overthe term of the loan using the effective interest method.  Anticipated exit fees, whose collection isexpected, are also recognized over the term of the loan as an adjustment toyield.  Fees on commitments that expireunused are recognized at expiration. Fees received in exchange for the credit enhancement of another lender,either subordinate or senior to us, in the form of a guarantee are recognizedover the term 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 is resumed when the loanbecomes contractually current and performance is demonstrated to be resumed.

 

Wedesignate loans as non-performing at such time as: (1) the loan becomes 90days delinquent or (2) the loan has a maturity default.  All non-performing loans are placed onnon-accrual status and income is recognized only upon actual cash receipt.  At March 31, 2008, we had one firstmortgage loan with a carrying value of $10,411 and one 40% participationinterest in a first mortgage loan with a carrying value of $21,000 which wereclassified as non-performing loans.  At December 31,2007, we had one non-performing loan with a carrying value of $29,058 which wassubsequently repaid in full on March 14, 2008, along with accrued interestand substantially all other fees and charges due.

 

Weclassify loans as sub-performing if they are not performing in accordance withtheir terms, in all material respects, but they do not qualify asnon-performing loans.  The specific factsand circumstances of these loans may cause them to become non-performing loansshould certain events occur.  At March 31,2008, two first mortgage loans with a total carrying value of $69,755,

 

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onesecond lien loan with a carrying value of $45,000 and one third lien loan witha carrying value of $6,764 were classified as sub-performing.  In April 2008, the first lien lendersfiled notices of default and acceleration with respect to the collateralsupporting the second lien and third lien loans classified as sub-performingloans as of March 31, 2008.  The first and second lien loans are secured byland, which is intended primarily for residential development.  Given the ongoing correction in the UnitedStates residential real estate markets, and the fact that the debt structureunderlying this land consists of several tranches with several largeinstitutional lenders in each tranche, we believe that the debt restructuringof these loans will be more complicated and take longer than a more customaryrestructuring.  Therefore, there is moreuncertainty surrounding the possible outcome of these loans.  We and our co-lenders are currently evaluating options to protect ourinterests.  At December 31, 2007,one first mortgage loan with a carrying value of $10,403, and one 40%participation interest in a first mortgage loan with a carrying value of$22,000, were classified as sub-performing.

 

Insome instances we may sell all or a portion of our investments to a thirdparty.  To the extent the fair valuereceived for an investment exceeds the amortized cost of that investment andFASB Statement No. 140, or SFAS 140, “Accounting for Transfers andServicing of Financial Assets and Extinguishments of Liabilities,” criteria ismet, under which control of the asset that is sold is surrendered making it a “truesale,” a gain on the sale will be recorded through earnings as otherincome.  To the extent an investment thatis sold has a discount or fees, which were deferred at the time the investmentwas made and were being recognized over the term of the investment, the unamortizedportion of the discount or fees are recognized at the time of sale and recordedas a gain on the sale of the investment through other income.  For the three months ended March 31,2008 and 2007, we recognized $3,499 from the purchase at a discount ofinvestment grade CRE CDO bonds and $2,686 in net gains from the sale of debtinvestments or commitments.

 

Rental revenue is recognized on a straight-line basis over the term ofthe lease. The excess of rents recognized over amounts contractually due pursuantto the underlying leases is included in other assets on the accompanyingbalance sheets. We may establish, on a current basis, an allowance against thisaccount for future potential tenant credit losses, which may occur. The balancereflected on the balance sheet will be net of such allowance.

 

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

 

#### **Reservefor Possible Loan Losses**

#### ** **

Specific valuationallowances are established for possible loan losses on loans in instances whereit is deemed possible that we will be unable to collect all amounts ofprincipal and interest due according to the contractual terms of the loan.  We consider the estimated value of thecollateral securing the loan, and compare it to the carrying value of theloan.  The estimated value of thecollateral is determined by selecting the most appropriate valuationmethodology, or methodologies, among several generally available and acceptedin the commercial real estate industry. The determination of the most appropriate valuation methodology is basedon the key characteristics of the collateral type, collateral location, qualityof the sponsor, and other factors.  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.  Because the determination of estimated valueis based upon projections of future economic events, which are inherentlysubjective, amounts ultimately realized from loans and investments may differmateirally from the carrying value at the balance sheet date.

 

If, uponcompletion of the valuation, the estimated value of the underlying collateralsecuring the loan is less than the net carrying value of the loan, an allowanceis created with a corresponding charge to the provision for possible loanlosses.  The allowance for each loan ismaintained at a level we believe is adequate to absorb possible losses.  Impairment losses are recognized as a directwrite-down of the loan investment with a corresponding charge-off to theallowance.  During the three months endedMarch 31, 2008, no charge-offs were incurred.  During the year ended December 31, 2007,we incurred a charge-off totaling $3,200 related to a defaulted loan which hasa carrying value of $19,155 at December 31, 2007 and is recorded in otherassets.  We maintained a reserve forpossible loan losses of $16,658 against investments with a carrying value of $205,414as of March 31, 2008, and a reserve for possible loan losses of $8,658 againstinvestments with a carrying value of $264,612 as of December 31, 2007.

 

**StockBased Compensation Plans**

 

Wehave a stock-based compensation plan, described more fully in Note 14.  We account for this plan using the fair valuerecognition

 

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provisionsof FASB Statement 123(R), “Share-Based Payment, a revision of FASB Statement No. 123,Accounting for Stock-Based Compensation.”

 

TheBlack-Scholes option-pricing model was developed for use in estimating the fairvalue of traded options, which have no vesting restrictions and are fullytransferable.  In addition, optionvaluation models require the input of highly subjective assumptions includingthe expected stock price volatility. Because our plan has characteristics significantly different from thoseof traded options and because changes in the subjective input assumptions canmaterially affect the fair value estimate, in our opinion, the existing modelsdo not necessarily provide a reliable single measure of the fair value of ourstock options.

 

Compensation cost for stock options, if any, is recognized ratably overthe vesting period of the award.  Ourpolicy is to grant options with an exercise price equal to the quoted closingmarket price of our stock on the business day preceding the grant date.  Awards of stock or restricted stock areexpensed as compensation on a current basis over the benefit period.

 

Thefair value of each stock option granted is estimated on the date of grant forawards to co-leased employees, and quarterly for options issued tonon-employees, using the Black-Scholes option pricing model with the followingweighted average assumptions for grants in 2008 and 2007.

 

| ** **                       | ** ** | **2008**  | ** ** | **2007**  | ** ** |
|----------------------------------|------------|-----------|------------|-----------|------------|
| Dividend yield                   |       | 8.5       | %          | 7.9       | %          |
| Expected life of  option         |       | 5.5 years |       | 5.9 years |       |
| Risk-free  interest rate         |       | 3.5       | %          | 4.3       | %          |
| Expected stock  price volatility |       | 35.0      | %          | 28.0      | %          |

 

**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, or FFO, plus certainaccounting gains (as defined in the partnership agreement of our OperatingPartnership which was amended and restated in April 2006) exceed theproduct of our weighted average stockholders equity (as defined in thepartnership agreement of our Operating Partnership) multiplied by 9.5% (dividedby 4 to adjust for quarterly calculations). We will record any distributions onthe Class B limited partner interests as an incentive distribution expensein the period when earned and when payment of such amounts has become probableand reasonably estimable in accordance with the partnership agreement.  These cash distributions will reduce the amountof cash available for distribution to our common unit holders in our OperatingPartnership and to our common stockholders. We incurred approximately $2,496 and $2,817 with respect to such Class Blimited partner interests for the three months ended March 31, 2008 and2007, respectively.

 

#### **DerivativeInstruments**

#### ** **

**In thenormal course of business, we use a variety of derivative instruments tomanage, or hedge, interest rate risk.  Werequire that hedging derivative instruments be effective in reducing theinterest rate risk exposure that they are designated to hedge.  This effectiveness is essential forqualifying for hedge accounting.  Somederivative instruments are associated with an anticipated transaction.  In those cases, hedge effectiveness criteriaalso require that it be probable that the underlying transaction occurs.  Instruments that meet these hedging criteriaare formally designated as hedges at the inception 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 ofassessing fair value result in a general approximation of value, and such valuemay never actually 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.  Toaddress exposure to interest rates, we use derivatives primarily to hedge themark-to-market risk of our liabilities with respect to certain of ourassets.  We may also use derivatives tohedge variability in sales proceeds to be received upon the sale of loans held forsale.

 

We usea variety of commonly used derivative products that are considered plainvanilla derivatives.  These derivativestypically

 

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includeinterest rate swaps, caps, collars and floors. We also use total rate of return swaps, or TROR swaps, which are tied tothe Lehman Brothers CMBS index. We expressly prohibit the use of unconventionalderivative instruments and using derivative instruments for trading orspeculative purposes.  Further, we have apolicy of only entering into contracts with major financial institutions basedupon their credit ratings 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 fairvalue.  Derivatives that are not hedgesmust be adjusted to fair value through income. If a derivative is a hedge, depending on the nature of the hedge, changesin the fair value of the derivative will either be offset against the change infair value of the hedged asset, liability, or firm commitment through earnings,or recognized in other comprehensive income until the hedged item is recognizedin earnings.  The ineffective portion ofa derivative’s change in fair value will be immediately recognized inearnings.  SFAS 133 may increase ordecrease reported net income and stockholders’ equity prospectively, dependingon future levels of LIBOR, swap spreads and other variables affecting the fairvalues of derivative instruments and hedged items, but will have no effect oncash flows, provided the contract is carried through to full term.**

** **

We may employ swaps,forwards or purchased options to hedge qualifying forecasted transactions.  Gains and losses related to thesetransactions are deferred and recognized in net income as interest expense orother income in the same period or periods that the underlying transactionoccurs, expires or is otherwise terminated.

 

All hedges held by us aredeemed to be effective in meeting the hedging objectives established by ourcorporate policy governing interest rate risk management.  The effect of our derivative instruments onour financial statements is discussed more fully in Note 17 to our ConsolidatedFinancial Statements.

 

**Income Taxes**

 

Weelected to be taxed as a REIT, under Sections 856 through 860 of the InternalRevenue Code, beginning with our taxable year ended December 31,2004.  To qualify as a REIT, we must meetcertain organizational and operational requirements, including a requirement todistribute at least 90% of our ordinary taxable income to stockholders.  As a REIT, we generally will not be subjectto federal income tax on taxable income that 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 could materially adverselyaffect our net income and net cash available for distributions 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 subject to certain stateand local taxes.

 

**Our TRSs are subject to federal,state and local taxes.**

 

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**Results of Operations (Amounts inthousands)**

 

***Comparison of the three months ended March 31, 2008 to the threemonths ended March 31, 2007***

 

***Revenues***

 

| ** **                                                    | ** ** | **2008** | ** ** | **2007** | ** ** | **$ Change** | ** ** |
|---------------------------------------------------------------|------------|----------|------------|----------|------------|-------------------|------------|
| Investment  income                                            |       | $        | 74,595     |     | $          | 59,969            |       | $ | 14,626 |   |
| Rental revenue,  net                                          |       | 3,699    |       | 1,736    |       | 1,963             |       |
| Gain on sales  and other income                               |       | 7,797    |       | 6,429    |       | 1,368             |       |
| Total revenues                                                |       | 86,091   |       | 68,134   |       | $                 | 17,957     |   |
|                                                          |       |     |       |     |       |              |       |
| Equity in net  income (loss) of unconsolidated joint ventures |       | $        | 3,109      |     | $          | (695              | )          | $ | 3,804 |   |

 

Investmentincome is generated on our whole loans, subordinate interests in whole loans,mezzanine loans, preferred equity interests and CMBS.  For the three months ended March 31,2008, $29,708 was earned on fixed rate investments while the remaining $44,887was earned on floating rate investments. The increase over the prior year is due primarily to a larger number ofinvestments in 2008 versus 2007.

 

**Rental revenue of $3,699 in 2008includes revenue earned on 292 Madison Avenue and revenue earned on our TICinterest in 55 Corporate Drive, which has been held as a proportionatelyconsolidated property since its acquisition in June 2006. Following itsacquisition, 55 Corporate Drive was being redeveloped. The property wasaccounted for as an operating property beginning in the three months ended December 31,2007.  Rental revenue in 2008 includesthe effect of adjustments for straight-line rent for 55 Corporate Drive and 292Madison Avenue.  The increase over theprior year is due to the purchase of 292 Madison Avenue in July 2007.**

** **

Otherincome of $7,797 for the three months ended March 31, 2008 is primarilyattributable to $10 in net gains from the sales of three loans and a gain of$3,499 on the extinguishment of debt on two of our CDO bonds.  The remaining balance is primarily composedof interest on restricted cash balances in our three CDOs (only two of whichwere in place during the same period in 2007) and other cash balances held byus.  Other income of $6,429 for the threemonths ended March 31, 2007 is comprised primarily of gains recorded onthe sale of one loan and lending investment of $2,686 and interest earned onrestricted cash balances.

 

**The income on investments inunconsolidated joint ventures of $3,109 for the three months ended March 31,2008 represents our proportionate share of the income generated by our jointventure interests including $186 of real estate-related depreciation andamortization, which when added back, results in a contribution to FFO of$3,295.  Our use of FFO as an importantfinancial measure is discussed in more detail below.  The loss on investments in unconsolidatedjoint venture of $695 for the three months ended March 31, 2007 wasprimarily derived from our investment in One Madison Avenue in New York, NewYork. **In July 2007, we entered into an agreement tosell our entire investment in the One Madison Avenue joint venture to SL Greenfor approximately $147.0 million, subject to an external appraisal, which wasto be approved by the board of directors of both parties.  The sale transaction closed on August 17,2007, at which time we realized a gain of $92,235.

** **

***Expenses***

 

| ** **                             | ** ** | **2008** | ** ** | **2007** | ** ** | **$ Change** | ** ** |
|----------------------------------------|------------|----------|------------|----------|------------|-------------------|------------|
| Interest expense                       |       | $        | 41,443     |     | $          | 36,461            |       | $ | 4,982 |   |
| Management fees                        |       | 7,145    |       | 4,839    |       | 2,306             |       |
| Incentive fee                          |       | 2,496    |       | 2,818    |       | (322              | )          |
| Depreciation and  amortization         |       | 1,830    |       | 671      |       | 1,159             |       |
| Marketing,  general and administrative |       | 2,804    |       | 3,820    |       | (1,016            | )          |
| Provision for  loan loss/(recovery)    |       | 8,000    |       | 1,248    |       | 6,752             |       |
| Provision for  taxes                   |       | 11       |       | 534      |       | (523              | )          |
| Total expenses                         |       | $        | 63,729     |     | $          | 50,391            |       | $ | 13,338 |   |

 

Interest expense was$41,443 for the three months ended March 31, 2008 compared to $36,461 forthe three months ended March 31, 2007. Interest expense for the three months ended March 31, 2008consisted primarily of $29,844 of interest on the investment grade tranches ofour three CDOs (only two of which were in place during the same period in2007), $2,232 of interest on borrowings on our master repurchase facilitieswith Wachovia and Goldman, $2,871 of expense on our three $50,000 issuances oftrust preferred securities, $2,759 of interest on our unsecured revolvingcredit facility, and the amortization of deferred financing costs related toour CDOs, repurchase facilities and unsecured revolving credit facility.  The $36,461 of interest expense during thesame period in 2007 was comprised primarily of $24,826 of interest on theinvestment grade tranches of our first two CDOs, $4,178 of interest on

 

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borrowings on our masterrepurchase facilities, and $2,871 of expense accrued against our three $50,000issuances of trust preferred securities.

 

Management fees increased$2,306 for the three months ended March 31, 2008 to $7,145 versus $4,839for the same period in 2007 due primarily to an increase in our stockholder’sequity as a result of additional issuances of common and preferred equity onwhich base management fees are calculated. The remaining increase is attributable to the amount paid or payable toour Manager on investments in our three CDOs (only two of which was in placeduring the same period in 2007) in accordance with the CDO collateralmanagement agreements in lieu of the 0.15% fee otherwise payable to SL GreenOperating Partnership, L.P. on those investments under the asset servicingagreement, higher fees paid or payable to SL Green Operating Partnership, L.P.under our outsource and servicing agreements due to the increase in ourinvestment balances and the scheduled 3% annual increase in the fee payableunder our outsource agreement.

 

We recorded an incentivefee expense of $2,496 during the three months ended March 31, 2008 inaccordance with requirements of the partnership agreement of our OperatingPartnership which entitles owners of Class B limited partner interests inour Operating Partnership to an incentive return equal to 25% of the amount bywhich FFO plus certain accounting gains (as defined in the partnership agreementof our Operating Partnership) exceed the product of our weighted averagestockholders equity (as defined in the amended and restated partnershipagreement of our Operating Partnership) multiplied by 9.5% (divided by 4 toadjust for quarterly calculations).  Wealso recorded incentive fee expense of $2,817 for the three months ended March 31,2007, which reflects a lower FFO recognized during that period compared to2008.

 

Thedecrease in marketing, general and administrative expenses to $2,804 for the threemonths ended March 31, 2008 versus the same period in 2007 was dueprimarily to higher equity related compensation, in 2007.  As a percentage of total revenues, marketing,general and administrative expenses declined to 3.3% for the three months endedMarch 31, 2008 from 5.6% for the same period in 2007.

 

**Liquidity and Capital Resources**

 

**Liquidity is a measurement of theability to meet cash requirements, including ongoing commitments to repayborrowings, fund and maintain loans and investments, pay dividends and othergeneral business needs.  Our principalsources of working capital and funds for additional investments primarilyinclude: (1) cash flow from operations; (2) borrowings under our repurchasefacilities and unsecured revolving credit facility; (3) our CDOs; (4) otherforms of financing or additional securitizations including CMBS or subsequentCDO offerings; (5) proceeds from common or preferred equity offerings, (6)issuances of trust preferred securities and, to a lesser extent, (7) the proceedsfrom principal payments on our investments, and (8) the sale or syndication ofcertain of our debt investments or real estate investments.  We believe these sources of financing will besufficient to meet our short-term liquidity needs.  Due to recent conditions in the capital andcredit markets, we do not anticipate having the ability in the near-term toaccess equity capital through the public markets or debt capital through newCDO issuances.  Therefore, we will relyprimarily on cash flows from operations, principal and interest payments on ourinvestments, sales or syndications of loans, and other forms of secured orunsecured debt, or private equity, that may become available to us.**

** **

**On April 1, 2008, we completedour acquisition of American Financial in a transaction with a total value ofapproximately $3.3 billion. In connection with this transaction, we utilizedapproximately $290.6 million of cash, issued 15.6 million shares of commonstock and incurred $1.2 billion of debt including the assumption ofapproximately $1.3 billion of American Financial’s secured debt.**

** **

**Our ability to fund ourshort-term liquidity needs, including distributions to stockholders, throughcash flow from operations can be evaluated through the consolidated statementof cash flows provided in our financial statements.  However, the net cash from operations or netcash used in operations disclosed on the statement of cash flows should beadjusted to exclude the effect of loans originated for sale and the proceeds ofloans sold during any respective reporting period.  These activities are included in cash flowfrom operations in accordance with GAAP, but constitute an integral part of ourinvestment activity.  Consequently, netcash flow from operations is not necessarily reflective of our true recurringoperating activities and our ability to fund our required distributions tostockholders through our operating activities.**

** **

**Our ability to meet our long-termliquidity and capital resource requirements will be subject to obtainingadditional debt financing and equity capital. Our inability to renew, replace or expand our sources of financing onsubstantially similar terms, may have an adverse effect on our business andresults of operations.  In addition, anevent of default can be triggered under our repurchase facilities and ourunsecured revolving credit facility if, among other things, the managementagreement with the Manager is terminated. Depending on market conditions, our debt financing will generally be inthe range of 70% to 80% of the carrying value of our total assets.  Any**

 

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**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.  Our debt financing terms may require us tokeep uninvested cash on hand, or to maintain a certain portion of our assetsfree of liens, each of which could serve to limit our borrowing ability.  Moreover, our debt may be secured by ourassets.  If we default in the payment ofinterest or principal on any such debt, breach any representation or warrantyin connection with any borrowing or violate any covenant in any loan document,our lender may accelerate the maturity of such debt requiring us to immediatelyrepay all outstanding principal.  If weare unable to make such payment, our lender could foreclose on our assets thatare pledged as collateral to such lender. The lender could also sue us or force us into bankruptcy.  Any such event would have a material adverseeffect on our liquidity and the value of our common stock.  In addition, posting additional collateral tosupport our credit and repurchase facilities will reduce our liquidity andlimit our ability to leverage our assets.**

** **

**To maintain our status as a REITunder the Internal Revenue Code, we must distribute annually at least 90% ofour taxable income.  These distributionrequirements limit our ability to retain earnings and thereby replenish orincrease capital for operations. However, we believe that our significant capital resources and access tofinancing, as noted above, will provide us with financial flexibility at levelssufficient to meet current and anticipated capital requirements, including fundingnew lending and investment opportunities.**

** **

**Cash Flows**

 

Netcash provided by operating activities decreased $83,688 to $9,812 for the threemonths ended March 31, 2008 compared to cash provided of $93,500 for sameperiod in 2007.  Operating cash flow isgenerated primarily by net interest income on our investment portfolio.  The decrease in operating cash flow for thethree months ended March 31, 2008 compared to the same period in 2007 wasprimarily due to the net proceeds from loans held for sale in 2007 of$83,008.  There were no net proceeds fromloans held for sale in 2008.

 

Net cash provided byinvesting activities for the three months ended March 31, 2008 was $35,785as compared to net cash used in investing activities of $336,430 during thesame period in 2007.  The increase in cash provided by investingactivities is primarily due to a significant decline in the new investmentoriginations net of repayments for the three months ended March 31, 2008as compared to the same period in 2007.

 

Net cash used byfinancing activities for the three months ended March 31, 2008 was $31,076as compared to net cash provided by financing activities of $240,046 during thesame period in 2007.  The decrease forthe three months ended 2008 as compared to the same period in 2007 is primarilyattributable to a decrease of $152,851 in restricted cash in connection withfinancing investments in our CDOs, and an increase of dividends paid in 2008 of$80,661 which was due to the declaration of a $2.00 per common share specialdividend in December 2007 paid in January 2008.

 

**Capitalization**

** **

Ourauthorized capital stock consists of 125,000,000 shares, $0.001 par value, ofwhich we have authorized the issuance of up to 100,000,000 shares of commonstock, $0.001 par value per share, and 25,000,000 shares of preferred stock,par value $0.001 per share.  As of March 31,2008, 34,853,911 shares of common stock and 4,600,000 shares of preferred stockwere issued and outstanding.

 

**Preferred Stock**

** **

**In April 2007, we issued4,600,000 shares of our 8.125% Series A cumulative redeemable preferredstock (including the underwriters’ over-allotment option of 600,000 shares)with a mandatory liquidation preference of $25.00 per share. Holders of the Series Acumulative redeemable preferred shares receive annual dividends of $2.03125 pershare paid on a quarterly basis and dividends are cumulative, subject tocertain provisions. On or after April 18, 2012, we may at our optionredeem the Series A cumulative redeemable preferred stock at par for cash.Net proceeds (after deducting underwriting fees and expenses) from the offeringwere approximately $111,205.**

** **

**Common Stock**

** **

Asof the date of our formation, April 12, 2004, we had 500,000 shares ofcommon stock outstanding valued at approximately $200.  On August 2, 2004 we completed ourinitial public offering of 12,500,000 shares of common stock resulting in netproceeds of approximately $172,900, which was used to fund investments andcommence our operations.  As ofMarch 31, 2008 and December 31, 2007, 594,333 restricted shares hadalso been issued under our 2004 Equity Incentive Plan, or our Equity IncentivePlan.  These shares have a vesting periodof two to four years.

 

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InDecember 2004, we sold 5,500,000 shares of our common stock, at a price of$17.27 per share, resulting in net proceeds of approximately $93,740 under aprivate placement exemption from the registration requirements of Section 5of the Securities Act of 1933, as amended. We subsequently registered these shares for resale under the SecuritiesAct in August 2005.  A total of4,225,000 shares were sold to various institutional investors and an additional1,275,000 shares were sold to SL Green Operating Partnership, L.P. pursuant toits contractual right to choose to maintain up to a 25% ownership interest inthe outstanding shares of our common 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.

 

InSeptember 2005, we sold 3,833,333 shares of our common stock, at a priceof $25.80 per share, resulting in net proceeds of approximately $97,830.  A total of 2,875,000 shares were sold througha public offering and an additional 958,333 shares were sold to SL GreenOperating Partnership, L.P. pursuant to its contractual right to choose tomaintain up to a 25% ownership interest in our outstanding shares of commonstock.  Net proceeds were used for loanacquisitions and originations, repayment of outstanding principal under one ofour repurchase facilities and general corporate purposes.

 

InMay 2006, we sold 3,000,000 shares of our common stock, at a price of$26.75 per share, resulting in net proceeds of approximately $79,787.  A total of 2,250,000 shares were sold througha public offering and an additional 750,000 shares were sold to SL GreenOperating Partnership, L.P. pursuant to its contractual right to choose tomaintain up to a 25% ownership interest in the outstanding shares of our commonstock.  Net proceeds were used for loanacquisitions and originations, repayment of outstanding principal under ourrepurchase facilities and general corporate purposes.

 

In May 2007 our new$500,000 shelf registration statement was declared effective by the Securitiesand Exchange Commission, or SEC. This registration statement provides us withthe ability to issue common and preferred stock, depository shares andwarrants. We currently have $373.3 million available under the shelf.

 

InSeptember 2007, we sold 4,825,000 shares of common stock, at a publicoffering price of $26.25 per share, resulting in net proceeds of approximately$124.5 million.  A total of 3,618,750shares were sold through a public offering and an additional 1,206,250 shareswere sold directly to SL Green Operating Partnership, L.P. pursuant to itscontractual right to choose to maintain up to a 25% ownership interest in ouroutstanding shares of common stock. After this offering, SL Green Operating Partnership, L.P. owned7,624,583 shares of our common stock. Net proceeds were used to retire borrowings under the Company’sunsecured facility and to create additional funding capacity for opportunisticinvestments.

 

InNovember 2007, we sold, through a private placement pursuant to Section 4(2) ofthe Securities Act, 3,809,524 shares of common stock at a price of $26.25 pershare to an affiliate of Morgan Stanley Real Estate Special Situations FundIII, a global diversified fund managed by Morgan Stanley Real Estate, raising grossproceeds of approximately $100,000. Subsequent to this private placement, SL Green’s ownership percentagewas approximately 22% of the outstanding shares of our common stock at March 31,2008.

 

**OutperformancePlan (Amounts in thousands except per share data)**

 

In June 2005, thecompensation committee of our board of directors approved a long-term incentivecompensation program, the 2005 Outperformance Plan.  Participants in the 2005 Outperformance Plan,all of whom are co-leased employees, will share in a “performance pool” if ourtotal return to stockholders for the period from June 1, 2005 through May 31,2008 exceeds a cumulative total return to stockholders of 30% during themeasurement period over a base share price of $20.21 per share.  The size of the pool will be 10% of theoutperformance amount in excess of the 30% benchmark, subject to a maximumlimit equal to the lesser of 4% of our outstanding shares and units of limitedpartnership interest as of the end of the performance period, or 1,200,000shares.  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.  Inthe event the potential performance pool reaches the maximum dilution capbefore May 31, 2008 and remains at that level or higher for 30 consecutivedays, the performance period will end early and the pool will be formed on thelast 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 the 2005 OutperformancePlan will be made in the form of partnership units, or LTIP Units, that mayultimately become exchangeable for shares of our common stock or cash, at ourelection.  Under the 2005 OutperformancePlan, LTIP Units have been granted and additional LTIP Units may be granted inthe future prior to the determination of the performance pool; however, theseLTIP Units will only vest upon satisfaction of performance and otherthresholds, and will not be entitled to distributions until after theperformance pool, or minimum performance 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

 

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number of LTIP Unitsearned, had they been issued at the beginning of the performance period.  Those distributions will be paid in the formof additional LTIP Units.  Once aperformance pool has been established, the earned LTIP Units will receiveregular quarterly distributions on a per unit basis equal to the dividends pershare paid on our common stock, whether or not they are vested.  Any LTIP Units that are not earned upon theestablishment of the performance pool will be automatically forfeited, and theLTIP Units that are earned will be subject to time-based vesting, with 50% ofthe LTIP Units earned vesting in May 2009 and the balance vesting one yearlater based on continued employment with our Manager or SL Green.  We will record the expense of the restrictedstock award in accordance with FASB Statement No. 123(R).  Compensation expense of $308 and $383 wasrecorded for the three months ended March 31, 2008 and 2007, respectively,related to the 2005 Outperformance Plan. The measurement date under our 2005 Outperformance Planwill occur on May 31, 2008 and, absent any material increase in the priceof our common stock on the NYSE, we expect that our 2005 Outperformance Planwill expire with no value to any of the plan participants.

 

**DeferredStock 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, feesdeferred under the program shall be credited in the form of phantom stockunits.  The phantom stock units are convertible into an equal number ofshares of common stock upon such directors’ termination of service from theBoard 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 31,2008, there were approximately 38,713 phantom stock units outstanding, of which26,713 units are vested.

 

**Market Capitalization**

 

At March 31,2008, our CDOs and borrowings under our repurchase facilities, unsecuredrevolving credit facility and mortgage loans (excluding our share of jointventure debt of $242 million) represented 79% of our consolidated marketcapitalization of $3.9 billion (based on a common stock price of $20.93 pershare, the closing price of our common stock on the New York Stock Exchange on March 31,2008).  Market capitalization includesour consolidated debt and common stock.

 

**Indebtedness**

** **

**The table below summarizesborrowings at March 31, 2008 and December 31, 2007, which currentlyinclude our Wachovia and Goldman repurchase facilities, KeyBank unsecuredrevolving credit facility, any proportionately consolidated mortgage debt orterm loans, our CDOs and our subordinated debentures:**

** **

| ** **                       | ** ** | **March 31,  2008** | ** ** | **December 31,  2007** | ** ** |
|----------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| Repurchase  agreements           |       | $                        | 166,777    |                        | $          | 200,197 |   |
| Credit facilities                |       | 50,000                   |       | —                      |       |
| Mortgage notes  payable          |       | 153,624                  |       | 153,624                     |       |
| Collateralized  debt obligations |       | 2,721,700                |       | 2,735,145                   |       |
| Junior  subordinated debentures  |       | 150,000                  |       | 150,000                     |       |
| Total                            |       | $                        | 3,242,101  |                        | $          | 3,238,966 |   |
|                             |       |                     |       |                        |       |
| Cost of debt                     |       | LIBOR+0.82               | %          | LIBOR+0.81                  | %          |

** **

**RepurchaseFacilities**

** **

**We have two repurchasefacilities, one with Wachovia Capital Markets, LLC or one or more of itsaffiliates, or Wachovia, and one with Goldman Sachs Mortgage Company, orGoldman.**

 

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Therepurchase facility with Wachovia is a $500,000 facility.  This facility was initially established as a$250,000 facility, was increased to $350,000 from $250,000 effective January 2005,and was subsequently increased to $500,000 effective April 2005. In June 2007,we modified the facility by further reducing the credit spreads.  As a result of the modifications, the$500,000 facility bears interest at spreads of 0.65% to 2.50% over one-monthLIBOR and, based on its expected investment activities, provides for advancerates that vary from 60% to 95% based upon the collateral provided under aborrowing base calculation.  In October 2006,we extended the facility’s maturity date until October 2009.  The lender has a consent right with respectto the inclusion of investments in this facility, determines periodically themarket value of the investments, and has the right to require additionalcollateral, a partial repayment of the facility (margin call), or a reductionin unused availability under the facility, sufficient to rebalance the facilityif the estimated market value of the included investments declines.  We had no accrued interest and borrowings of$121,867 at a weighted average spread to LIBOR of 1.33% as of March 31,2008, and no accrued interest and borrowings of $165,286 at a weighted averagespread to LIBOR of 1.33%, as of December 31, 2007.

 

Wealso have a repurchase facility with Goldman. In October 2006 we increased this facility from $200,000 to$400,000 and extended its maturity date until September 2009.  In June 2007, we modified the facilityby further reducing the credit spreads. As a result of the modifications, the facility bears interest at spreadsof 1.00% to 1.50% over one-month LIBOR and, based on its expected investmentactivities, provides for advance rates that vary from 70% to 90% based upon thecollateral provided under a borrowing base calculation.  As with the Wachovia facility, the lender hasa consent right to the inclusion of investments in this facility, determines periodicallythe market value of the investments, and has the right to require additionalcollateral, a partial repayment of the facility (margin call), or a reductionin unused availability under the facility, sufficient to rebalance the facilityif the estimated market value of the included investments declines.  We had accrued interest of $128 andborrowings of $44,910 at a weighted average spread to LIBOR of 1.18% as of March 31,2008, and accrued interest of $189 and borrowings of $34,911 at a weighted averagespread to LIBOR of 1.07% under this facility at December 31, 2007.

 

The terms of ourrepurchase facilities (together with any related guarantees) include covenantsthat****(a) limit our maximumtotal indebtedness to no more than 85% of total assets, (b) require us tomaintain minimum liquidity of at least $15,000, (c) require our fixedcharge coverage ratio to be at no time less than 1.25 to 1.00, (d) requireour minimum interest coverage ratio to be at no time less than 1.35 to 1.00,and (e) require us to maintain minimum tangible net worth of not less than(i) $400,000, plus (ii) 75% of the net proceeds of our subsequentequity issuances following the date of the June 2007 amendments. Thecovenants also restrict us from making distributions in excess of a maximum of100% of our FFO (as defined therein) for the previous four quarters under theWachovia facility, except that we may in any case pay distributions necessaryto maintain our REIT status.  An event of default can be triggered on ourrepurchase facilities if, among other things, GKK Manager LLC is terminated asour Manager.  As of March 31, 2008and December 31, 2007, we were in compliance with all such covenants.

 

The repurchase facilitiesrequire that we pay down borrowings under these facilities as principalpayments on the loans and investments pledged to these facilities arereceived.  Assets pledged as collateral under thesefacilities may include stabilized and transitional whole loans, subordinateinterests in whole loans, mezzanine loans, and rated CMBS or commercial realestate CDO securities originated or acquired by us.

 

#### **UnsecuredRevolving Credit Facility**

#### ** **

In May 2006, weclosed on a $100,000 senior unsecured revolving credit facility with KeyBankNational Association, or KeyBank, with an initial term of three years and aone-year extension option.  The initialfacility was supported by a negative pledge of an identified asset base(involving substitution rights) with advance rates that vary from 30% to 90% ofthe asset value provided under a borrowing base calculation.  The lender also had consent rights to theinclusion of assets in the borrowing base calculation.  The facility bore interest at 1.90% over one-monthLIBOR to the extent our leverage ratio, defined as total liabilities to totalassets, including our proportionate share of the liabilities and assets of ourunconsolidated subsidiaries, is less than 80% and 2.10% over one-month LIBOR tothe extent out leverage ratio is equal to or greater than 80%. In June 2007the facility was increased to $175,000 and interest spreads on the facilitywere reduced.  The facility is supportedby a negative pledge of an identified asset base with advance rates that varyfrom 30% to 90% of the asset value provided under a borrowing base calculation.  The lender also has consent rights to theinclusion of assets in the borrowing base calculation. Following themodifications in June 2007, the facility bears interest at 1.65% overone-month LIBOR. We had accrued interest of $6 and borrowings of $50,000 as of March 31,2008, and no accrued interest and borrowings under this facility at December 31,2007.

 

The terms of theunsecured revolving credit facility include covenants that****(a) limit our maximum totalindebtedness to no more than 85% of total assets, (b) require our fixedcharge coverage ratio to be at no time less than 1.30, and (c) require usto maintain minimum tangible net worth of not less than $450,000 plus 75% ofthe net proceeds from equity offerings completed following the date of the

 

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June 2007amendment.  The covenants also restrictus from making distributions in excess of a maximum of 100% of our FFO (asdefined by the National Association of Real Estate Investment Trusts, orNAREIT) for the previous four quarters, except that we may in any case paydistributions necessary to maintain our REIT status.  Anevent of default can be triggered on our unsecured revolving credit facilityif, among other things, GKK Manager LLC is terminated as our Manager.  As of March 31, 2008 and December 31,2007, we were in compliance with all such covenants.

 

#### **Mortgage Loan**

#### ** **

Wehave one consolidated interest-only mortgage loan in an amount equal to ourownership percentage in the entity multiplied by the outstanding principalbalance of the mortgage loan, which loan financed the acquisition of 55Corporate Drive in June 2006.  Themortgage has an outstanding principal balance of $190,000, of which we haveconsolidated 49.75% or $94,525, with an effective interest rate of 5.75% and aterm of ten years.

 

#### **Collateralized Debt Obligations**

#### ** **

During2005 we issued approximately $1,000,000 of CDOs through two indirectsubsidiaries, Gramercy Real Estate CDO 2005-1 Ltd., or the 2005 Issuer,and Gramercy Real Estate CDO 2005-1 LLC, or the 2005 Co-Issuer. The CDOconsists of $810,500 of investment grade notes, $84,500 of non-investment gradenotes, which were co-issued by the 2005 Issuer and the 2005 Co-Issuer, and$105,000 of preferred shares, which were issued by the 2005 Issuer.  The investment grade notes were issued withfloating rate coupons with a combined weighted average rate of three-monthLIBOR plus 0.49%.  We incurredapproximately $11,957 of costs related to Gramercy Real Estate CDO 2005-1,which are amortized on a level- yield basis over the average life of the CDO.

 

During2006 we issued an additional approximately $1,000,000 of CDOs through twonewly-formed indirect subsidiaries, Gramercy Real Estate CDO 2006-1 Ltd.,or the 2006 Issuer, and Gramercy Real Estate CDO 2006-1 LLC, or the 2006Co-Issuer. The CDO consists of $903,750 of investment grade notes, $38,750 ofnon-investment grade notes, which were co-issued by the 2006 Issuer and the2006 Co-Issuer, and $57,500 of preferred shares, which were issued by the 2006Issuer.  The investment grade notes wereissued with floating rate coupons with a combined weighted average rate ofthree-month LIBOR plus 0.37%. We incurred approximately $11,364 of costsrelated to Gramercy Real Estate CDO 2006-1, which are amortized on alevel-yield basis over the average life of the CDO.

 

InAugust 2007, we issued $1,100,000 of CDOs through two newly-formedindirect subsidiaries, Gramercy Real Estate CDO 2007-1 Ltd., or the 2007Issuer, and together with the 2005 Issuer and the 2006 Issuer, the Issuers, andGramercy Real Estate CDO 2007-1 LLC, or the 2007 Co-Issuer, and together withthe 2005 Co-Issuer and the 2006 Co-Issuer, the Co-Issuers. The CDO consists of$1,045,550 of investment grade notes, $22,000 of non-investment grade notes,which were co-issued by the 2007 Issuer and the 2007 Co-Issuer, and $32,450 ofpreferred shares, which were issued by the 2007 Issuer.  The investment grade notes were issued withfloating rate coupons with a combined weighted average rate of three-monthLIBOR plus 0.46%. We incurred approximately $16,816 of costs related toGramercy Real Estate CDO 2007-1, which are amortized on a level-yield basisover the average life of the CDO.

 

Weretained all non-investment grade securities, the preferred shares and thecommon shares in the Issuer of each CDO. The Issuers and Co-Issuers in each CDO holds assets, consistingprimarily of whole loans, subordinate interests in whole loans, mezzanine loansand preferred equity investments and CMBS, which serve as collateral for theCDO.  Each CDO may be replenished,pursuant to certain rating agency guidelines relating to credit quality anddiversification, with substitute collateral for loans that are repaid duringthe first five years of the CDO. Thereafter, the CDO securities will be retiredin sequential order from senior-most to junior-most as loans are repaid.  The financial statements of the Issuer ofeach CDO are consolidated in our financial statements. The investment gradenotes are treated as a secured financing, and are non-recourse to us. Proceedsfrom the sale of the investment grade notes issued in each CDO were used torepay substantially all outstanding debt under our repurchase agreements and tofund additional investments.

 

In January 2008, we repurchased $4,000 of Class B notes inthe 2005 Issuer and $9,500 of Class B notes in the 2007 Issuer at a dollarprice of approximately $0.79 and $0.70, respectively.  We recorded a net gain of $3,499 inconnection with the repurchase of notes of such Issuers.

 

**JuniorSubordinated Debentures**

** **

**In January 2006, May 2005and August 2005, we completed issuances of $50,000 each in unsecured trustpreferred securities through three DST’s, Gramercy Capital Trust I, or GCTI,Gramercy Capital Trust II, or GCTII, and Gramercy Capital Trust II, or GCT III,that are**

 

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**also wholly-owned subsidiaries ofour Operating Partnership.  Thesecurities issued in January 2006 bear interest at a fixed rate of 7.65%for the first ten years ending January 2016, with an effective rate of7.43% when giving effect to the swap arrangement previously entered into incontemplation of this financing. Thereafter the rate will float based on the three-month LIBOR plus 270basis points.  The securities issued in May 2005bear interest at a fixed rate of 7.57% for the first ten years ending June 2015and the securities issued in August 2005 bear interest at a fixed rate of7.75% for the first ten years ending October 2015.  Thereafter the rates will float based on thethree-month LIBOR plus 300 basis points.**

** **

Allissuances of trust preferred securities require quarterly interestdistributions; however, payments may be deferred while the interest expense isaccrued for a period of up to four consecutive quarters if our OperatingPartnership exercises its right to defer such payments, which it may elect todo on more than one occasion.  The trustpreferred securities are redeemable, at the option of our OperatingPartnership, in whole or in part, with no prepayment premium any time after June 30,2010, October 30, 2010 or January 30, 2011 for the securities issuedby GCTI, GCTII and GCTIII, respectively.

 

GCTI,GCTII and GCTIII each issued $1,550 aggregate liquidation amount of commonsecurities, representing 100% of the voting common stock of those entities toour Operating Partnership for a total purchase price of $4,650.  GCTI, GCTII and GCTIII used the proceeds fromthe sale of the trust preferred securities and the common securities topurchase our Operating Partnership’s junior subordinated notes.  The terms of the junior subordinated notesmatch the terms of the trust preferred securities.  The notes are subordinate and junior in rightof payment to all present and future senior indebtedness and certain other ofour financial obligations.  We realizednet 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 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.

 

**Contractual Obligations**

** **

Combinedaggregate principal maturities of our CDOs, repurchase facilities, trustpreferred securities, proportionately consolidated mortgage note related to ourTIC interest in 55 Corporate Drive, mortgage note relating to 292 MadisonAvenue, unsecured revolving credit facility, unfunded loan commitments and ourobligations under our management agreement, outsource agreement, CDO collateralmanagement agreements and operating lease as of March 31, 2008 are asfollows (amounts in thousands):

 
| ** ** | ** ** | **CDOs**  | ** ** | **Repurchase  Facilities** | ** ** | **Trust  Preferred  Securities** | ** ** | **Mortgage  Note  Payable(1)** | ** ** | **Unsecured  Revolving  Credit  Facility** | ** ** | **Unfunded  Loan (2)  Commitments** | ** ** | **Outsource and  Management  Agreements (3)** | ** ** | **CDO  Collateral  Management  Agreements** | ** ** | **Operating  Lease** | ** ** | **Total** | ** ** |
|------------|------------|-----------|------------|----------------------------|------------|----------------------------------|------------|--------------------------------|------------|--------------------------------------------|------------|-------------------------------------|------------|---------------------------------------------------------|------------|---------------------------------------------|------------|----------------------|------------|-----------|------------|
| 2008       |       | $         | —     |                       | $          | —                           |       | $                              | —     |                                       | $          | —                              |       | $                                                       | —     |                                        | $          | 23,792               |       | $         | 17,880     |   | $ | 5,139 |   | $ | 261 |   | $ | 47,072 |   |
| 2009       |       | —    |       | 166,777                    |       | —                           |       | —                         |       | 50,000                                     |       | 86,196                              |       | 18,263                                                  |       | 5,139                                       |       | 265                  |       | 326,640   |       |
| 2010       |       | —    |       | —                     |       | —                           |       | —                         |       | —                                     |       | 55,651                              |       | —                                                  |       | 4,205                                       |       | 283                  |       | 60,139    |       |
| 2011       |       | —    |       | —                     |       | —                           |       | —                         |       | —                                     |       | —                              |       | —                                                  |       | 2,302                                       |       | 297                  |       | 2,599     |       |
| 2012       |       | —    |       | —                     |       | —                           |       | —                         |       | —                                     |       | —                              |       | —                                                  |       | 555                                         |       | 302                  |       | 857       |       |
| Thereafter |       | 2,721,700 |       | —                     |       | 150,000                          |       | 153,624                        |       | —                                     |       | —                              |       | —                                                  |       | —                                      |       | 752                  |       | 3,026,076 |       |
| Total      |       | $         | 2,721,700  |                       | $          | 166,777                          |       | $                              | 150,000    |                                       | $          | 153,624                             |       | $                                                       | 50,000     |                                        | $          | 165,639              |       | $         | 36,143     |   | $ | 17,340 |   | $ | 2,160 |   | $ | 3,463,383 |   |

 

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(1)   We have a49.75% interest in the mortgage for $94,525 associated with 55 Corporate Drive and a 100%interest in the $59,099 note associated with 292 Madison Avenue.

(2)   Based onloan budgets and estimates.

(3)   Managementfee is calculated as 1.75% of our gross stockholders equity (as defined in themanagement agreement) on December 31, 2007, inclusive of the trust preferredsecurities issued on May 20, 2005, August 9, 2005 andJanuary 27, 2006.

 

**Off-Balance-SheetArrangements**

** **

Wehave several off-balance-sheet investments, including joint ventures andstructured finance investments.  These investments all have varying ownershipstructures.  Substantially all of our joint venture arrangements areaccounted for under the equity method of accounting as we have the ability toexercise significant influence, but not control over the operating andfinancial decisions of these

 

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jointventure arrangements.  Our off-balance-sheet arrangements are discussed inNote 6, “Investments in Unconsolidated Joint Ventures” in the accompanyingfinancial statements.

 

**Dividends**

 

Tomaintain our qualification as a REIT, we must pay annual dividends to ourstockholders of at least 90% of our REIT taxable income, determined beforetaking into consideration the dividends paid deduction and net capitalgains.  We intend to continue to payregular quarterly dividends to our stockholders.  Before we pay any dividend, whether forFederal income tax purposes or otherwise, which would only be paid out ofavailable cash to the extent permitted under our unsecured and secured creditand repurchase facilities, and our term loans, we must first meet both ouroperating requirements and scheduled debt service on our mortgages and loanspayable.

 

**Inflation**

 

Amajority of our assets and liabilities are interest rate sensitive innature.  As a result, interest rates andother factors influence our performance more so than inflation.  Changes in interest rates do not necessarilycorrelate with inflation rates or changes in inflation rates.  Further, our financial statements areprepared in accordance with GAAP and our distributions are determined by ourboard of directors based primarily on our net income as calculated for taxpurposes, in each case, our activities and balance sheet are measured withreference to historical costs or fair market value without consideringinflation.

 

**RelatedParty Transactions (Amounts in thousands)**

 

In connection with our initial public offering, weentered into a management agreement with the Manager, which was subsequentlyamended and restated in April 2006. The management agreement provides for a term through December 2009with automatic one-year extension options and is subject to certain terminationrights.  We pay our Manager an annualmanagement fee equal to 1.75% of our gross stockholders equity (as defined inthe management agreement) inclusive of our trust preferred securities.  We incurred expense to the Manager under thisagreement of an aggregate of $7,145 and $4,839 for the three months ended March 31,2008 and 2007, respectively.

 

To provide an incentive to enhance the value of ourcommon stock, the holders of the Class B limited partner interests of ourOperating Partnership are entitled to an incentive return equal to 25% of theamount by which FFO plus certain accounting gains and losses (as defined in thepartnership agreement of our Operating Partnership) exceed the product of theweighted average stockholders equity (as defined in the partnership agreementof our Operating Partnership) multiplied by 9.5% (divided by four to adjust forquarterly calculations).  We will recordany distributions 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$2,496 and $2,817 with respect to such Class B limited partner interestsfor the three months ended March 31, 2008 and 2007.

 

We are obligated to reimburse our Manager for itscosts incurred under an asset servicing agreement between the Manager and anaffiliate of SL Green Operating Partnership, L.P. and a separate outsourceagreement between the Manager and SL 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 assetservicing fee may be reduced by SL Green Operating Partnership, L.P. for feespaid directly to outside servicers by us. The outsource agreement provides for an annual fee payable by us, whichfee is currently $1,366 per year, increasing 3% annually over the prior year onthe anniversary date of the outsource agreement in August of eachyear.  For the three months ended March 31,2008 and 2007, we realized expense of $341 and $332, respectively, to ourManager under the outsource agreement. For the three months ended March 31, 2008 and 2007, we realizedexpense of $1,324 and $769, respectively, to our Manager under the assetservicing agreement.  Payments under theoutsource agreement will increase subsequent to the closing of our merger withAmerican Financial merger to reflect higher costs resulting from the increasedsize and number of assets of the combined company.

 

Inconnection with the closing of our first CDO in July 2005, the 2005 Issuerentered into a collateral management agreement with the Manager. Pursuant tothe collateral management agreement, the Manager has agreed to provide certainadvisory and administrative services in relation to the collateral debtsecurities and other eligible investments securing the CDO notes.  The collateral management agreement providesfor a senior collateral management fee, payable quarterly in accordance withthe priority of payments as set forth in the indenture, equal to 0.15% perannum of the net outstanding portfolio balance, and a subordinate collateralmanagement fee, 

 

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payablequarterly in accordance with the priority of payments as set forth in theindenture, equal to 0.25% per annum of the net outstanding portfoliobalance.  Net outstanding portfoliobalance is the sum of the (i) aggregate principal balance of thecollateral 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 underthe first CDO, the Board of Directors has allocated to the Manager thesubordinate collateral management fee paid on the CDO securities not held byus.  At March 31, 2008 and December 31,2007 we owned all of the non-investment grade bonds, preferred equity andequity in both CDOs.  The senior collateral management fee andbalance of the subordinate collateral management fee is allocated to us.  For the three months ended March 31,2008 and 2007, we realized expense of $512 and $507, respectively, to theManager under such collateral management agreement.

 

Exceptfor the 2005 CDO, fees payable in connection with CDOs or other securitizationvehicles are governed by the management agreement.  Pursuant to that agreement, if a collateralmanager is retained as part of the formation of a CDO or other securitizationvehicle, our Manager or an affiliate will be the collateral manager and willreceive the following fees:  (i) 0.25% per annum of the principalamount outstanding of bonds issued by a managed transitional CDO that are ownedby third-party investors unaffiliated with us or our Manager, which CDO isstructured to own loans secured by transitional properties, (ii) 0.15% perannum of the book value of the principal amount outstanding of bonds issued bya managed non-transitional CDO that are owned by third-party investorsunaffiliated with us or our Manager, which CDOs structured to own loans securedby non-transitional properties, (iii) 0.10% per annum of the principalamount outstanding of bonds issued by a static CDO that are owned by thirdparty investors unaffiliated with us or the Manager, which CDO is structured toown non-investment grade bonds, and (iv) 0.05% per annum of the principalamount outstanding of bonds issued by a static CDO that are owned bythird-party investors unaffiliated with us or the Manager, which CDO isstructured to own investment grade bonds. For the purposes of the management agreement, a “managed transitional”CDO means a CDO that is actively managed, has a reinvestment period and isstructured to own debt collateral secured primarily by non-stabilized realestate assets that are expected to experience substantial net operating incomegrowth, and a “managed non-transitional” CDO means a CDO that is activelymanaged, has a reinvestment period and is structured to own debt collateralsecured primarily by stabilized real estate assets that are not expected toexperience substantial net operating income growth.  Both “managed transitional” and “managednon-transitional” CDOs may at any given time during the reinvestment period ofthe respective vehicles invest in and own non-debt collateral (in limited quantity)as defined by the respective indentures. If any fees are paid to the collateral manager in excess of the feestructure provided for above, such fees are paid to us.  For the three months ended March 31, 2008 and 2007, we realizedexpense of $571 and $565, respectively, to the Manager under thisagreement.  With respect to the CDO whichclosed in August, 2007, we realized expense of $216 to our Manger for the threemonths ended March 31, 2008.

 

**In April 2005, we closed ona $57,503 initial investment in a joint venture with SL Green to acquire, ownand operate the South Building located at One Madison Avenue, New York, NewYork, or the South Building.  The jointventure, which was owned 45% by a wholly-owned subsidiary of us and 55% by awholly-owned subsidiary of SL Green was created to acquire, own and operate theSouth Building. The joint venture interests are *pari passu*.  The jointventure completed the acquisition of the South Building from Metropolitan LifeInsurance Company for the purchase price of approximately $802,800 plus closingcosts, financed in part through a $690,000 first mortgage loan on the SouthBuilding.  The South Building comprisesapproximately 1.2 million square feet and is almost entirely net leased toCredit Suisse Securities (USA) LLC (“CS”) pursuant to a lease with a 15-year remaining term.  In August 2007 we sold our entireinvestment in the joint venture to SL Green Realty Corp. for approximately$147.0 million and realized a gain of $92,235. In August 2007, an affiliate of SL Green loaned approximately$147.0 million to our Operating Partnership. This loan was to be repaid with interest at an annual rate of 5.80% onthe earlier of September 1, 2007 or the closing of the sale of our 45%interest in One Madison Avenue to SL Green. As a result of the sale of our interest in August 2007, the loanwas repaid with interest on such date.**

 

**In June 2006, we closed onthe acquisition of a 49.75% TIC interest in 55 Corporate Drive, located inBridgewater, New Jersey with a 0.25% interest to be acquired in thefuture.  The remaining 50% of theproperty is owned as a TIC interest by an affiliate of SL Green OperatingPartnership, L.P.  The property iscomprised of three buildings totaling approximately six hundred and seventythousand square feet which is 100% net leased to an entity whose obligationsare guaranteed by Sanofi-Aventis Group through April 2023. The transactionwas valued at $236,000 and was financed with a $190,000, 10-year, fixed-ratefirst mortgage loan.**

** **

Commencingin May 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 isfor approximately 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, 2008and 2007, we paid $62 and $63 under this lease, respectively.

 

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**In July 2005,we closed on the purchase from an SL Green affiliate of a $40,000 mezzanineloan which bears interest at 11.20%.  Aspart of that sale, the seller retained an interest-only participation.  We have determined that the yield on ourmezzanine loan after giving effect to the interest-only participation retainedby the seller is at market.  Themezzanine loan is secured by the equity interests in an office property in NewYork, New York.**

** **

**In February 2006,we closed on the purchase of a $90,000 whole loan, which bears interest atthree month LIBOR plus 2.15%, to a joint venture in which SL Green is an equityholder.  The loan is secured by 55Corporate Drive in Bridgewater, New Jersey. The loan was repaid in full in June 2006 with the proceeds from newmortgage financing obtained in connection with the sale of the property, 49.75%of which is now owned by us through a TIC structure.**

** **

**In March 2006,we closed on the purchase of a $25,000 mezzanine loan, which bears interest atone-month LIBOR plus 8.00%, to a joint venture in which SL Green is an equityholder.  The mezzanine loan was repaid infull on May 9, 2006, when we originated a $90,287 whole loan, which bearsinterest at one-month LIBOR plus 2.75%, to the joint venture.  The whole loan is secured by office andindustrial properties in northern New Jersey and has a book value of $90,477and $90,389 as of March 31, 2008 and December 31, 2007, respectively.**

** **

**In August 2006,we acquired from a financial institution a 50% pari-passu interest in a $65,000preferred equity investment secured by an office property in New York, NewYork.  An affiliate of SL Greensimultaneously acquired and owns the other 50% pari-passu interest. Theinvestment bears interest at a blended fixed rate of 10.52%.**

** **

**In December 2006,we acquired from a financial institution a pari-passu interest of $125,000 in a$200,000 mezzanine loan, which bears interest at 6.384% and is secured by amulti-family portfolio in New York, New York. An affiliate of SL Green simultaneously acquired the remaining $75,000pari-passu interest in the mezzanine loan.**

** **

**In January 2007,we originated two mezzanine loans totaling $200,000. The $150,000 loan wassecured by a pledge of cash flow distributions and partial equity interests ina portfolio of multi-family properties and bore interest at one-month LIBORplus 6.00%. The $50,000 loan was initially secured by cash flow distributionsand partial equity interests in an office property. On March 8, 2007 the$50,000 loan was increased by $31,000 when the existing mortgage loan on theproperty was defeased, upon which event our loan became secured by a firstmortgage lien on the property and was reclassified as a whole loan. The wholeloan currently bears interest at one-month LIBOR plus 6.00% for the initialfunding and one-month LIBOR plus 1.00% for the subsequent funding. At closing,an affiliate of SL Green acquired from us and held a 15.15% pari-passu interestin the mezzanine loan and the whole loan. As of March 31, 2008 and December 31,2007, our interest in the whole loan had a carrying value of $65,066 and$65,033, respectively. The investment in the mezzanine loan was repaid in fullin September 2007.**

** **

**In March 2007,we closed on the acquisition of a $62,500 pari-passu interest in one tranche ofa multiple-level mezzanine structure primarily secured by pledges of equity andrights to cash distributions, which was used to fund the acquisition of a largeoffice portfolio.  The investment bearsinterest at one-month LIBOR plus 2.85%. At closing, an affiliate of SL Green simultaneously acquired a $62,500pari-passu interest in the same tranche of the mezzanine structure.  The investment was repaid in full in May 2007.**

** **

**In April 2007, we purchasedfor $103,200 a 45% TIC interest to acquire the fee interest in a parcel of landlocated at 2 Herald Square, located along 34th Street in New York,New York.  The acquisition was financedwith a $86,063 10-year fixed rate mortgage loan.  The property is subject to a long-term groundlease with an unaffiliated third party for a term of 70 years.  The remaining TIC interest is owned by awholly-owned subsidiary of SL Green. The TIC interests are *pari passu*.  As of March 31, 2008 and December 31,2007, the investment had a carrying value of $22,074 and $20,390, respectively.  We recorded our *pro rata*share of net income of $1,504 for the three months ended March 31, 2008.**

** **

**In July 2007,we purchased for $144,240 an investment in a 45% TIC interest to acquire a 79%fee interest and 21% leasehold interest in the fee position in a parcel of landlocated at 885 Third Avenue, on which is situated The Lipstick Building.  The transaction was financed with a $120,44310-year fixed rate mortgage loan.  Theproperty is subject to a 70-year leasehold ground lease with an unaffiliatedthird party. The remaining TIC interest is owned by a wholly-owned subsidiaryof SL Green.  The TIC interests are paripassu.  As of March 31, 2008 and December 31,2007, the investment had a carrying value of $30,694 and $28,332,respectively.  We recorded our pro ratashare of net income of $1,931 for the three months ended March 31, 2008.**

** **

In July 2007, we acquired for $71,871 a 100% fee interest in theproperty located at 292 Madison Avenue, New York, New York, purchased from SLGreen.  We entered into a 70-year groundlease with an unaffiliated third party which simultaneously purchased from

 

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**SL Greenthe Class B office building situated on the property.  Our acquisition of the fee interest wasfinanced with a $59,099 10-year fixed rate mortgage loan.**

** **

**In August 2007,we closed on the purchase from a financial institution of a $12,500 mezzanineloan on a substantially complete residential condominium project in the uppereast side of Manhattan.  The investmentbears interest at the current pay rate of 11% over LIBOR, and a 19% look-backinternal rate of return at maturity.  Atclosing, an affiliate of SL Green simultaneously acquired a $12,500 pari-passuinterest in the same tranche of the capital structure.**

** **

**In September 2007,we acquired a 50% interest in a $25,000 senior mezzanine loan from SLGreen.  Immediately thereafter we, alongwith SL Green, sold all of our interests in the loan to an unaffiliated thirdparty.  Additionally, we acquired from SLGreen a 100% interest in a $25,000 junior mezzanine loan associated with thesame properties as the preceding senior mezzanine loan. Immediately thereafterwe participated 50% of its interest in the loan back to SL Green.  In October 2007, we acquired a 50% *pari-passu* interest in $57,795 of two additional tranches inthe senior mezzanine loan from an unaffiliated third party.  At closing, an affiliate of SL Greensimultaneously acquired the other 50% pari-passu interest in the two tranches.**

** **

**In September 2007,the Manager earned a $1,000 collateral selection fee payable by NomuraInternational plc.  We purchased $18,000of par bonds of the same securities to which the collateral selection fee wasrelated and was earned.  As part of the closing on the securitiespurchased, we collected and immediately remitted the fee due to the Manager.**

** **

**In November 2007,we acquired from a syndicate comprised of financial institutions a $25,000interest in a $100,000 junior mezzanine investment secured by a hotel portfolioand franchise headquarters.  An affiliateof SL Green simultaneously acquired and owns another $25,000 interest in theinvestment.  The investment was purchasedat a discount and bears interest at an effective spread to one-month LIBOR of9.50%.**

** **

**In December 2007,we acquired a $52,000 interest in a senior mezzanine loan from a financialinstitution.  Immediately thereafter weparticipated 50% of our interest in the loan to an affiliate of SL Green.  The investment, which is secured by a retail propertyin New York, New York, was purchased at a discount and bears interest at aneffective spread to one-month LIBOR of 5.00%.**

** **

**In December 2007,we acquired a 50% interest in a $200,000 senior mezzanine loan from a financialinstitution.  Immediately thereafter weparticipated 50% of our interest in the loan to an affiliate of SL Green.  The investment was purchased at a discountand bears interest at an effective spread to one-month LIBOR of 6.50%.**

** **

**BrightStar Couriers LLC, or Bright Star, provides messenger services to us.  Bright Star is owned by Gary Green, a son ofStephen L. Green, our Chairman.  Theaggregate amount of fees paid by us for such services for the three monthsended March 31, 2008 and 2007, was less than $1 and less than $1, respectively.**

** **

**Fundsfrom Operations**

 

Wepresent FFO because we consider it an important supplemental measure of ouroperating performance and believe that it is frequently used by securitiesanalysts, investors and other interested parties in the evaluation of REITS.  We also use FFO for the calculation of theincentive fee payable to the holders of Class B limited partner interestsin our Operating Partnership and as one of several criteria to determineperformance-based incentive compensation for members of our senior management,which may be payable in cash or equity awards. The revised White Paper on FFO approved by the Board of Governors of theNational Association of Real Estate Investment Trusts, or NAREIT, in April 2002defines FFO as net income (loss) (computed in accordance with GAAP), excludinggains (or losses) from items which are not a recurring part of our business,such as debt restructurings, and sales of properties, plus real estate-relateddepreciation and amortization and after adjustments for unconsolidatedpartnerships and joint ventures.  We consider gains and losses on the sales ofdebt investments and real estate investments including tenancy-in-commoninvestments to be a normal part of our recurring operations and thereforeinclude such gains and 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 entirely indicative of funds available to fund our cash needs,including our ability to make cash distributions.  Our calculation of FFO may be different fromthe calculation used by other companies and, therefore, comparability may belimited.

 

FFO for the three monthsended March 31, 2008 and 2007 are as follows (amounts in thousands):

 

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| ** **                                        | ** ** | **For the Three Months Ended** | ** ** |
|---------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                        | ** ** | **2008**                                           | ** ** | **2007** | ** ** |
| Income from  continuing operations                |       | $                                                  | 25,482     |   | $ | 17,582 |   |
| Add:                                              |       |                                               |       |   |   |
| Depreciation and  amortization                    |       | 4,589                                              |       | 2,419 |   |
| FFO adjustment  for unconsolidated joint ventures |       | 186                                                |       | 1,947 |   |
| Less:                                             |       |                                               |       |   |   |
| Provision for  taxes                              |       | (11                                                | )          | (534 | ) |
| Dividends on  preferred stock                     |       | (2,336                                             | )          | — |   |
| Non real estate  depreciation and amortization    |       | (3,877                                             | )          | (1,836 | ) |
| Funds from  operations                            |       | $                                                  | 24,033     |   | $ | 19,578 |   |
| ** **                                        |       |                                               |       |   |   |
| Funds from  operations per share - basic          |       | $                                                  | 0.69       |   | $ | 0.75 |   |
| Funds from  operations per share - diluted        |       | $                                                  | 0.69       |   | $ | 0.71 |   |

 

**CautionaryNote Regarding Forward-Looking Information**

 

This report contains “forward-lookingstatements” within the meaning of Section 27A of the Securities Act and Section 21Eof the Securities Exchange Act of 1934, as amended, or the Exchange Act.  You can identify forward-looking statementsby the use of forward-looking expressions such as “may,” “will,” “should,” “expect,”“believe,” “anticipate,” “estimate,” “intend,” “plan,” “project,” “continue,”or any negative or other variations on such expressions.  Forward-looking statements includeinformation concerning possible or assumed future results of our operations,including any forecasts, projections, plans and objectives for futureoperations.  Although we believe that ourplans, intentions and expectations as reflected in or suggested by thoseforward-looking statements are reasonable, we can give no assurance that theplans, intentions or expectations will be achieved.  We have listed below some important risks,uncertainties and contingencies which could cause our actual results,performance or achievements to be materially different from the forward-lookingstatements we make in this report.  Theserisks, uncertainties and contingencies include, but are not limited to, thefollowing:

 

·                  thesuccess or failure of our efforts to implement our current business strategy;

·                  economicconditions generally and in the commercial finance and real estate marketsspecifically;

·                  theperformance and financial condition of borrowers, tenants, and corporatecustomers;

·                  theactions of our competitors and our ability to respond to those actions;

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

·                  theavailability, terms and deployment of short-term and long-term capital;

·                  availabilityof qualified personnel;

·                  availabilityof investment opportunities on real estate-related and other securities;

·                  theadequacy of our cash reserves and working capital;

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

·                  thetiming of cash flows, if any, from our investments;

·                  risksof structured finance investments;

·                  changesin governmental regulations, tax rates and similar matters;

·                  legislativeand regulatory changes (including changes to laws governing the taxation ofREITs or the exemptions from registration as an investment company);

·                  environmentaland/or safety requirements;

·                  ourability to satisfy complex rules in order for us to qualify as a REIT, forfederal income tax purposes and qualify for our exemption under the InvestmentCompany Act, our operating partnership’s ability to satisfy the rules inorder for it to qualify as a partnership for federal income tax purposes, andthe ability of certain of our subsidiaries to qualify as REITs and 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;

·                  GKKManager LLC remaining as our manager;

·                  competitionwith other companies;

·                  thecontinuing threat of terrorist attacks on the national, regional and localeconomies;

·                  certainfactors relating to our acquisition of American Financial including, but notlimited to, the ability to integrate American Financial’s business and to achieveexpected synergies, operating efficiencies and other benefits, or withinexpected cost

 

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projections, andto preserve the goodwill of the acquired business, and the amount of expensesand other liabilities incurred or accrued in connection with closing of themerger; and

·                  otherfactors discussed under Item IA Risk Factors in the Annual Report on Form 10-Kfor the year ended December 31, 2007.

 

We assume no obligationto update publicly any forward-looking statements, whether as a result of newinformation, future events, or otherwise. In evaluating forward-looking statements, you should consider theserisks and uncertainties, together with the other risks described fromtime-to-time in our reports and documents which are filed with the SEC, and youshould not place undue reliance on those statements.

 

Therisks included here are not exhaustive. Other sections of this report may include additional factors that couldadversely affect our business and financial performance.  Moreover, we operate in a very competitiveand rapidly changing environment.  Newrisk factors emerge from time to time and it is not possible for management topredict all such risk factors, nor can it assess the impact of all such riskfactors on our business or the extent to which any factor, or combination offactors, may cause actual results to differ materially from those contained inany forward-looking statements.  Giventhese risks and uncertainties, investors should not place undue reliance onforward-looking statements as a prediction of actual results.

 

**RecentlyIssued Accounting Pronouncements**

 

**In June 2006,the FASB issued Interpretation No. 48, or FIN 48, “**Accounting for Uncertaintyin Income Taxes.” This interpretation,clarifies the accounting for uncertainty in income taxes recognized in anenterprise’s financial statements in accordance with SFAS 109.  This interpretation prescribes a recognitionthreshold and measurement attribute for the financial statement recognition andmeasurement of a tax position taken or expected to be taken in a taxreturn.  FIN 48 also provides guidance onderecognition, classification, disclosure, and transition.  This interpretation was effective January 1,2007 for us.  The adoption of FIN 48 didnot have a material impact on our financial results for the year ended December 31,2007.

** **

**In February 2007, the FASBissued Statement No. 159, or SFAS 159, ‘‘The Fair Value Option forFinancial Assets and Financial Liabilities.’’ SFAS 159 permits entities to choose to measure many financialinstruments and certain other items, at fair value. SFAS 159 also establishespresentation and disclosure requirements designed to facilitate comparisonsbetween entities that choose different measurement attributes for similar typesof assets and liabilities. SFAS 159 applies to reporting periods beginningafter November 15, 2007.  We did notelect SFAS 159 for any of our financial assets and financial liabilities as ofMarch 31, 2008.**

** **

**In June 2007, the AmericanInstitute of Certified Public Accountants, or AICPA, issued Statement ofPosition (“SOP”) 07-01 “Clarification of the Scope of the Audit and AccountingGuide for Investment Companies and Accounting by Parent Companies and EquityMethod Investors for Investments in Investment Companies,” or SOP 07-1.  SOP 07-1 clarifies the scope of accountingfor investment companies and provides guidance for determining whether anentity is within the scope of the AICPA Audit and Accounting Guide forInvestment Companies or the Guide.  Forthose entities that are investment companies under SOP 07-1, the specializedindustry accounting principles of the Guide (referred to as Investment Companyaccounting) should be retained by a parent company when it consolidates itsinterest in the investment company or by an equity method investor when it recordsits interest in the investment company. The SOP also provides for certain disclosure requirements for parentcompanies and equity method investors in investment companies that continueinvestment company accounting in the parent’s consolidated financial statementsor the financial statements of the equity method investor.  The SOP was to be effective for fiscal yearsbeginning on or after December 15, 2007; however in a meeting on October 17,2007, the FASB voted to indefinitely defer the effective date and add to theFASB’s technical agenda, consideration of amending certain provisions of theSOP.  We maintain an exemption from theInvestment Company Act of 1940, as amended, and are therefore not regulated asan investment company and as a REIT, we are not subject to the AICPA’sInvestment Company Accounting and Auditing Guide.  We continue to monitor the FASB’sdevelopments with respect to SOP 07-1.**

** **

**In December 2007, the FASBissued Statement No. 141 (revised), “Business Combinations,”  or SFAS 141(R), which attempts to improve therelevance, representational faithfulness, and comparability of the informationthat a reporting entity provides in its financial reports**

 

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**about a business combination andits effects. This Statement replaces SFAS 141, “Business Combinations”. SFAS141(R) retains the fundamental requirements in Statement 141 that theacquisition method of accounting (which Statement 141 called the purchasemethod) be used for all business combinations and for an acquirer to beidentified for each business combination. This Statement also retains theguidance in SFAS 141 for identifying and recognizing intangible assetsseparately from goodwill. The most significant changes in SFAS 141(R) are:(1) acquisition and restructuring would be now expensed; (2) stockconsideration will be measured based on the quoted market price as of theacquisition date instead of the date the deal is announced; (3) contingentconsideration arising from contractual and noncontractual contingencies thatmeet the more-likely-than-not recognition threshold will be measured andrecognized as an asset or liability at fair value at the acquisition date usinga probability-weighted discounted cash flows model, with subsequent changes infair value reflected in earnings. Noncontractual contingencies that do not meetthe more-likely-than-not criteria will continue to be recognized when they areprobable and reasonably estimable; and (4) acquirer records 100% step-upto fair value for all assets & liabilities, including the minorityinterest portion and goodwill is recorded as if a 100% interest was acquired.SFAS 141(R) is effective for fiscal years beginning after December 15,2008.  We are currently evaluating theeffect, if any, that this pronouncement will have on our future financialposition or results of operations.**

** **

**In February 2008, the FASBissued Staff Position No. 140-3, or FSP 140-3, “Accounting for Transfersof Financial Assets and Repurchase Financing Transactions.” FSP 140-3 providesguidance on the accounting for a purchase of a financial asset from acounterparty and contemporaneous financing of the acquisition throughrepurchase agreements with the same counterparty.  Under this guidance, the purchase and relatedfinancing are linked, unless all of the following conditions are met at theinception of the transaction: 1) the purchase and corresponding financing arenot contractually contingent; 2) the repurchase financing provides recourse; 3)the financial asset and repurchase financing are readily obtainable in themarketplace and are executed at market rates; and 4) the maturity of financialasset and repurchase are not conterminous. A linked transaction would require a determination under FAS 140 toconclude if the transaction meets the requirements for sale accounting.  If the linked transaction does not meet saleaccounting requirements, the net investment in the linked transaction is to berecorded as a derivative with the corresponding change in fair value of thederivative being recorded through earnings. The value of the derivative would reflect changes in the value of theunderlying debt investments and changes in the value of the underlying creditprovided by the counterparty.  TheCompany currently presents these transactions gross, with the acquisition ofthe financial assets in total assets and the related repurchase agreements asfinancing in total liabilities on the consolidated balance sheets and theinterest income earned on the debt investments and interest expense incurred onthe repurchase obligations are reported gross on the consolidated incomestatements.  FAS 140-3 is effective forfinancial statements issued for fiscal years beginning after November 15,2008.  We are currently evaluating theeffect, if any, that this pronouncement will have on our future financialposition or results of operations.**

** **

**In March 2008, the FASB issuedSFAS No. 161, Disclosures about Derivative Instruments and HedgingActivities, an amendment of FASB Statement No. 133, or SFAS 161. SFAS161 is intended to improve financial reporting about derivative instruments andhedging activities by requiring enhanced disclosures to enable investors tobetter understand how and why an entity uses derivative instruments and theireffects on an entity’s financial position, financial performance and cashflows. SFAS 161 is effective for financial statements issued for fiscal yearsand interim periods beginning after November 15, 2008 with earlyapplication encouraged. We are currently evaluating the impact of adopting SFASNo. 161 may have on our consolidated financial statements.**

 

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**ITEM 3. Quantitative and Qualitative Disclosure About Market Risk**

** **

##### **Market Risk**

##### ** **

Marketrisk includes risks that arise from changes in interest rates, commodityprices, equity prices and other market changes that affect market sensitiveinstruments.  In pursuing our businessplan, we expect that the primary market risks to which we will be exposed arereal estate, interest rate, liquidity and credit risks.

 

During 2007 andcontinuing in the first quarter of 2008, the global capital markets experiencedunprecedented volatility, resulting in dramatic changes in credit spreads,prices of financial assets, liquidity and the availability and cost of debt andequity capital.  The impact has been mostsevere in the single-family residential real estate mortgage markets in theUnited States, but has more recently affected the commercial real estate debtmarkets in which we invest.  Inparticular, subsequent to the issuance of our third CDO in August 2007,the commercial real estate securitization markets have experienced severedeclines in transaction activity, reductions in short-term and long-termliquidity, and widening credit spreads. We have historically relied on the securitization markets as a source ofefficient match-funded financing structures for our growing portfolio ofcommercial loans and CMBS investment portfolio. Overall, this environment has led to increased costs, reducedavailability of efficient debt capital and reduced production volumes for us.  Currently, the new issue market forstructured finance transactions including commercial real estate CDOs isdormant.  This capital markets environmenthas led to increased cost of funds and reduced availability of efficient debtcapital, factors which have caused us to reduce our investment activity.  These conditions have also adversely impactedthe ability of commercial property owners to service their debt and refinancetheir loans as they mature.

 

We believe our businesseswill ultimately benefit in the long run, from a market environment where assetsare priced and structured more conservatively. In addition, our acquisition of American Financial will combine theexisting operating platforms of American Financial with our own to create anintegrated commercial real estate finance and operating company, and willtransform us from primarily a specialty finance company into a $7.5 billiondiversified enterprise with complementary business lines consisting ofcommercial real estate finance and property investments.

 

#### **RealEstate 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, andincreases in operating expenses (such as energy costs).  In the event net operating income decreases,a borrower may have difficulty repaying our loans, which could result in lossesto us.  In addition, decreases inproperty values reduce the value of the collateral and the potential proceedsavailable to a borrower to repay our loans, which could also cause us to sufferlosses.  Even when a property’s netoperating income is sufficient to cover the property’s debt service at the timea loan is made, there can be no assurance that this will continue in thefuture. We employ careful business selection, rigorous underwriting and creditapproval processes and attentive asset management to mitigate these risks.

 

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

###### ** **

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

 

Our operating resultswill depend in large part on differences between the income from our assets andour borrowing costs.  Most of our assetsand borrowings are variable-rate instruments that we finance with variable ratedebt.  The objective of this strategy isto minimize the impact of interest rate changes on the spread between the yieldon our assets and our cost of funds.  Weenter into hedging transactions with respect to all liabilities relating tofixed rate assets.  If we were to financefixed rate assets with variable rate debt and the benchmark for our variablerate debt increased, our net income would decrease.  Furthermore, as most of our availablefinancing provides for an ability of the lender to mark-to-market our assetsand make margin calls based on a change in the value of our assets, financingfixed rate assets with this debt creates the risk that an increase in fixedrate benchmarks (such as “swap” yields) would decrease the value of our fixedrate assets.  We have entered intocertain swap transactions in anticipation of drawing upon our mark-to-marketdebt to hedge against this risk.  Some ofour loans are subject to various interest rate floors.  As a result, if interest rates fall below thefloor rates, the spread between the yield on our assets and our cost of fundswill increase, which will generally increase our returns.  Because we generate income principally fromthe spread between the yields on our assets and the cost of our

 

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borrowing and hedgingactivities, our net income will generally increase if LIBOR increases anddecreases if LIBOR decreases, but this may not always be true in thefuture.  A hypothetical 100 basis pointincrease in interest rates along the entire interest rate curve for the threemonths ended March 31, 2008 would have increased our interest cost byapproximately $7,333, offset by an increase in our investment income ofapproximately $5,416.

 

Our exposure to interestrates will also be affected by our overall corporate leverage, which wegenerally target to be 70% to 80% of the carrying value of our assets, althoughour actual leverage may vary depending on our mix of assets.

 

In the event of asignificant rising interest rate environment and/or economic downturn,delinquencies and defaults could increase and result in loan losses to us,which could adversely affect our liquidity and operating results.  Further, such delinquencies or defaults couldhave an adverse effect on the spreads between interest-earning assets andinterest-bearing liabilities.

 

**The aggregate carrying values, allocated by producttype and weighted average coupons of our loans and other lending investmentsand CMBS as of March 31, 2008 and December 31, 2007 were as follows:**

** **
| ** **                                           | ** ** | **Carrying Value ****(1)** | ** ** | **Allocation by  Investment Type** | ** ** | **Fixed Rate:  Average Yield** | ** ** | **Floating Rate:  Average Spread over  LIBOR ****(2)** | ** ** |
|------------------------------------------------------|------------|--------------------------------------|------------|----------------------------------------------|------------|------------------------------------------|------------|----------------------------------------------------------------------------|------------|
| ** **                                           | ** ** | **2008**                             | ** ** | **2007**                                     | ** ** | **2008**                                 | ** ** | **2007**                                                                   | ** ** | **2008** | ** ** | **2007** | ** ** | **2008** | ** ** | **2007** | ** ** |
| Whole  loans, floating rate                          |       | $                                    | 1,565,300  |                                         | $          | 1,594,338                                |       | 61                                                                         | %          | 60 | % | — |   | — |   | 337 bps |   | 332 bps |   |
| Whole  loans, fixed rate                             |       | 155,250                              |       | 204,192                                      |       | 6                                        | %          | 8                                                                          | %          | 7.15 | % | 7.79 | % | — |   | — |   |
| Subordinate  interests in whole loans, floating rate |       | 142,917                              |       | 146,901                                      |       | 6                                        | %          | 6                                                                          | %          | — |   | — |   | 471 bps |   | 447 bps |   |
| Subordinate  interests in whole loans, fixed rate    |       | 43,314                          |       | 61,890                                       |       | 2                                        | %          | 2                                                                          | %          | 8.31 | % | 8.78 | % | — |   | — |   |
| Mezzanine  loans, floating rate                      |       | 411,757                              |       | 413,813                                      |       | 16                                       | %          | 16                                                                         | %          | — |   | — |   | 603 bps |   | 607 bps |   |
| Mezzanine  loans, fixed rate                         |       | 223,504                              |       | 203,753                                      |       | 9                                        | %          | 8                                                                          | %          | 8.99 | % | 8.91 | % | — |   | — |   |
| Preferred  equity, fixed rate                        |       | 11,868                               |       | 11,858                                       |       | —                                   |       | —                                                                     |       | 10.09 | % | 10.09 | % | — |   | — |   |
| Subtotal/  Weighted average                          |       | $                                    | 2,553,910  |                                         | $          | 2,636,745                                |       | 100                                                                        | %          | 100 | % | 8.30 | % | 8.45 | % | 398 bps |   | 395 bps |   |
| ** **                                           | ** ** | ** **                           | ** ** | ** **                                   | ** ** | ** **                               | ** ** | ** **                                                                 | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| CMBS, floating rate                                  |       | 54,261                               |       | 23,817                                       |       | 7                                        | %          | 3                                                                          | %          | — |   | — |   | 783 bps |   | 593 bps | ** ** |
| CMBS,  fixed rate                                    |       | 781,661                              |       | 768,166                                      |       | 93                                       | %          | 97                                                                         | %          | 6.21 | % | 6.13 | % | — |   | — |   |
| Subtotal/  Weighted average                          |       | 835,922                              |       | 791,983                                      |       | 100                                      | %          | 100                                                                        | %          | 6.21 | % | 6.13 | % | 783 bps |   | 593 bps |   |
|                                                 |       |                                 |       |                                         |       |                                     |       |                                                                       |       |   |   |   |   |   |   |   |   |
| Total                                                |       | $                                    | 3,389,832  |                                         | $          | 3,428,728                                |       | 100                                                                        | %          | 100 | % | 6.95 | % | 7.02 | % | 407 bps |   | 397 bps |   |

 

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**(1) Loan and other lending investments are presented after scheduled amortizationpayments and prepayments, and are net of unamortized fees, discounts, assetsales and unfunded commitments.**

** **

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

** **

As of March 31,2008, our loans and other lending investments and CMBS had the followingmaturity characteristics:

 

| **Year of Maturity** | ** ** | **Number of  Investments  Maturing** | ** ** | **Current  Carrying Value  (In thousands)** | ** ** | **% of Total** | ** ** |
|--------------------------------|------------|-------------------------------------------|------------|-------------------------------------------------------|------------|--------------------------|------------|
| 2008                           |       | 24                                        |       | 687,372                                               |       | 20                       | %          |
| 2009                           |       | 33                                        |       | 994,444                                               |       | 29                       | %          |
| 2010                           |       | 18                                        |       | 453,298                                               |       | 14                       | %          |
| 2011                           |       | 3                                         |       | 63,734                                                |       | 2                        | %          |
| 2012                           |       | 4                                         |       | 109,025                                               |       | 3                        | %          |
| Thereafter                     |       | 25                                        |       | 1,081,959                                             |       | 32                       | %          |
| Total                          |       | 107                                       |       | 3,389,832                                             |       | 100                      | %          |
|                           |       |                                      |       |                                                  |       |                     |       |
| Weighted average  maturity (1) |       |                                      |       | 3.9 years                                             |       |                     |       |

 

59

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(1) Thecalculation of weighted average maturity is based upon the remaining initialterm of the investment and does not include option or extension periods or theability to prepay the investment after a negotiated lock-out period, which maybe available to the borrower.

 

Combinedaggregate principal maturities of our consolidated CDOs, repurchase facilities,trust preferred securities, proportionately consolidated mortgage note payablerelated to our TIC interest in 55 Corporate Drive, and unsecured revolvingcredit facility as of March 31, 2008 are as follows:

 
| ** ** | ** ** | **CDOs**  | ** ** | **Repurchase  Facilities** | ** ** | **Trust  Preferred  Securities** | ** ** | **Mortgage  Note  Payable** | ** ** | **Unsecured  Revolving  Credit  Facility** | ** ** | **Total** | ** ** |
|------------|------------|-----------|------------|----------------------------|------------|----------------------------------|------------|-----------------------------|------------|--------------------------------------------|------------|-----------|------------|
| 2008       |       | $         | —     |                       | $          | —                           |       | $                           | —     |                                       | $          | —    |       | $ | — |   | $ | — |   |
| 2009       |       | —    |       | 166,777                    |       | —                           |       | —                      |       | 50,000                                     |       | 216,777   |       |
| 2010       |       | —    |       | —                     |       | —                           |       | —                      |       | —                                     |       | —    |       |
| 2011       |       | —    |       | —                     |       | —                           |       | —                      |       | —                                     |       | —    |       |
| 2012       |       | —    |       | —                     |       | —                           |       | —                      |       | —                                     |       | —    |       |
| Thereafter |       | 2,721,700 |       | —                     |       | 150,000                          |       | 153,624                     | (1)        | —                                     |       | 3,025,324 |       |
| Total      |       | $         | 2,721,700  |                       | $          | 166,777                          |       | $                           | 150,000    |                                       | $          | 153,624   |       | $ | 50,000 |   | $ | 3,242,101 |   |

 

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(1) Wehave a 49.75% interest in the mortgage note for $94,525 and a 100% interest inthe $59,099 note.

 

The followingtable summarizes the notional and fair value of the our derivative financialinstrument at March 31, 2008.  Thenotional value is an indication of the extent of our involvement in thisinstrument at that time, but does not represent exposure to credit, interestrate or market risks:

 
| ** **          | ** ** | **Benchmark Rate** | ** ** | **Notional  Value** | ** ** | **Strike  Rate** | ** ** | **Effective  Date** | ** ** | **Expiration  Date** | ** ** | **Fair  Value** | ** ** |
|---------------------|------------|-------------------------|------------|---------------------|------------|------------------|------------|---------------------|------------|----------------------|------------|-----------------|------------|
| Interest Rate  Swap |       | 1 month LIBOR           |       | $                   | 3,462      |             | 4.280      | %                   | 7/2005     |                 | 12/2009    |            | $          | (113 | ) |
| Interest Rate  Swap |       | 3 month LIBOR           |       | 3,465               |       | 5.178            | %          | 4/2006              |       | 3/2010               |       | (175            | )          |
| Interest Rate  Swap |       | 3 month LIBOR           |       | 14,650              |       | 4.425            | %          | 11/2007             |       | 7/2015               |       | (701            | )          |
| Interest Rate  Swap |       | 3 month LIBOR           |       | 12,000              |       | 3.063            | %          | 1/2008              |       | 7/2010               |       | (146            | )          |
| Interest Rate  Swap |       | 3 month LIBOR           |       | 12,000              |       | 9.850            | %          | 8/2006              |       | 8/2011               |       | (871            | )          |
| Interest Rate Swap  |       | 3 month LIBOR           |       | 2,000               |       | 3.073            | %          | 1/2008              |       | 7/2010               |       | (25             | )          |
| Interest Rate  Swap |       | 3 month LIBOR           |       | 347,526             |       | 5.408            | %          | 8/2007              |       | 5/2017               |       | (32,354         | )          |
| Interest Rate  Swap |       | 3 month LIBOR           |       | 699,441             |       | 5.331            | %          | 8/2007              |       | 1/2018               |       | (73,866         | )          |
| Interest Rate  Swap |       | 1 month LIBOR           |       | 42,718              |       | 4.990            | %          | 1/2007              |       | 1/2017               |       | (4,210          | )          |
| Interest Rate Swap  |       | 1 month LIBOR           |       | 24,143              |       | 5.114            | %          | 2/2008              |       | 1/2017               |       | (2,137          | )          |
| Interest Rate  Swap |       | 1 month LIBOR           |       | 16,412              |       | 5.203            | %          | 2/2008              |       | 5/2017               |       | (1,550          | )          |
| Total               |       |                    |       | $                   | 1,177,817  |             |       |                |       |                 |       |            | $          | (116,148 | ) |

 

**ITEM4.  Controls and Procedures**

 

**Evaluation of Disclosure Controls and Procedures**

** **

We maintain disclosurecontrols and procedures that are designed to ensure that information requiredto be disclosed in our Exchange Act reports is recorded, processed, summarizedand reported within the time periods specified in the SEC’s rules andforms, and that such information is accumulated and communicated to ourmanagement, including our Chief Executive Officer and Chief Financial Officer,as appropriate, to allow timely decisions regarding required disclosure basedclosely on the definition of “disclosure controls and procedures” in Rule 13a-15(e).  Notwithstanding the foregoing, a controlsystem, no matter how well designed and operated, can provide only reasonable,not absolute, assurance that it will detect or uncover failures within ourcompany to disclose material information otherwise required to be set forth inour periodic reports.  Also, we may haveinvestments in certain unconsolidated entities. As we do not control these entities, our disclosure controls andprocedures with respect to such entities are necessarily substantially morelimited than those we maintain with respect to our consolidated subsidiaries.

 

As of the end of theperiod covered by this report, we carried out an evaluation, under thesupervision and with the participation of our

 

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management, including ourChief Executive Officer and our Chief Financial Officer, of the effectivenessof the design and operation of our disclosure controls and procedures.  Based upon that evaluation, our ChiefExecutive Officer and Chief Financial Officer concluded that our disclosurecontrols and procedures were effective as of the end of the period covered bythis report.

 

**Changes in Internal Controls over Financial Reporting**

** **

**Therewere no changes in our internal control over financial reporting identified inconnection with the evaluation of such internal control that occurred duringour last fiscal quarter that have materially affected, or are reasonably likelyto materially**affect, our internal control overfinancial reporting.

 

61

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**PART II            OTHER INFORMATION**

 

**ITEM 1.            LEGAL PROCEEDINGS**

 

None

 

**ITEM 1A.         RISK FACTORS**

 

There have been no material changes to the risk factors disclosed inItem 1A of Part I in our Annual Report on Form 10-K for the yearended December 31, 2007.

 

**ITEM 2.            UNREGISTERED SALES OF EQUITYSECURITIES AND USE OF PROCEEDS**

 

None

 

**ITEM 3.            DEFAULTS UPON SENIOR SECURITIES**

 

None

 

**ITEM 4.            SUBMISSION OF MATTERS TO A VOTE OFSECURITY HOLDERS**

 

None

 

**ITEM 5.            OTHER INFORMATION**

 

None

 

62

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**ITEM 6.            EXHIBITS**

 

(a)          Exhibits:

 
| **Exhibit No.** | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                                         |
|----------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                    |
| 2.1*            |       | Letter Agreement, dated  March 24, 2008, by and among the Company, GKK Capital LP, GKK Stars  Acquisition LLC, GKK Stars Acquisition Corp., GKK Stars Acquisition LP,  American Financial Realty Trust and First State Group, L.P. (incorporated by  reference to Exhibit 2.2 of the Company’s Form 8-K (No. 001-32248)  which was filed with the SEC on March 25, 2008). |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                    |
| 3.1*            |       | Articles of  Incorporation of the Company (incorporated by reference to Exhibit 3.1  of the Company’s Amendment No. 5 to its Registration Statement on Form S-11/A  (No. 333-114673), which was filed with the Commission on July 26,  2004 and declared effective by the Commission on July 27, 2004).                                                              |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                    |
| 3.2*            |       | Articles Supplementary  designating the Company’s 8.125% Series A Cumulative Redeemable  Preferred Stock, liquidation preference $25.00 per share, par value $.001 per  share (incorporated by reference to Exhibit 3.1 of the Company’s Form 8-K  (No. 001-32248) which was filed with the Commission on April 18,  2007).                                          |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                    |
| 3.3*            |       | Amended and Restated Bylaws  of the Company (incorporated by reference to Exhibit 3.2 of the Company’s  Current Report on Form 8-K (No. 001-32248) which was filed with the  Commission on December 14, 2007).                                                                                                                                                                 |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                    |
| 4.1*            |       | Form of specimen  stock certificate evidencing the common stock of the Company, par value $.001  per share (incorporated by reference to Exhibit 4.1 of the Company’s Form 8-K  (No. 001-32248) which was filed with the Commission on April 18,  2007).                                                                                                                  |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                    |
| 4.2*            |       | Form of stock  certificate evidencing the 8.125% Series A Cumulative Redeemable  Preferred Stock of the Company, liquidation preference $25.00 per share, par  value $.001 per share (incorporated by reference to Exhibit 4.2 of the  Company’s Form 8-K (No. 001-32248) which was filed with the  Commission on April 18, 2007).                                   |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                    |

 

63

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|   |   |                                                                                                                                                                                                                                                                                                                                                                                       |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.1*  |   | Loan Agreement, dated March 28,  2008, by and among First States Investors HFS, L.P., First States Investors  FPC, L.P. and First States Investors TRS, L.P., as borrowers, and Gramercy  Investment Trust, as lender (incorporated by reference to Exhibit 10.5  of the Company’s Form 8-K (No. 001-32248) which was filed with the  SEC on April 7, 2008). |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                       |
| 31.1+  |   | Certification by the  Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley  Act of 2002                                                                                                                                                                                                                                                                              |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                       |
| 31.2+  |   | Certification by the  Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley  Act of 2002                                                                                                                                                                                                                                                                              |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                       |
| 32.1+  |   | Certification by the  Chief Executive Officer pursuant to 18 U.S.C. section 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                                                                                                                                                                                                               |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                       |
| 32.2+  |   | Certification by the  Chief Financial Officer pursuant to 18 U.S.C. section 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                                                                                                                                                                                                               |

 

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| *      |   | Incorporated  by reference. |
|--------|--------|-----------------------------|
|   |   |                        |
| +      |   | Filed  herewith.            |

 

64

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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/ John B.  Roche |
|   |                    |  John  B. Roche |
|   |                    |  Chief  Financial Officer |
|   |                    |   |
|   |                    |   |
| Date:  | May 9,  2008       |   |   |
|        |                         |  |  |

 

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