** **

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

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**FORM 10-Q**

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**x        QUARTERLY REPORT PURSUANT TO SECTION 13OR 15(d) OF**

**THE SECURITIES EXCHANGE ACT OF 1934**

**Forthe quarterly period ended June 30, 2006**

**o        TRANSITION REPORT PURSUANT TO SECTION 13OR 15(d) OF**

**THE SECURITIES EXCHANGE ACT OF 1934**

**Forthe transition period from               to               .**

**CommissionFile Number: 001-32248**

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**GRAMERCY CAPITAL CORP.**

(Exact name ofregistrant as specified in its charter)

 

| **Maryland**                     | **** **** | ****06-1722127****   |
|----------------------------------|----------------|----------------------|
| (State or other  jurisdiction of |           | (I.R.S. Employer     |
| incorporation or  organization)  |           | Identification  No.) |

**420 Lexington Avenue, New York,New York 10170**(Address of principal executive offices) (Zip Code)

**(212)297-1000**(Registrant’s telephone number, including area code)

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Indicate by checkmark whether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days.  YES x     NO o

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, or a non-accelerated filer.  See definition of “accelerated filer” and “non-acceleratedfiler” in Rule 12b-2 of the Exchange Act.
| Large accelerated filer  o |   | Accelerated filer x |   | Non-accelerated filer o |
|----------------------------|--------|---------------------|--------|-------------------------|

Indicate by check mark whether the registrant is ashell company (as defined in Rule 12b-2 of the Exchange Act).YES o     NOx

The number of sharesoutstanding of the registrant’s common stock, $0.001 par value, was 25,834,642as of August 9, 2006.

 

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**GRAMERCYCAPITAL CORP.**

**INDEX**
| **PART I.**                                                                                                       | ** **                                                                                      | **FINANCIAL  INFORMATION** | ** ** |
|-------------------------------------------------------------------------------------------------------------------|-------------------------------------------------------------------------------------------------|----------------------------|------------|
|                                                                                                              |                                                                                            |                       |       |
| **ITEM  1.**                                                                                                      | ** **                                                                                      | **FINANCIAL  STATEMENTS**  | ** ** |
| Consolidated Balance Sheets  as of June 30, 2006 (unaudited) and December 31, 2005                                |                                                                                            |
|                                                                                                              |                                                                                            |
| Consolidated Statements of Income for the three and  six months ended June 30, 2006 and 2005 (unaudited)          |                                                                                            |
|                                                                                                              |                                                                                            |
| Consolidated Statement of Stockholders’ Equity for the  three and six months ended June 30, 2006 (unaudited) |                                                                                            |
|                                                                                                              |                                                                                            |
| Consolidated Statements of Cash Flows for the six  months ended June 30, 2006 and 2005 (unaudited)                |                                                                                            |
|                                                                                                              |                                                                                            |
| Notes to Consolidated Financial Statements  (unaudited)                                                           |                                                                                            |
| **ITEM 2.**                                                                                                       | **MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL  CONDITION AND RESULTS OF OPERATIONS** | ** **                 |
| ** **                                                                                                        | ** **                                                                                      | ** **                 |
| **ITEM 3.**                                                                                                       | **QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET  RISK**                                 | ** **                 |
| ** **                                                                                                        | ** **                                                                                      | ** **                 |
| **ITEM 4.**                                                                                                       | **CONTROLS AND PROCEDURES**                                                                     | ** **                 |
| ** **                                                                                                        | ** **                                                                                      | ** **                 |
| **PART  II.**                                                                                                     | **OTHER  INFORMATION**                                                                          |                       |
| ** **                                                                                                        | ** **                                                                                      | ** **                 |
| **ITEM  1.**                                                                                                      | **LEGAL  PROCEEDINGS**                                                                          | ** **                 |
| ** **                                                                                                        | ** **                                                                                      | ** **                 |
| **ITEM  1A.**                                                                                                     | **RISK  FACTORS**                                                                               | ** **                 |
| ** **                                                                                                        | ** **                                                                                      | ** **                 |
| **ITEM 2.**                                                                                                       | **UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF  PROCEEDS**                                | ** **                 |
| ** **                                                                                                        | ** **                                                                                      | ** **                 |
| **ITEM 3.**                                                                                                       | **DEFAULTS UPON SENIOR SECURITIES**                                                             | ** **                 |
| ** **                                                                                                        | ** **                                                                                      | ** **                 |
| **ITEM 4.**                                                                                                       | **SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS**                                         | ** **                 |
| ** **                                                                                                        | ** **                                                                                      | ** **                 |
| **ITEM  5.**                                                                                                      | **OTHER  INFORMATION**                                                                          | ** **                 |
| ** **                                                                                                        | ** **                                                                                      | ** **                 |
| **ITEM  6.**                                                                                                      | **EXHIBITS**                                                                                    | ** **                 |
| ** **                                                                                                        | ** **                                                                                      | ** **                 |
| **Signatures**                                                                                                    | ** **                                                                                      |

 

i

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**PART I. FINANCIALINFORMATION**

**ITEM 1.  Financial Statements**

**GramercyCapital Corp.Consolidated Balance Sheets(Amounts in thousands, except share and per share data)**
|                                                                                                                                                                               | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                    | ** ** | **2006**          | ** ** | **2005**              | ** ** |
| ** **                                                                                                                                                                    | ** ** | **(Unaudited)**   | ** ** | ** **            | ** ** |
| ** **                                                                                                                                                                    | ** ** | ** **        | ** ** | ** **            | ** ** |
| **Assets:**                                                                                                                                                                   | ** ** | ** **        | ** ** | ** **            | ** ** |
| Cash and cash  equivalents                                                                                                                                                    |       | $                 | 38,055     |                  | $          | 70,576 |   |
| Restricted cash                                                                                                                                                               |       | 74,599            |       | 53,833                |       |
| Loans and other lending  investments, net                                                                                                                                     |       | 1,593,353         |       | 1,163,745             |       |
| Investment in  unconsolidated joint ventures                                                                                                                                  |       | 59,243            |       | 58,040                |       |
| Loans held for sale,  net                                                                                                                                                     |       | 62,213            |       | 42,000                |       |
| Operating real estate,  net                                                                                                                                                   |       | 83,988            |       | 51,173                |       |
| Accrued interest                                                                                                                                                              |       | 11,037            |       | 7,187                 |       |
| Deferred financing  costs                                                                                                                                                     |       | 17,546            |       | 17,488                |       |
| Deferred costs                                                                                                                                                                |       | 2,480             |       | 1,894                 |       |
| Derivative instruments,  at fair value                                                                                                                                        |       | 8,078             |       | 2,271                 |       |
| Other assets                                                                                                                                                                  |       | 17,044            |       | 1,603                 |       |
| Total assets                                                                                                                                                                  |       | $                 | 1,967,636  |                  | $          | 1,469,810 |   |
| ** **                                                                                                                                                                    | ** ** | ** **        | ** ** | ** **            | ** ** |
| **Liabilities and Stockholders’  Equity:**                                                                                                                               | ** ** | ** **        | ** ** | ** **            | ** ** |
| Repurchase agreements                                                                                                                                                         |       | $                 | 393,170    |                  | $          | 117,366 |   |
| Collateralized debt  obligation                                                                                                                                               |       | 810,500           |       | 810,500               |       |
| Mortgage note payable                                                                                                                                                         |       | 94,525            |       | 41,000                |       |
| Management fees payable                                                                                                                                                       |       | 1,684             |       | 1,329                 |       |
| Incentive fee payable                                                                                                                                                         |       | 2,771             |       | 1,237                 |       |
| Dividends payable                                                                                                                                                             |       | 13,096            |       | 10,726                |       |
| Accounts payable and  accrued expenses                                                                                                                                        |       | 14,213            |       | 11,561                |       |
| Other liabilities                                                                                                                                                             |       | 29,389            |       | 3,687                 |       |
| Junior subordinated  deferrable interest debentures held by trusts that issued trust preferred  securities                                                                    |       | 150,000           |       | 100,000               |       |
| Total liabilities                                                                                                                                                             |       | 1,509,348         |       | 1,097,406             |       |
|                                                                                                                                                                          |       |              |       |                  |       |
| Commitments and  contingencies                                                                                                                                                |       | —            |       | —                |       |
| ** **                                                                                                                                                                    | ** ** | ** **        | ** ** | ** **            | ** ** |
| **Stockholders’ Equity:**                                                                                                                                                | ** ** | ** **        | ** ** | ** **            | ** ** |
| Preferred stock, par  value $0.001, 25,000,000 shares authorized, no shares issued or outstanding                                                                             |       | —            |       | —                |       |
| Common stock, par value  $0.001, 100,000,000 shares authorized, 25,817,642 and 22,802,642 shares  issued and outstanding at June 30, 2006 and December 31, 2005, respectively |       | 25                |       | 22                    |       |
| Additional  paid-in-capital                                                                                                                                                   |       | 450,097           |       | 369,529               |       |
| Accumulated other  comprehensive income                                                                                                                                       |       | 8,166             |       | 2,851                 |       |
| Retained earnings                                                                                                                                                             |       | —            |       | 2                     |       |
| Total  stockholders’ equity                                                                                                                                              |       | 458,288           |       | 372,404               |       |
| Total liabilities and stockholders’ equity                                                                                                                               |       | $                 | 1,967,636  |                  | $          | 1,469,810 |   |

 

The accompanying notes are an integral part of thesefinancial statements.

1

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**Gramercy Capital Corp.Consolidated Statements of Income(Unaudited, amounts in thousands, except per share data)**
|                                                                                                                        | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                                                             | ** ** | **2006**                                        | ** ** | **2005**                                      | ** ** | **2006** | ** ** | **2005** | ** ** |
| **Revenues**                                                                                                           | ** ** | ** **                                      | ** ** | ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| Investment  income                                                                                                     |       | $                                               | 39,134     |                                          | $          | 15,689 |   | $ | 71,013 |   | $ | 25,939 |   |
| Rental revenue,  net                                                                                                   |       | —                                          |       | —                                        |       | 914 |   | — |   |
| Gain on sales  and other income                                                                                        |       | 4,371                                           |       | 3,069                                         |       | 8,568 |   | 3,509 |   |
| Total revenues                                                                                                         |       | 43,505                                          |       | 18,758                                        |       | 80,495 |   | 29,448 |   |
| ** **                                                                                                             | ** ** | ** **                                      | ** ** | ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Expenses**                                                                                                           | ** ** | ** **                                      | ** ** | ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest expense                                                                                                       |       | 20,777                                          |       | 6,264                                         |       | 38,499 |   | 9,065 |   |
| Management fees                                                                                                        |       | 3,861                                           |       | 1,870                                         |       | 7,384 |   | 3,538 |   |
| Incentive fee                                                                                                          |       | 1,578                                           |       | —                                        |       | 2,771 |   | — |   |
| Depreciation and  amortization                                                                                         |       | 228                                             |       | 106                                           |       | 683 |   | 128 |   |
| Marketing,  general and administrative                                                                                 |       | 2,779                                           |       | 1,632                                         |       | 5,549 |   | 3,266 |   |
| Provision for  loan loss                                                                                               |       | 500                                             |       | 525                                           |       | 500 |   | 525 |   |
| Total expenses                                                                                                         |       | 29,723                                          |       | 10,397                                        |       | 55,386 |   | 16,522 |   |
| Income from  continuing operations before equity in net loss of unconsolidated joint  ventures and provision for taxes |       | 13,782                                          |       | 8,361                                         |       | 25,109 |   | 12,926 |   |
| Equity in net  loss of unconsolidated joint ventures                                                                   |       | (630                                            | )          | (404                                          | )          | (1,357 | ) | (404 | ) |
| Income from  continuing operations before provision for taxes                                                          |       | 13,152                                          |       | 7,957                                         |       | 23,752 |   | 12,522 |   |
| Provision for  taxes                                                                                                   |       | (335                                            | )          | (500                                          | )          | (382 | ) | (500 | ) |
| Net income  available to common stockholders                                                                           |       | $                                               | 12,817     |                                          | $          | 7,457 |   | $ | 23,370 |   | $ | 12,022 |   |
|                                                                                                                   |       |                                            |       |                                          |       |   |   |   |   |
| **Basic earnings per share:**                                                                                          | ** ** | ** **                                      | ** ** | ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net income  available to common stockholders                                                                           |       | $                                               | 0.53       |                                          | $          | 0.40 |   | $ | 0.99 |   | $ | 0.64 |   |
| **Diluted earnings per share:**                                                                                        | ** ** | ** **                                      | ** ** | ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net income  available to common stockholders                                                                           |       | $                                               | 0.50       |                                          | $          | 0.39 |   | $ | 0.94 |   | $ | 0.63 |   |
| Dividends per  common share                                                                                            |       | $                                               | 0.51       |                                          | $          | 0.35 |   | $ | 1.01 |   | $ | 0.57 |   |
| Basic weighted  average common shares outstanding                                                                      |       | 24,334                                          |       | 18,833                                        |       | 23,575 |   | 18,833 |   |
| Diluted weighted  average common shares and common share equivalents outstanding                                       |       | 25,530                                          |       | 19,033                                        |       | 24,767 |   | 19,026 |   |

 

Theaccompanying notes are an integral part of these financial statements.

2

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**Gramercy Capital Corp.Consolidated Statement ofStockholders’ Equity(Unaudited, amounts in thousands, except share data)**
|                                                       | ** ** | **Common  Stock** | ** ** | **Additional   Paid-** | ** ** | **Accumulated  Other  Comprehensive** | ** ** | **Retained** | ** ** | ** **   | ** ** | **Comprehensive** | ** ** |
|-------------------------------------------------------|------------|-------------------|------------|-----------------------------|------------|---------------------------------------|------------|--------------|------------|--------------|------------|-------------------|------------|
| ** **                                            | ** ** | **Shares**        | ** ** | **Par Value**          | ** ** | **In-Capital**                        | ** ** | **Income**   | ** ** | **Earnings** | ** ** | **Total**         | ** ** | **Income** | ** ** |
| **Balance at December 31, 2005**                      |       | 22,803            |       | $                           | 22         |                                  | $          | 369,529      |       | $            | 2,851      |              | $          | 2 |   | $ | 372,404 |   |   |   |
| Net income                                            |       |              |       |                        |       |                                  |       |         |       | 23,370       |       | 23,370            |       | $ | 23,370 |   |
| Net unrealized gain on  derivative instruments        |       |              |       |                        |       |                                  |       | 5,315        |       |         |       | 5,315             |       | 5,315 |   |
| Proceeds from common  stock offerings                 |       | 3,000             |       | 3                           |       | 79,952                                |       |         |       |         |       | 79,955            |       |   |   |
| Stock-based compensation  – fair value           |       |              |       |                        |       | 1,002                                 |       |         |       |         |       | 1,002             |       |   |   |
| Proceeds from stock  option exercises                 |       | 3                 |       | —                      |       | 45                                    |       |         |       |         |       | 45                |       |   |   |
| Deferred compensation  plan, net                      |       | 12                |       | —                      |       | 587                                   |       |         |       |         |       | 587               |       |   |   |
| Cash distributions  declared ($1.01 per common share) |       |              |       |                        |       | (1,018                                | )          |         |       | (23,372      | )          | (24,390           | )          |   |   |
| **Balance at June 30, 2006**                          |       | 25,818            |       | $                           | 25         |                                  | $          | 450,097      |       | $            | 8,166      |              | $          | — |   | $ | 458,288 |   | $ | 28,685 |   |

 

Theaccompanying notes are an integral part of these financial statements

3

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**Gramercy Capital Corp.****ConsolidatedStatements of Cash Flows(Unaudited, amounts in thousands)**
|                                                                                                                             | ** ** | **Six Months ended  June 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                                                                  | ** ** | **2006**                                      | ** ** | **2005** | ** ** |
| **Operating  Activities**                                                                                                   | ** ** | ** **                                    | ** ** | ** ** | ** ** |
| Net income available to  common stockholders                                                                                |       | $                                             | 23,370     |   | $ | 12,022 |   |
| Adjustments to  reconcile net income available to common stockholders to net cash used /  provided by operating activities: |       |                                          |       |   |   |
| Depreciation and  amortization                                                                                              |       | 2,743                                         |       | 953 |   |
| Amortization of  discount, premium and other fees on investments                                                            |       | (4,663                                        | )          | (505 | ) |
| Equity in net  loss of unconsolidated joint ventures                                                                        |       | 1,357                                         |       | 404 |   |
| Gain on sale of  security interests in operating real estate                                                                |       | (4,350                                        | )          | — |   |
| Amortization of  stock compensation                                                                                         |       | 1,589                                         |       | — |   |
| Provision for  loan loss                                                                                                    |       | 500                                           |       | — |   |
| Net realized  gain on loan held for sale                                                                                    |       | (753                                          | )          |   |   |
| Changes in operating  assets and liabilities:                                                                               |       |                                          |       |   |   |
| New investments  in loans held for sale                                                                                     |       | (62,213                                       | )          | — |   |
| Proceeds from  sale of loans held for sale                                                                                  |       | 41,665                                        |       | — |   |
| Accrued interest                                                                                                            |       | (3,850                                        | )          | (798 | ) |
| Other assets                                                                                                                |       | (1,496                                        | )          | 15 |   |
| Management fees  payable                                                                                                    |       | 355                                           |       | 246 |   |
| Incentive fee  payable                                                                                                      |       | 1,534                                         |       | — |   |
| Settlement of  derivative instruments                                                                                       |       | 843                                           |       | — |   |
| Accounts  payable, accrued expenses and other liabilities                                                                   |       | 22,456                                        |       | 2,485 |   |
| Net cash used /  provided by operating activities                                                                           |       | 19,087                                        |       | 15,347 |   |
| **Investing  Activities**                                                                                                   |       |                                          |       |   |   |
| New investment  originations                                                                                                |       | (715,095                                      | )          | (404,791 | ) |
| Principal collections  on investments                                                                                       |       | 288,106                                       |       | 62,424 |   |
| Investment in operating  real estate and securities                                                                         |       | (98,925                                       | )          | — |   |
| Proceeds from the sale  of security interests in operating real estate                                                      |       | 12,800                                        |       | — |   |
| Change in restricted  cash from investing activities                                                                        |       | (20,985                                       | )          | — |   |
| Deferred investment  costs                                                                                                  |       | (1,299                                        | )          | (483 | ) |
| Net cash used in  investing activities                                                                                      |       | (535,398                                      | )          | (400,444 | ) |
| **Financing  Activities**                                                                                                   |       |                                          |       |   |   |
| Proceeds from  repurchase facilities                                                                                        |       | 743,124                                       |       | 533,449 |   |
| Repayments of  repurchase facilities                                                                                        |       | (467,321                                      | )          | (272,334 | ) |
| Proceeds from mortgage  note payable                                                                                        |       | 94,525                                        |       | — |   |
| Settlement of  derivative instruments                                                                                       |       | 770                                           |       | — |   |
| Proceeds from stock  options exercised                                                                                      |       | 45                                            |       | — |   |
| Net proceeds from sale  of common stock                                                                                     |       | 79,955                                        |       | 60,333 |   |
| Issuance of trust  preferred securities                                                                                     |       | 50,000                                        |       | 50,000 |   |
| Deferred financing  costs and other liabilities                                                                             |       | 4,711                                         |       | (3,823 | ) |
| Dividends paid                                                                                                              |       | (22,019                                       | )          | (6,024 | ) |
| Net cash provided by  financing activities                                                                                  |       | 483,790                                       |       | 361,601 |   |
| Net decrease in cash  and cash equivalents                                                                                  |       | (32,521                                       | )          | (23,496 | ) |
| Cash and cash  equivalents at beginning of period                                                                           |       | 70,576                                        |       | 39,094 |   |
| Cash and cash  equivalents at end of period                                                                                 |       | $                                             | 38,055     |   | $ | 15,598 |   |
| ** **                                                                                                                  | ** ** | ** **                                    | ** ** | ** ** | ** ** |
| **Non-cash  activity**                                                                                                      | ** ** | ** **                                    | ** ** | ** ** | ** ** |
| Change in  investment in unconsolidated joint ventures                                                                      |       | $                                             | 2,545      |   | $ | — |   |
| Deferred gains  on derivative instruments                                                                                   |       | 6,015                                         |       | 2,287 |   |
| Change in fair  value of other assets                                                                                       |       | (700                                          | )          | — |   |
|                                                                                                                        |       |                                          |       |   |   |
| **Supplemental  cash flow disclosures**                                                                                     | ** ** | ** **                                    | ** ** | ** ** | ** ** |
| Interest paid                                                                                                               |       | $                                             | 34,571     |   | $ | 8,193 |   |
| Income taxes paid                                                                                                           |       | $                                             | 259        |   | $ | 1 |   |

 

Theaccompanying notes are an integral part of these financial statements.

4

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**1.   Organization**

Gramercy CapitalCorp. (the “Company” or “Gramercy”) is a national commercial real estatespecialty finance company that focuses on the direct origination andacquisition of whole loans, subordinate interests in whole loans, mezzanineloans, preferred equity, and net lease investments involving commercialproperties throughout the United States. When evaluating transactions, we assess our risk-adjusted return andtarget transactions with yields that ensure an equitable balance between risksand return.

Substantially allof our operations are conducted through GKK Capital LP, a Delaware limitedpartnership, or the Operating Partnership. We, as the sole general partner of, and holder of 100% of the commonunits of, the Operating Partnership, have responsibility and discretion in themanagement and control of the Operating Partnership, and the limited partnersof the Operating Partnership, in such capacity, have no authority to transactbusiness for, or participate in the management activities of, the OperatingPartnership.  Accordingly, we consolidatethe accounts of the Operating Partnership.

We are externallymanaged and advised by GKK Manager LLC, or the Manager, a majority-ownedsubsidiary of SL Green Realty Corp., or SL Green.  At June 30, 2006, SL Green also ownedapproximately 25% of the outstanding shares of our common stock. We qualifiedas a real estate investment trust, or REIT, under the Internal Revenue Codecommencing with our taxable year ending December 31, 2004 and expect to qualifyfor the current fiscal year.  To maintainour tax status as a REIT, we plan to distribute at least 90% of our taxableincome.  Unless the context requiresotherwise, all references to “we,” “our,” and “us” means Gramercy Capital Corp.

As ofJune 30, 2006, we held loans and other lending investments of $1,655,566 net offees, discounts, repayments, asset sales and unfunded commitments with anaverage spread to LIBOR of 366 basis points for our floating rate investmentsand an average yield of 9.51% for our fixed rate investments.  As of June 30, 2006, we also held interestsin four credit tenant lease, or CTL, investments comprised of a 49.75%tenancy-in-common, or TIC, interest in 55 Corporate Drive in Bridgewater, NewJersey, and three joint venture investments.

**Basis of Quarterly Presentation**

The accompanying financial statements have been preparedin accordance with accounting principles generally accepted in the UnitedStates for interim financial information and with the instructions to Form 10-Qand Article 10 of Regulation S-X. Accordingly, it does not include all of the information and footnotesrequired by accounting principles generally accepted in the United States, orGAAP, for complete financial statements. In management’s opinion, all adjustments (consisting of normal recurringaccruals) considered necessary for fair presentation have been included.  The 2006 operating results for theperiod presented are not necessarily indicative of the results that may be expectedfor the year ending December 31, 2006.  These financial statementsshould be read in conjunction with the financial statements and accompanyingnotes included in the Company’s annual report on Form 10-K for the year endedDecember 31, 2005.

The balance sheet at December 31, 2005 has been derivedfrom the audited financial statement at that date, but does not include all theinformation and footnotes required by GAAP for complete financial statements.

**2.   Significant Accounting Policies**

**Principles of Consolidation**

The consolidated financialstatements include our accounts and those of our subsidiaries which arewholly-owned or controlled by us, or entities which are variable interestentities in which we are the primary beneficiaries under FASB InterpretationNo. 46, FIN 46, “Consolidation of Variable Interest Entities.”  FIN 46 requires a variable interest entity,or VIE, to be consolidated by its primary beneficiary.  The primary beneficiary is the party thatabsorbs a majority of the VIE’s anticipated losses and/or a majority of theexpected returns.  We have evaluated ourinvestments for potential classification as variable interests by evaluatingthe sufficiency of the entities’ equity investment at risk to absorb losses,and determined that we are not the primary beneficiary for any of ourinvestments.  Entities which we do notcontrol and entities which are VIE’s, but where we are not the primarybeneficiary, are accounted for under the equity method.  When investments are made through a TICstructure, we report our pro rata share of the assets, liabilities, revenues,and expenses of the investment in our financial statements. All significantintercompany balances and transactions have been eliminated.

**Cashand Cash Equivalents**

We consider all highly liquid investments with maturities of threemonths or less when purchased to be cash equivalents.

5

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**Restricted Cash**

**Restricted cash at June 30, 2006consists primarily of $17,145 on deposit with the trustee of our collateralizeddebt obligation, or CDO.  Also includedare the proceeds of repayments from loans serving as CDO collateral, which willbe used to fund investments to replace those trust assets which are repaid orsold by the trust, interest payments received by the trustee on investmentsthat serve as collateral for the CDO, which are remitted to us on a quarterlybasis in the month following the end of our fiscal quarter, and future fundingobligations on certain investments.  Theremaining balance consists of interest reserves held on behalf of borrowers and$33,251 representing our share of the reserves of 55 Corporate Drive.**

### **Loansand Investments and Loans Held for Sale**

Loans held forinvestment are intended to be held to maturity and, accordingly, are carried atcost, net of unamortized loan origination fees, discounts, repayments, sales ofpartial interests in loans, and unfunded commitments unless such loan orinvestment is deemed to be impaired. Loans held for sale are carried at the lower of cost or market valueusing available market information obtained through consultation with dealersor other originators of such investments. We may originate or acquire preferred equity interests that allow us toparticipate in a percentage of the underlying property’s cash flows fromoperations and proceeds from a sale or refinancing.  Should we make such a preferred equityinvestment, we must determine whether that investment should be accounted foras a loan, joint venture or as an interest in real estate.  Our current preferred equity investments do notentitle us to a percentage of the underlying properties’ cash flows fromoperations or proceeds from a sale or refinancing and are, therefore, accountedfor as loans.

Specific valuation allowances are established forimpaired loans based on the fair value of collateral on an individual loanbasis.  The fair value of the collateralis determined by selecting the most appropriate valuation methodology, ormethodologies, 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.

If upon completionof the valuation, the fair value of the underlying collateral securing theimpaired loan is less than the net carrying value of the loan, an allowance iscreated with a corresponding charge to the provision for loan losses.  The allowance for each loan is maintained ata level we believe is adequate to absorb probable losses.  We maintained a reserve of $1,530 and $525 atJune 30, 2006 and 2005, respectively.

Our Managerevaluates our assets on a regular basis to determine if they continue tosatisfy our investment criteria. Subject to certain restrictions, our Managermay cause us to sell our investments opportunistically and use the proceeds ofany such sale for debt reduction, additional acquisitions or working capitalpurposes.

#### **Classificationsof Mortgage-Backed Securities**

Mortgage-backedsecurities, or MBS, are classified as available-for-sale securities.  As a result, changes in fair value will berecorded as a balance sheet adjustment to accumulated other comprehensiveincome, which is a component of stockholders equity, rather than through ourstatement of operations.  Ifavailable-for-sale securities were classified as trading securities, therecould be substantially greater volatility in earnings from period-to-period asthese investments would be marked to market and any reduction in the value ofthe securities versus the previous carrying value would be considered anexpense on our statement of operations. We had no investments as of June 30,2006 that were accounted for as trading securities.

#### **Valuationsof Mortgage-Backed Securities**

All MBS arecarried on the balance sheet at fair value. We determine the fair value of MBS based on the types of securities inwhich we have 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 cashflows.  The value of the securities isderived by applying discount rates to such cash flows based on current marketyields.  The yields employed are obtainedfrom our own experience in the market, advice from dealers and/or information obtainedin consultation 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.

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When the fairvalue of an available-for-sale security is less than the amortized cost, weconsider whether there is an other-than-temporary impairment in the value ofthe security (for example, whether the security will be sold prior to therecovery of fair value).  If, in ourjudgment, an other-than-temporary impairment exists, the cost basis of thesecurity is written down to the then-current 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.

#### **CreditTenant Lease Investments**

Consolidated CTL investments are recorded at cost lessaccumulated depreciation.  Costs directlyrelated to the acquisition of such investments are capitalized.  Certain improvements are capitalized whenthey are determined to increase the useful life of the building.  Capitalized items are depreciated using thestraight-line method over the shorter of the useful lives of the capitalizeditem or 40 years for buildings or facilities, the remaining life of thefacility for facility improvements, four to seven years for personal propertyand equipment, and the shorter of the remaining lease term or the expected lifefor tenant improvements.

Results of operations of properties acquired are included inthe Statement of Income from the date of acquisition.

In accordance with FASB No. 144, or SFAS 144, “Accountingfor the Impairment of Disposal of Long-Lived Assets,” a property to be disposedof is reported at the lower of its carrying amount or its estimated fair value,less its cost to sell.  Once an asset isheld for sale, depreciation expense and straight-line rent adjustments are nolonger recorded and historic results are reclassified as DiscontinuedOperations.

Inaccordance with FASB No. 141, or SFAS 141, “Business Combinations,” we allocatethe purchase price of real estate to land and building and, if determined to bematerial, intangibles, such as the value of above, below and at-market leasesand origination costs associated with the in-place leases.  We depreciatethe amount allocated to building and other intangible assets over theirestimated useful lives, which generally range from three to 40 years.  Thevalues of the above and below market leases are amortized and recorded aseither an increase (in the case of below market leases) or a decrease (in thecase of above market leases) to rental income over the remaining term of theassociated lease.  The value associated with in-place leases and tenantrelationships are amortized over the expected term of the relationship, whichincludes an estimated probability of the lease renewal, and its estimatedterm.  If a tenant vacates its space prior to the contractual terminationof the lease and no rental payments are being made on the lease, anyunamortized balance of the related intangible will be written off.  Thetenant improvements and origination costs are amortized as an expense over theremaining life of the lease (or charged against earnings if the lease isterminated prior to its contractual expiration date).  We assess fairvalue of the leases based on estimated cash flow projections that utilizeappropriate discount and capitalization rates and available marketinformation.  Estimates of future cash flows are based on a number offactors including the historical operating results, known trends, and market/economicconditions that may affect the property.

As ofJune 30, 2006, we had one proportionately consolidated CTL investment representinga 49.75% TIC interest in 55 Corporate Drive in Bridgewater, New Jersey.

**Investments in Unconsolidated Joint Ventures**

#### We account forour investments in unconsolidated joint ventures under the equity method ofaccounting since we exercise significant influence, but do not unilaterallycontrol, the entities and are not considered to be the primary beneficiaryunder FIN 46.  In the joint ventures, the rights of the other investor areprotective and participating. Unless we are determined to be the primarybeneficiary, these rights preclude us from consolidating the investments. The investments are recorded initially at cost as an investment inunconsolidated joint ventures, and subsequently are adjusted for equity in netincome (loss) and cash contributions and distributions.  Any differencebetween the carrying amount of the investments on our balance sheet and theunderlying equity in net assets is amortized as an adjustment to equity in netincome (loss) of unconsolidated joint ventures over the lesser of the jointventure term or 40 years.  None of the joint venture debt is recourse tous. As of June 30, 2006, we had investments of $59,243 in threeunconsolidated joint ventures.

#### **RevenueRecognition**

Interest income ondebt investments is recognized over the life of the investment using theeffective 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 as an adjustment to yield. Anticipated exit fees, whose collection is expected, are also recognizedover the term of the loan as an adjustment to yield.  Fees on commitments that expire unused arerecognized at expiration.  Fees receivedin exchange for the credit enhancement of another lender, either subordinate orsenior to us, in the form of a guarantee are recognized over the term of thatguarantee using the straight-line method.

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Income recognitionis generally suspended for debt investments at the earlier of the date at whichpayments become 90 days past due or when, in our opinion, a full recovery ofincome and principal becomes doubtful. Income recognition is resumed when the loan becomes contractuallycurrent and performance is demonstrated to be resumed.

In some instances we may sell all or a portion of our investments to athird party.  To the extent the fairvalue received for an investment exceeds the amortized cost of that investmentand FASB Statement No. 140, or SFAS 140, “Accounting for Transfers and Servicingof Financial Assets and Extinguishments of Liabilities,” criteria is met, underwhich control of the asset that is sold is surrendered making it a “true sale,”a gain on the sale will be recorded through earnings as other income.  To the extent an investment that is sold hasa discount or fees, which were deferred at the time the investment was made andwere being recognized over the term of the investment, the unamortized portionof the discount or fees are recognized at the time of sale and recorded as again on the sale of the investment through other income.  We recognized $314 in gains from the partialsyndication of two floating rate debt investments for the three months endedJune 30, 2006.  For the six months endedJune 30, 2006 we recognized $1,428 in net gains from the sale of two fixed ratedebt investments, one fixed rate debt commitment and the syndication ofportions of two floating rate debt investments.

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

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

#### **Reservefor Possible Credit Losses**

The expense for possible credit losses in connection with debtinvestments is the charge to earnings to increase the allowance for possiblecredit losses to the level that management estimates to be adequate consideringdelinquencies, loss experience and collateral quality.  Other factors considered relate to geographictrends and project diversification, the size of the portfolio and currenteconomic conditions.  Based upon thesefactors, we may establish the provision for possible credit losses byindividual asset or category of asset. When it is probable that we will be unable to collect all amountscontractually due, the account is considered impaired.

Where impairment is indicated, a valuation write-down or write-off ismeasured based upon the excess of the recorded investment amount over the netfair value of the collateral, as reduced by selling costs.  Any deficiency between the carrying amount ofan asset and the net sales price of foreclosed collateral is charged tothe allowance for credit losses.  Wemaintained a reserve for possible credit losses of $1,530 and $525 againstinvestments with a carrying value of $78,769 and $68,690 as of June 30, 2006and 2005, respectively.

**DeferredCosts**

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

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

**DeferredFinancing Costs**

Deferredfinancing costs represent commitment fees, legal and other third party costsassociated with obtaining commitments for financing which result in a closingof such financing.  These costs areamortized over the terms of the respective agreements and the amortization isreflected in 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.

**StockBased Compensation Plans**

We have a stock-based compensation plan, described more fully in Note14.  We account for this plan using thefair value recognition provisions of FASB Statement 123(R), “Share-BasedPayment, a revision of FASB Statement No. 123, Accounting for Stock-Based

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Compensation.”

The Black-Scholes option-pricing model was developed for use inestimating the fair value of traded options, which have no vesting restrictionsand are fully transferable.  In addition,option valuation models require the input of highly subjective assumptionsincluding the 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.

Compensationcost for stock options, if any, is recognized ratably over the vesting periodof the award.  Our policy is to grantoptions with an exercise price equal to the quoted closing market price of ourstock 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.

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

|                                  | ** ** | **2006**  | ** ** | **2005**  | ** ** |
|----------------------------------|------------|-----------|------------|-----------|------------|
| Dividend yield                   |       | 8.0       | %          | 8.4       | %          |
| Expected life of  option         |       | 6.8 years |       | 6.9 years |       |
| Risk-free  interest rate         |       | 4.13      | %          | 4.16      | %          |
| Expected stock price  volatility |       | 21.0      | %          | 19.1      | %          |

####  

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

The Class Blimited partner interests are entitled to receive an incentive return equal to25% of the amount by which funds from operations (as defined in the partnershipagreement of the Operating Partnership which was amended and restated in April2006) plus certain accounting gains exceed the product of our weighted averagestockholders equity (as defined in the amended and restated partnershipagreement of the Operating Partnership) multiplied by 9.5% (divided by 4 toadjust for quarterly calculations).  Wewill record any distributions on the Class B limited partner interests as anincentive distribution expense in the period when earned and when payment ofsuch amounts has become probable and reasonably estimable in accordance withthe partnership agreement.  These cashdistributions will reduce the amount of cash available for distribution to ourcommon unitholders in our Operating Partnership and to commonstockholders.  We incurred approximately$1,578 and $2,771 with respect to such Class B limited partner interests forthe three and six months ended June 30, 2006, respectively, and none for thethree and six months ended June 30, 2005.

#### **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 normalcourse of business, we are exposed to the effect of interest rate changes andlimit these risks by following established risk management policies andprocedures including the use of derivatives. To address exposure to interest rates, we use derivatives primarily tohedge the mark-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 heldfor sale.

We use a varietyof commonly used derivative products that are considered plain vanilladerivatives.  These derivatives typicallyinclude interest rate swaps, caps, collars and floors.  We also use total rate of return swaps, orTROR swaps, which are tied to the Lehman Brothers CMBS index. We expresslyprohibit the use of unconventional derivative instruments and using derivative

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instruments for tradingor speculative purposes.  Further, wehave a policy of only entering into contracts with major financial institutionsbased upon 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,changes in the fair value of the derivative will either be offset against thechange in fair value of the hedged asset, liability, or firm commitment throughearnings, or recognized in other comprehensive income until the hedged item isrecognized in earnings.  The ineffectiveportion of a derivative’s change in fair value will be immediately recognizedin earnings.  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 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 byus are deemed to be effective in meeting the hedging objectives established byour corporate policy governing interest rate risk management.  The effect of our derivative instruments onour financial statements is discussed more fully in Note 17.

# **Income Taxes**

We elected to betaxed as a REIT, under Sections 856 through 860 of the Internal Revenue Code,beginning with our taxable year ended December 31, 2004.  To qualify as a REIT, we must meet certainorganizational 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 ourstockholders.  If we fail to qualify as aREIT in any taxable year, we will then be subject to federal income taxes onour taxable income at regular corporate rates and we will not be permitted toqualify for treatment as a REIT for federal income tax purposes for four yearsfollowing the year during which qualification is lost unless the InternalRevenue Service grants us relief under certain statutory provisions.  Such an event could materially adverselyaffect our net income and net cash available for distributions tostockholders.  However, we believe thatwe will be organized and operate in such a manner as to qualify for treatmentas a REIT and we intend to operate in the foreseeable future in such a mannerso that we will qualify as a REIT for federal income tax purposes.  We may, however, be subject to certain stateand local taxes.

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

**UnderwritingCommissions and Costs**

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

**EarningsPer Share**

Wepresent both basic and diluted earnings per share, or EPS.  Basic EPS excludes dilution and is computedby dividing net income available to common stockholders by the weighted averagenumber of common shares outstanding during the period.  Diluted EPS reflects the potential dilutionthat could occur if securities or other contracts to issue common stock wereexercised or converted into common stock, where such exercise or conversionwould result in a lower EPS amount.

**Useof Estimates**

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

**Concentrationsof Credit Risk**

**Financialinstruments that potentially subject us to concentrations of credit riskconsist primarily of cash investments, debt investments and accountsreceivable.  Gramercy places its cashinvestments in excess of insured amounts with high quality financialinstitutions.  Our Manager performsongoing analysis of credit risk concentrations in our debt investment portfolioby evaluating exposure to various markets, underlying property types,investment structure, term, sponsors, tenants and other credit metrics.  Four investments accounted for more than 24%of the total carrying value of our debt investments as of June 30, 2006compared to four investments which accounted for more than 20% of the totalcarrying value of our debt investments as of December 31, 2005. Fiveinvestments accounted for approximately 21% and 20% of the revenue earned onour debt investments for the three and six months ended June 30, 2006 comparedto two**

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**investmentswhich accounted for approximately 22% and 25% of the revenue earned on our debtinvestments for the three and six months ended June 30, 2005.**

**RecentlyIssued Accounting Pronouncements**

**Statement of Financial AccountingStandard No. 123(R), or SFAS No. 123(R) “Share-Based Payment, a revision ofFASB Statement No. 123, Accounting for Stock-Based Compensation,” requires allshare-based payments to employees, including grants of employee stock options,to be recognized in the income statement based on their fair value.  Thenew standard is effective for interim or annual reporting periods beginningafter January 1, 2006.  Theimplementation of SFAS No. 123(R) did not have a material effect on ourfinancial position or results of operations for the three and six months endedJune 30, 2006.**

**In March2005, the FASB issued FASB Interpretation No. 47, or FIN 47, “Accounting forConditional Asset Retirement Obligations” an interpretation of FASB StatementNo. 143, or SFAS 143. FIN 47 clarifies the term***conditionalasset retirement obligation* in SFAS 143 as a legal obligation to perform anasset retirement activity in which the timing and/or method of settlement areconditional on a future event that may or may not be within the control of theentity.  FIN 47 clarifies that future expenses to removeasbestos from buildings should be estimated and accrued as a liability at thetime of acquisition with an offset to increase the cost of the associatedstructure.  Uncertainty about thetiming and/or method of settlement of a conditional asset retirement obligationshould be factored into the measurement of a liability when sufficientinformation exists. SFAS No. 143 acknowledges that in some cases, sufficientinformation may not be available to reasonably estimate the fair value of anasset retirement obligation.  FIN 47 also clarifies when an entity wouldhave sufficient information to reasonably estimate the fair value of an assetretirement obligation.  FIN 47 is effective for the year ended December31, 2005 and did not have a material effect on our financial position orresults of operations for the three and six months ended June 30, 2006.

**In June 2005, the FASB ratifiedthe consensus in EITF Issue No. 04-5, or Issue 04-5, Determining Whether aGeneral Partner, or the General Partners as a Group, Controls a LimitedPartnership or Similar Entity When the Limited Partners Have Certain Rights,which provides guidance in determining whether a general partner controls alimited partnership.  Issue 04-5 states that the general partner in alimited partnership is presumed to control that limited partnership.  Thepresumption may be overcome if the limited partners have either (1) thesubstantive ability to dissolve the limited partnership or otherwise remove thegeneral partner without cause or (2) substantive participating rights, whichprovide the limited partners with the ability to effectively participate insignificant decisions that would be expected to be made in the ordinary courseof the limited partnership’s business and thereby preclude the general partnerfrom exercising unilateral control over the partnership.  If the criteriain Issue 04-5 are met, a company could be required to consolidate certain ofits existing unconsolidated joint ventures.  Our adoption of Issue 04-5for new or modified limited partnership arrangements effective June 30, 2005and existing limited partnership arrangements effective January 1, 2006 did nothave a material effect on our financial position or results of operations forthe three and six months ended June 30, 2006.**

**In February 2006, the FASB issuedStatement of Financial Accounting Standard No. 155, or SFAS No. 155, “Accountingfor Certain Hybrid Financial Instruments – an amendment of FASB Statements No.133 and 140”. SFAS No. 155 (1) permits fair value re-measurement for any hybridfinancial instrument that contains an embedded derivative that would otherwiserequire bifurcation, (2) clarifies which interest-only strips andprincipal-only strips are not subject to the requirements of FASB Statement No.133, (3) establishes a requirement to evaluate interests in securitizedfinancial assets to identify interests that are freestanding derivatives orthat are hybrid financial instruments that contain an imbedded derivativerequiring bifurcation, (4) clarifies that concentrations of credit risk in theform of subordination are not embedded derivatives, and (5) amends FASBStatement No. 140 to eliminate the prohibition on a qualifying special-purposeentity from holding a derivative financial instrument that pertains to abeneficial interest in other than another derivative financial instrument. SFASNo. 155 is effective January 1, 2007 and we are currently evaluating theeffect, if any, that this pronouncement will have on our future financialresults.**

**InJuly 2006, the FASB issued Interpretation No. 48, or FIN 48, “**Accounting for Uncertaintyin Income Taxes”. This interpretation,among other things, creates a two-step approach for evaluating uncertain taxpositions. Recognition (step one) occurs when an enterprise concludes that atax position, based solely on its technical merits, is more-likely-than-not tobe sustained upon examination. Measurement (step two) determines the amount ofbenefit that more-likely-than-not will be realized upon settlement.Derecognition of a tax position that was previously recognized would occur whena company subsequently determines that a tax position no longer meets themore-likely-than-not threshold of being sustained. FIN 48 specificallyprohibits the use of a valuation allowance as a substitute for derecognition oftax positions, and it has expanded disclosure requirements.  FIN 48 is effective for fiscal yearsbeginning after December 15, 2006, in which the impact of adoption should beaccounted for as a cumulative-effect adjustment to the beginning balance ofretained earnings. We are currently evaluating the effect, if any, thatthis pronouncement will have on our future financial results.

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**3.             Loans and Other Lending Investments**

**The aggregate carrying values, allocated by producttype and weighted average coupons of our loans and other lending investments asof June 30, 2006 and December 31, 2005 were as follows:**
|                                                      | ** ** | **Carrying Value (1)   ($ in thousands)** | ** ** | **Allocation by   Investment Type** | ** ** | **Fixed Rate:  Average Yield** | ** ** | **Floating Rate:  Average Spread over  LIBOR (2)** | ** ** |
|------------------------------------------------------|------------|--------------------------------------------------------------------|------------|----------------------------------------------------|------------|------------------------------------------|------------|------------------------------------------------------------------------|------------|
| ** **                                           | ** ** | **2006**                                                           | ** ** | **2005**                                           | ** ** | **2006**                                 | ** ** | **2005**                                                               | ** ** | **2006** | ** ** | **2005** | ** ** | **2006** | ** ** | **2005** | ** ** |
| Whole loans,  floating rate                          |       | $                                                                  | 938,416    |                                               | $          | 561,388                                  |       | 57                                                                     | %          | 46 | % | — |   | — |   | 303bps |   | 325 bps |   |
| Whole loans,  fixed rate                             |       | 115,347                                                            |       | 94,448                                             |       | 7                                        | %          | 8                                                                      | %          | 9.64 | % | 10.64 | % | — |   | — |   |
| Subordinate  interests in whole loans, floating rate |       | 404,789                                                            |       | 362,983                                            |       | 24                                       | %          | 30                                                                     | %          | — |   | — |   | 425bps |   | 443 bps |   |
| Subordinate  interests in whole loans, fixed rate    |       | 48,206                                                             |       | 37,104                                             |       | 3                                        | %          | 3                                                                      | %          | 9.56 | % | 9.19 | % | — |   | — |   |
| Mezzanine loans,  floating rate                      |       | 81,766                                                             |       | 82,793                                             |       | 5                                        | %          | 7                                                                      | %          | — |   | — |   | 724bps |   | 858 bps |   |
| Mezzanine loans,  fixed rate                         |       | 43,291                                                             |       | 43,352                                             |       | 2                                        | %          | 4                                                                      | %          | 8.88 | % | 8.88 | % | — |   | — |   |
| Preferred equity,  floating rate                     |       | 11,850                                                             |       | 11,795                                             |       | 1                                        | %          | 1                                                                      | %          | — |   | — |   | 900bps |   | 900 bps |   |
| Preferred equity,  fixed rate                        |       | 11,901                                                             |       | 11,882                                             |       | 1                                        | %          | 1                                                                      | %          | 10.28 | % | 10.28 | % | — |   | — |   |
| Total / Average                                      |       | $                                                                  | 1,655,566  |                                               | $          | 1,205,745                                |       | 100                                                                    | %          | 100 | % | 9.51 | % | 9.92 | % | 366bps |   | 417 bps |   |

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

**(2)   Spreads over an index other than LIBOR have been adjusted to aLIBOR based equivalent.**

As of June 30,2006, our investment portfolio had the following maturity characteristics:

| Year of Maturity     | ** ** | **Number of  Investments  Maturing** | ** ** | **Current  Carrying Value** | ** ** | **% of Total** | ** ** |
|--------------------------------|------------|-------------------------------------------|------------|----------------------------------|------------|--------------------------|------------|
| ** **                     | ** ** | ** **                                | ** ** | **(In thousands)**          | ** ** | ** **               | ** ** |
| 2006                           |       | 8                                         |       | $                                | 223,548    |                     | 13         | % |
| 2007                           |       | 28                                        |       | 627,645                          |       | 38                       | %          |
| 2008                           |       | 13                                        |       | 491,625                          |       | 30                       | %          |
| 2009                           |       | 8                                         |       | 134,945                          |       | 8                        | %          |
| 2010                           |       | 2                                         |       | 6,612                            |       | 1                        | %          |
| 2011                           |       | 2                                         |       | 56,901                           |       | 3                        | %          |
| Thereafter                     |       | 5                                         |       | 114,290                          |       | 7                        | %          |
| Total                          |       | 66                                        |       | $                                | 1,655,566  |                     | 100        | % |
|                           |       |                                      |       |                             |       |                     |       |
| Weighted average  maturity (1) |       | 2.1 years                                 |       |                             |       |                     |       |

 

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(1)   The calculation of weighted average maturity is based upon theinitial term of the investment and does not include option or extensionperiods, which may be available to the borrower.

For the three and sixmonths ended June 30, 2006 and 2005 the Company’s investment income from debtinvestments was generated by the following investment types:

|                                       | ** ** | **Three months ended  June 30, 2006** | ** ** | **Three months ended  June 30, 2005** | ** ** |
|---------------------------------------|------------|-----------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| **Investment Type**              | ** ** | **Investment  Income**                                    | ** ** | **% of  Total**                                      | ** ** | **Investment  Income** | ** ** | **% of  Total** | ** ** |
| Whole loans                           |       | $                                                         | 22,505     |                                                      | 58         | % | $ | 5,991 |   | 38 | % |
| Subordinate  interests in whole loans |       | 11,925                                                    |       | 30                                                        | %          | 6,517 |   | 42 | % |
| Mezzanine loans                       |       | 3,939                                                     |       | 10                                                        | %          | 2,422 |   | 16 | % |
| Preferred equity                      |       | 765                                                       |       | 2                                                         | %          | 385 |   | 2 | % |
| CMBS                                  |       | —                                                    |       | —                                                    |       | 374 |   | 2 | % |
| Total                                 |       | $                                                         | 39,134     |                                                      | 100        | % | $ | 15,689 |   | 100 | % |

 

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|                                       | ** ** | **Six months ended  June 30, 2006** | ** ** | **Six months ended  June 30, 2005** | ** ** |
|---------------------------------------|------------|---------------------------------------------------------|------------|---------------------------------------------------------|------------|
| **Investment Type**              | ** ** | **Investment  Income**                                  | ** ** | **% of  Total**                                    | ** ** | **Investment  Income** | ** ** | **% of  Total** | ** ** |
| Whole loans                           |       | $                                                       | 39,677     |                                                    | 56         | % | $ | 8,983 |   | 35 | % |
| Subordinate  interests in whole loans |       | 22,091                                                  |       | 31                                                      | %          | 12,160 |   | 47 | % |
| Mezzanine loans                       |       | 7,737                                                   |       | 11                                                      | %          | 3,370 |   | 13 | % |
| Preferred equity                      |       | 1,508                                                   |       | 2                                                       | %          | 691 |   | 2 | % |
| CMBS                                  |       | —                                                  |       | —                                                  |       | 735 |   | 3 | % |
| Total                                 |       | $                                                       | 71,013     |                                                    | 100        | % | $ | 25,939 |   | 100 | % |

At June 30, 2006 andDecember 31, 2005, our debt investment portfolio had the following geographicdiversification:

|            | ** ** | **2006**            | ** ** | **2005**             | ** ** |
|------------|------------|---------------------|------------|----------------------|------------|
| **Region** | ** ** | **Carrying  Value** | ** ** | **% of  Total** | ** ** | **Carrying  Value** | ** ** | **% of  Total** | ** ** |
| Northeast  |       | $                   | 894,215    |                 | 54         | % | $ | 464,054 |   | 39 | % |
| West       |       | 350,469             |       | 21                   | %          | 378,040 |   | 31 | % |
| South      |       | 324,597             |       | 20                   | %          | 258,511 |   | 21 | % |
| Midwest    |       | 65,863              |       | 4                    | %          | 74,949 |   | 6 | % |
| Various    |       | 20,422              |       | 1                    | %          | 30,191 |   | 3 | % |
| Total      |       | $                   | 1,655,566  |                 | 100        | % | $ | 1,205,745 |   | 100 | % |

Inconnection with a preferred equity investment we have guaranteed a portion ofthe outstanding principal balance of the first mortgage loan that is afinancial obligation of the entity in which we have invested in the event of aborrower default under such loan.  Theloan matures in 2032.  This guarantee isconsidered to be an off-balance-sheet arrangement.  As compensation, we received a creditenhancement fee of $125 from the borrower, which is recognized as the fairvalue of the guarantee and has been recorded on our balance sheet as aliability. The liability will be amortized over the life of the guarantee usingthe straight-line method and corresponding fee income will be recorded.  Our maximum exposure under this guarantee isapproximately $1,449 as of June 30, 2006. Under the terms of the guarantee, the investment sponsor is required toreimburse us for the entire amount paid under the guarantee until the guaranteeexpires.

**4. Investments inUnconsolidated Joint Ventures**

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

**On April 29, 2005, we closed on a$57,503 initial investment in a joint venture with SL Green to acquire, own andoperate the South Building located at One Madison Avenue, New York, New York,or the Property.  The joint venture isowned 45% by our wholly-owned subsidiary and 55% by a wholly-owned subsidiaryof SL Green.  The joint venture interestsare *pari passu*.  Also on April 29, 2005, the joint venturecompleted the acquisition of the Property from Metropolitan Life InsuranceCompany for the purchase price of approximately $802,800 plus closing costs,financed in part through a $690,000 first mortgage loan on the Property.  The first mortgage is non-recourse to us.  The Property comprises approximately 1.2million square feet and is almost entirely net leased to Credit SuisseSecurities (USA) LLC, or CS, pursuant to a lease with a 15-year remainingterm.  As of June 30, 2006 the investmenthas a carrying value of $56,138.  Werecorded our pro rata share of net losses of the joint venture of $353 and $753for the three and six months ended June 30, 2006, respectively, and $404 forthe three and six months ended June 30, 2005.**

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

**On November 29, 2005, we closedon the purchase of a 50% interest in an office building in Pasadena, CA.  We also acquired an interest in certainrelated assets as part of the transaction. The three hundred forty-fivethousand square foot office property, which is net leased to Bank of Americathrough September 2015, assuming the exercise of options, and relatedcollateral were acquired for $52,000 plus closing costs, using a non-recourse,$50,000, 10-year fixed-rate first mortgage loan.  As of June 30, 2006 the investment has acarrying value of $561.  For the threeand six months ended June 30, 2006, we recorded our pro rata share of netlosses of the joint ventures of $334 and $661, respectively.**

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**5.  Property Acquisitions**

***55 CorporateDrive***

**On June 7, 2006 we 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 property is comprised ofthree buildings totaling approximately six hundred and seventy thousand squarefeet which is 100% net leased to an entity whose obligations are guaranteed bySanofi-Aventis Group through April 2023. The transaction was valued at $236,000and was financed with a $190,000, 10-year, fixed-rate first mortgage loan.  The remaining 50% of the property is owned asa TIC interest by SL Green Realty Corp. Upon closing the acquisition of theproperty, the $90,000 whole loan previously held by us was repaid in full usingproceeds from the new mortgage financing.**

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

***200 FranklinSquare Drive***

OnSeptember 6, 2005, we closed on the acquisition of a 100% fee interest in200 Franklin Square Drive, located in Somerset, New Jersey. The property is atwo hundred thousand square foot building which is 100% net leased to PhilipsHolding USA Inc., a wholly-owned subsidiary of Royal Philips Electronics,through December 2021.  The property wasacquired for a purchase price of $50,250, excluding closing costs, and financedwith a $41,000, 10-year, fixed-rate first mortgage loan.

**On March 31, 2006, following theconversion of the entity that owns 200 Franklin Square Drive into a Delawarestatutory trust, or DST, we sold approximately 29.3% of our security interestsin the DST to a third party. Subsequently, we sold an additional 45.7% of our security interests inthe DST to the same party, reducing our final ownership interest to 25.0%.  We received total cash consideration of$12,800 for these interests and the buyer assumed 75% of the DST’s underlyingmortgage debt.  The disposition resultedin a net gain of $4,350, after transaction costs, $2,632 of which wasrecognized during the three months ended June 30, 2006.**

**7.  Junior Subordinated Debentures**

**On January 27, 2006, we completeda third issuance of $50,000 in unsecured trust preferred securities through aseparate newly formed DST, Gramercy Capital Trust III, or GCTIII, that is awholly-owned subsidiary of the Operating Partnership.  The securities bear interest at a fixed rateof 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.**

**In May and August 2005, wecompleted issuances of $50,000 each in unsecured trust preferred securitiesthrough two DST’s, Gramercy Capital Trust I, or GCTI, and Gramercy CapitalTrust II, or GCTII, that are also wholly-owned subsidiaries of the OperatingPartnership.  The securities issued inMay 2005 bear interest at a fixed rate of 7.57% for the first ten years endingJune 2015 and the securities issued in August 2005 bear interest at a fixedrate of 7.75% for the first ten years ending October 2015.  Thereafter the rates will float based on thethree-month LIBOR plus 300 basis points.**

**All issuances of trust preferredsecurities require quarterly interest distributions; however, payments may bedeferred while the interest expense is accrued for a period of up to fourconsecutive quarters if the Operating Partnership exercises its right to defersuch payments.  The trust preferredsecurities are redeemable, at the option of the Operating Partnership, in wholeor in part, with no prepayment premium any time after June 30, 2010, October30, 2010 or January 30, 2011 for the securities issued by GCTI, GCTII andGCTIII, respectively.**

**GCTI, GCTII and GCTIII eachissued $1,550 aggregate liquidation amount of common securities, representing100% of the voting common stock of those entities to the Operating Partnershipfor a total purchase price of $4,650. GCTI, GCTII and GCTIII used the proceeds from the sale of the trustpreferred securities and the common securities to purchase the OperatingPartnership’s junior subordinated notes. The terms of the junior subordinated notes match the terms of the trustpreferred securities.  The notes aresubordinate and junior in right of payment to all present and future seniorindebtedness and certain other of our financial obligations.  We realized net proceeds from each offeringof approximately $48,956.**

Our interests in GCTI, GCTII and GCTIII areaccounted for using the equity method and the assets and liabilities of thoseentities are not consolidated into our financial statements.  Interest on the junior subordinated notes isincluded in interest expense on our consolidated income statements while thevalue of the junior subordinated notes, net of our investment in the truststhat issued the securities, are presented as a separate item in ourconsolidated balance sheet.

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**8.  Collateralized DebtObligations**

During 2005 we issuedapproximately $1,000,000 of CDOs through two newly-formed indirectsubsidiaries, Gramercy Real Estate CDO 2005-1 Ltd., or the Issuer, andGramercy Real Estate CDO 2005-1 LLC, or the Co-Issuer. The CDO consists of$810,500 of investment grade notes, and $84,500 of non-investment grade notes,which were co-issued by the Issuer and the Co-Issuer, and $105,000 of preferredshares, which were issued by the Issuer. We retained all non-investment grade securities, the preferred sharesand the common shares in the Issuer.  TheIssuer holds assets, consisting primarily of whole loans, subordinate interestsin whole loans, mezzanine loans and preferred equity investments, which serveas collateral for the CDO. The investment grade notes were issued with floatingrate coupons with a combined weighted average rate of three-month LIBOR plus0.49%. The CDO may be replenished, pursuant to certain rating agency guidelinesrelating to credit quality and diversification, with substitute collateral forloans that are repaid during the first five years of the CDO. Thereafter, theCDO securities will be retired in sequential order from senior-most tojunior-most as loans are repaid. We incurred approximately $11,957 of costsrelated to the CDO, which are amortized on a level- yield basis over theaverage life of the CDO.  The Issuer isconsolidated in our financial statements. The investment grade notes aretreated as a secured financing, and are non-recourse to us. Proceeds from thesale of the investment grade notes issued were used to repay substantially alloutstanding debt under our repurchase agreements and to fund additionalinvestments.

**9.   Debt Obligations**

#### **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.**

The repurchasefacility with Wachovia is a $500,000 facility. This facility was initially established at $250,000, was increased to$350,000 from $250,000 effective January 3, 2005, and was subsequentlyincreased to $500,000 effective April 22, 2005. As part of the April 2005 increase to $500,000, the initial term of thefacility was modified to reflect staggered maturities in which $250,000 maturesin August 2007, $150,000 matures in December 2007 and the remaining $100,000matures in June 2008.  On March 21, 2006we further modified the facility by reducing the interest spreads.  As a result of the modifications, the$500,000 facility bears interest at spreads of 1.00% to 2.50% over a 30-dayLIBOR and, based on our expected investment activities, provides for advancerates that vary from 60% to 100% based upon the collateral provided under aborrowing base calculation.  The lenderhas a consent right to the inclusion of investments in this facility,determines periodically the market value of the investments, and has the rightto require additional collateral if the estimated market value of the includedinvestments declines.  We had no accruedinterest and borrowings of $350,942 at a weighted average spread to LIBOR of1.15% and $67,717 at a weighted average spread to LIBOR of 1.50% under thisfacility at June 30, 2006 and December 31, 2005, respectively.

Borrowings under the Wachovia facility at June 30, 2006 and December 31,2005 were secured by the following investments:

|                                       | ** ** | **Carrying Value (1)** | ** ** |
|---------------------------------------|------------|----------------------------------|------------|
| **Investment Type**              | ** ** | **2006**                         | ** ** | **2005** | ** ** |
| Whole loans                           |       | $                                | 465,876    |   | $ | 33,223 |   |
| Subordinate  interests in whole loans |       | 49,823                           |       | 74,689 |   |
| Mezzanine loans                       |       | 51,344                           |       | — |   |
| CDO securities  (2)                   |       | —                           |       | 49,500 |   |
| CMBS                                  |       | —                           |       | — |   |
| Total                                 |       | $                                | 567,043    |   | $ | 157,412 |   |

** **

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**(1)**          Approximates fair value.

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

We also have a$200,000 repurchase facility with Goldman. This facility has an initial term of three years expiring in January2008 with one six-month extension option. On March 21, 2006, we modified this facility by reducing the interestspreads.  As a result of the modifications,the facility bears interest at spreads of 1.00% to 2.25% over a 30-day LIBORand, based on our expected investment activities, provides for advance ratesthat vary from 40% to 85% based upon the collateral provided under a borrowingbase calculation.  On May 24, 2006, weincreased the facility to $400,000 for a period of six months, with onethree-month extension option.  As withthe Wachovia facility, the lender has a consent right to the inclusion ofinvestments in this facility, determines periodically the market value of theinvestments, and has the right to require additional collateral if theestimated market value of the included investments declines.  We had accrued interest of $583 andborrowings of $42,228 at a weighted average spread to LIBOR of

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1.25% and accruedinterest of $163 and borrowings of $49,649 at a weighted average spread toLIBOR of 1.71% under this facility at June 30, 2006 and December 31, 2005,respectively.

Borrowings under the Goldman facility at June 30, 2006 and December 31,2005 were secured by the following investments:

|                          | ** ** | **Carrying Value (1)** | ** ** |
|--------------------------|------------|----------------------------------|------------|
| **Investment Type** | ** ** | **2006**                         | ** ** | **2005** | ** ** |
| Whole loans              |       | $                                | 78,094     |   | $ | 59,457 |   |
| Total                    |       | $                                | 78,094     |   | $ | 59,457 |   |

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**(1)   Approximates fair value.**

The terms of bothof our repurchase facilities include covenants that****(a) limit our maximum total indebtedness to no more than 85%of total assets, (b) require us to maintain minimum liquidity of at least$10,000 for the first two years and $15,000 thereafter, (c) requires our fixedcharge coverage ratio to be at no time less than 1.50 to 1.00, (d) requires ourminimum interest coverage ratio to be at no time less than 1.75 to 1.00, (e)require us to maintain minimum tangible net worth of not less than the greaterof (i) $129,750, or (i) plus (ii) 75% of the proceeds of our subsequent equityissuances and (f) restrict the maximum amount of our total indebtedness.  The covenants also restrict us from makingdistributions in excess of a maximum of 103% of our funds from operations (asdefined by the National Association of Real Estate Investment Trusts, orNAREIT) through July 2005 and 100% thereafter, except that we may in any casepay distributions necessary to maintain our REIT status.  Underour facility with Wachovia, an event of default will be triggered if GKKManager LLC ceases to be our Manager.  Asof June 30, 2006 and December 31, 2005, we were in compliance with all suchcovenants.

The repurchasefacilities require that we pay down borrowings under these facilities asprincipal payments on the loans and investments pledged to these facilities arereceived.

In certaincircumstances, we have purchased debt investments from a counterparty andsubsequently financed the acquisition of those debt investments throughrepurchase agreements with the same counterparty.  We currently record the acquisition of thedebt investments as assets and the related repurchase agreements as financingliabilities gross on the consolidated balance sheets. Interest income earned onthe debt investments and interest expense incurred on the repurchaseobligations are reported gross on the consolidated income statements.  However, under a certain technicalinterpretation of FAS 140, such transactions may not qualify as a purchase byus.  We believe, and it is industrypractice, that we are accounting for these transactions in an appropriatemanner.  However, the result of thistechnical interpretation would prevent us from presenting the debt investmentsand repurchase agreements and the related interest income and interest expenseon a gross basis on our financial statements. Instead, we would present the net investment in these transactions withthe counterparty and a derivative with the corresponding change in fair valueof the derivative being recorded through earnings.  The value of the derivative would reflectchanges in the value of the underlying debt investments and changes in thevalue of the underlying credit provided by the counterparty.

#### **UnsecuredRevolving Credit Facility**

In May 2006, weclosed on a $100,000 senior unsecured revolving credit facility with KeyBankwith an initial term of three years and a one-year extension option.  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.  The facility bears interest at 1.90% over30-day LIBOR to the extent our leverage ratio, defined as total liabilities tototal assets, including our proportionate share of the liabilities and assetsof our unconsolidated subsidiaries, is less than 80% and 2.10% over 30-dayLIBOR to the extent out leverage ratio is equal to or greater than 80%.  We had no outstanding borrowings against thisfacility as of June 30, 2006.

The terms of theunsecured revolving credit facility include covenants that****(a) limit our maximum total indebtednessto no more than 85% of total assets, (b) require our fixed charge coverageratio to be at no time less than 1.50, (c) require our minimum interestcoverage ratio to be at no time less than 1.70, (d) require us to maintainminimum tangible net worth of not less than $370,000 plus 75% of the netproceeds from equity offerings completed after the closing of the facility and(e) restrict the maximum amount of our total indebtedness.  The covenants also restrict us from makingdistributions in excess of a maximum of 100% of our funds from operations (asdefined by NAREIT), except that we may in any case pay distributions necessaryto maintain our REIT status.  As of June 30, 2006, we were in compliancewith all such covenants.

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In conjunctionwith the closing of the unsecured revolving credit facility with KeyBank, our$25,000 revolving credit facility with Wachovia was terminated.

#### **MortgageLoan**

We have oneconsolidated interest-only mortgage loan in an amount equal to our ownershippercentage in the entity multiplied by the outstanding principal balance of themortgage loan, which loan financed the acquisition of 55 Corporate Drive inJune 2006.  The mortgage has anoutstanding principal balance of $190,000, of which we have consolidated 49.75%or $94,525, with an effective interest rate of 5.75% and a term of ten years.

Combined aggregateprincipal maturities of our consolidated CDO, repurchase facilities, trustpreferred securities, mortgage notes payable and unsecured revolving creditfacility as of June 30, 2006 are as follows:

|            | ** ** | **Collateralized  Debt  Obligations** | ** ** | **Repurchase  Facilities** | ** ** | **Trust  Preferred  Securities** | ** ** | **Mortgage  Note  Payable** | ** ** | **Unsecured  Revolving  Credit  Facility** | ** ** | **Total** | ** ** |
|------------|------------|---------------------------------------|------------|----------------------------|------------|----------------------------------|------------|-----------------------------|------------|--------------------------------------------|------------|-----------|------------|
| 2006       |       | $                                     | —     |                       | $          | —                           |       | $                           | —     |                                       | $          | —    |       | $ | — |   | $ | — |   |
| 2007       |       | —                                |       | 350,942                    |       | —                           |       | —                      |       | —                                     |       | 350,942   |       |
| 2008       |       | —                                |       | 42,228                     |       | —                           |       | —                      |       | —                                     |       | 42,228    |       |
| 2009       |       | —                                |       | —                     |       | —                           |       | —                      |       | —                                     |       | —    |       |
| 2010       |       | —                                |       | —                     |       | —                           |       | —                      |       | —                                     |       | —    |       |
| 2011       |       | —                                |       | —                     |       | —                           |       | —                      |       | —                                     |       | —    |       |
| Thereafter |       | 810,500                               |       | —                     |       | 150,000                          |       | 94,525(                     | 1)         | —                                     |       | 1,055,025 |       |
| Total      |       | $                                     | 810,500    |                       | $          | 393,170                          |       | $                           | 150,000    |                                       | $          | 94,525    |       | — |   | $ | 1,448,195 |   |
|            |            |                                       |            |                            |            |                                  |            |                             |            |                                            |            |           |            |  |  |  |  |  |  |

 

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(1) We have a 49.75%interest in the entity that is the obligor under the mortgage note.

**10. **Operating Partnership Agreement / Manager

At June 30, 2006,we owned all of the Class A limited partnership interests in our OperatingPartnership.  At June 30, 2006, themajority of the Class B limited partnership interests were owned by our Managerand SL Green Operating Partnership, L.P. Interests were also held by certainofficers and employees of SL Green Realty Corp., including some of whom areamong our executive officers, certain of which interests are subject toperformance thresholds.

At June 30, 2006, themajority of the interests in our Manager were held by SL Green OperatingPartnership, L.P. Interests were also held by certain officers and employees ofSL Green Realty Corp., including some of whom are among our executive officers,certain of which interests are subject to performance thresholds.

**11.  Related Party Transactions**

In connection with our initial public offering, we entered into amanagement agreement with our Manager, which was subsequently amended andrestated in April 2006.  The amended andrestated agreement provides for a term through December 2009 with automaticone-year extension options and is subject to certain termination rights.  We pay our Manager an annual management feeequal to 1.75% of our gross stockholders equity (as defined in the amended andrestated management agreement) inclusive of our trust preferredsecurities.  We incurred expense to ourManager under this agreement of an aggregate of approximately $2,501 and $4,739for the three and six months ended June 30, 2006, respectively, andapproximately $1,326 and $2,530 for the three and six months ended June 30,2005, respectively.

To provide an incentivefor our Manager to enhance the value of the common stock, the holders of theClass B limited partner interests of the Operating Partnership are entitled toan incentive return equal to 25% of the amount by which funds from operations(as defined in the partnership agreement of the Operating Partnership which wasamended and restated in April 2006) plus certain accounting gains exceed theproduct of our weighted average stockholders equity (as defined in the amendedand restated partnership agreement of the Operating Partnership) multiplied by9.5% (divided by 4 to adjust for quarterly calculations).  We will record any distributions on the ClassB limited partner interests as an incentive distribution expense in the periodwhen earned and when payments of such amounts have become probable andreasonably estimable in accordance with the partnership agreement.  We incurred approximately $1,578 and $2,771with respect to such Class B limited partner interests for the three and sixmonths ended June 30, 2006, respectively

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and none for the threeand six months ended June 30, 2005.

We are obligatedto reimburse our Manager for its costs incurred under an asset servicingagreement between our Manager and an affiliate of SL Green OperatingPartnership, L.P. and a separate outsourcing agreement between our Manager andSL Green Operating Partnership, L.P.  Theasset servicing agreement, which was amended and restated in April 2006,provides for an annual fee payable to SL Green Operating Partnership, L.P. byus of 0.05% of the book value of all credit tenant lease assets andnon-investment grade bonds and 0.15% of the book value of all otherassets.  The asset servicing fee may bereduced by SL Green Operating Partnership, L.P. for fees paid directly to outsideservicers by us.  The outsourcing agreementcurrently provides for a fee payable by us of $1,288 per year, increasing 3%annually over the prior year on the anniversary date of the outsourcingagreement in August of each year.  Forthe three months ended June 30, 2006 and 2005, we realized expense of $322 and$312, respectively, and for the six months ended June 30, 2006 and 2005, werealized expense of $645 and $625, respectively, to our Manager under theoutsourcing agreement.  For the threemonths ended June 30, 2006 and 2005, we realized expense of $539 and $232,respectively, and for the six months ended June 30, 2006 and 2005, we realizedexpense of $1,000 and $383, respectively, to our Manager under the assetservicing agreement.

In connection withthe closing of our CDO in July 2005, the Issuer entered into a collateralmanagement agreement with our Manager. Pursuant to the collateral managementagreement, our Manager has agreed to provide certain advisory andadministrative services in relation to the collateral debt securities and othereligible investments securing the CDO notes. The collateral management agreement provides for a senior collateralmanagement fee, payable quarterly in accordance with the priority of paymentsas set forth in the indenture, equal to 0.15% per annum of the net outstandingportfolio balance, and an additional subordinate collateral management fee,payable quarterly in accordance with the priority of payments as set forth inthe 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 the collateraldebt securities, excluding defaulted securities, (ii) aggregate principalbalance of all principal proceeds held as cash and eligible investments in certainaccounts, and (iii) with respect to the defaulted securities, the calculationamount of such defaulted securities. As compensation for the performance of itsobligations as collateral manager, our Board of Directors has allocated to ourManager the subordinate collateral management fee paid on securities not heldby us.  The senior collateral management fee andbalance of the subordinate collateral management fee is allocated to us.  For the three and six months ended June 30,2006 we realized expense of $499 and $1,000, respectively, to our Manager underthe collateral management agreement.

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

In connection withthe 5,500,000 shares of common stock that were sold on December 3, 2004 andsettled on December 31, 2004 and January 3, 2005 in a private placement, weagreed to pay our Manager a fee of $1,000 as compensation for financialadvisory, structuring and costs incurred on our behalf.   This fee was recorded as a reduction in theproceeds of the private placement.  Apartfrom legal fees and stock clearing charges totaling $245, no other fees werepaid by us to an investment bank, broker/dealer or other financial advisor inconnection with the private placement, resulting in total costs of 1.3% oftotal gross proceeds.

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

**On June 7, 2006 we closed on theacquisition of a 49.75% TIC interest in 55 Corporate Drive, located inBridgewater, New Jersey with a .25% interest to be acquired in the future.  The remaining 50% of the property is owned asa TIC interest by SL Green Realty Corp.** The property is comprised of three buildings totaling approximately sixhundred and seventy thousand square feet which is 100% net leased to an entitywhose obligations are guaranteed by Sanofi-Aventis Group through April 2023. Thetransaction was valued at $236,000 and was financed with a $190,000, 10-year,fixed-rate first mortgage loan.

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**Commencing May 1, 2005 we are partyto a lease agreement with SLG Graybar Sublease LLC, an affiliate of SL Green,for our corporate offices at 420 Lexington Avenue, New York, New York.  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 seven thousandsquare feet of approximately $249 per annum for year one rising to $315 perannum in year ten.  For the three and sixmonths ended June 30, 2006 we paid $63 and $125 under this lease.**

**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 and sixmonths ended June 30, 2006 was $2 and $3, respectively, and less than $1 forthe three and six months ended June 30, 2005.**

**SL GreenOperating Partnership, L.P. is an equity holder in the joint venture that isthe borrower on an investment with a book value of $7,190 and $29,026 ,respectively, as of June 30, 2006 and December 31, 2005, respectively.**

**On July14, 2005, we closed on the purchase from an SL Green affiliate of a $40,000mezzanine loan which bears interest at 11.20%. As part of that sale, the seller retained an interest-onlyparticipation.  We have determined thatthe yield on our mezzanine loan after giving effect to the interest-onlyparticipation retained by the seller is at market.  The mezzanine loan is secured by the equityinterests in an office property in New York, New York.**

**OnFebruary 27, 2006, we closed on the purchase of a $90,000 whole loan, whichbears interest at 30-day LIBOR plus 2.15%, to a joint venture in which SL Greenis an equity holder.  The loan is securedby 55 Corporate Drive in Bridgewater, New Jersey.  The loan was repaid in full in June 2006 withthe proceeds from new mortgage financing obtained in connection with the saleof the property, 49.75% of which is now owned by us through a TIC structure.**

**On March17, 2006, we closed on the purchase of a $25,000 mezzanine loan, which bearsinterest at 30-day LIBOR plus 8.00%, to a joint venture in which SL Green is anequity holder.  The loan was secured byoffice and industrial properties in northern New Jersey.  The loan was repaid in full in May 2006.**

**On May 9,2006 we originated a $90,287 whole loan, which bears interest at 30-day LIBORplus 2.75%, to a joint venture in which SL Green is an equity holder.  The loan is secured by office and industrialproperties in northern New Jersey and has a book value of $89,884 as of June30, 2006.**

**On August1, 2006 we acquired from a financial institution a 50% pari passu interest in a$65,000 preferred equity investment secured by an office property in New York,New York.  An affiliate of SL Greensimultaneously acquired and owns the other 50% pari passu interest.  The investment bears interest at a blendedfixed rate of 10.52%.**

**Duringthe six months ended June 30, 2006, we earned fees of $162,500 from SL Greenrepresenting SL Green’s proportionate share of fees for financing andstructural advisory services related to a specific potential transaction.**

**12.  DeferredCosts**

Deferred costs at June 30, 2006 and December 31, 2005consisted of the following:

|                                | ** ** | **June 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|--------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| Deferred  financing            |       | $                       | 22,655     |                        | $          | 20,553 |   |
| Deferred  acquisition          |       | 3,138                   |       | 2,210                       |       |
|                           |       | 25,793                  |       | 22,763                      |       |
| Less accumulated  amortization |       | (5,767                  | )          | (3,381                      | )          |
|                           |       | $                       | 20,026     |                        | $          | 19,382 |   |

Deferred financing costs relate to our existing repurchase facilitieswith Wachovia and Goldman, our unsecured revolving credit facility withKeyBank, our CDO 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.

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Deferred acquisition costs consist of fees and directcosts incurred to originate our investments and are amortized using theeffective yield method over the related term of the investment.

**13.  FairValue of Financial Instruments**

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

Cash equivalents, accruedinterest, and accounts payable balances reasonably approximate their fairvalues due to the short maturities of these items.  The carrying value of our CDO, repurchase andrevolving  credit facilities approximatefair value because they bear interest at floating rates, which we believe, forfacilities with a similar risk profile, reasonably approximate marketrates.  Our junior subordinateddebentures reasonably approximate fair value based upon the amount at whichsimilarly issued instruments have been valued. Our fixed rate mortgage payable is carried at its unpaid principalbalance, which approximates fair value due to the short period of time the notehas been outstanding.  Loans andcommercial mortgage backed securities are carried at amounts, which reasonablyapproximate their fair value as determined by our Manager.

The fair value of our fixed-ratedebt investments as determined by our Manager in consultation with marketdealers of such instruments as of June 30, 2006 are as follows:

|                              | ** ** | **Carrying  Value** | ** ** | **Fair Value** | ** ** |
|------------------------------|------------|---------------------|------------|----------------|------------|
| Fixed-rate debt  investments |       | $                   | 215,463    |           | $          | 215,463 |   |
|                              |            |                     |            |                |            |  |  |

Disclosureabout fair value of financial instruments is based on pertinent informationavailable to us at June 30, 2006. Although we are not aware of any factors that would significantly affectthe reasonable fair value amounts, such amounts have not been comprehensivelyrevalued for purposes of these financial statements since that date and currentestimates of fair value may differ significantly from the amounts presentedherein.

**14.  Stockholders’ Equity**

**CommonStock**

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

As of the date of our formation,April 12, 2004, we had 500,000 shares of common stock outstanding valued atapproximately $200.  On August 2, 2004 wecompleted our initial public offering of 12,500,000 shares of common stockresulting in net proceeds of approximately $172,900, which was used to fundinvestments and commence our operations. As of June 30, 2006, 350,000 restricted shares had also been issuedunder our 2004 Equity Incentive Plan, or the Equity Incentive Plan.  These shares have a vesting period of threeto four years and are not entitled to receive distributions declared by us onour common stock until such time as the shares have vested, or the shares havebeen designated to receive dividends by the Compensation Committee of our Boardof Directors.

On December 3, 2004, we sold5,500,000 shares of common stock, at a price of $17.27 per share, resulting innet proceeds of approximately $93,740 under a private placement exemption fromthe registration requirements of Section 5 of the Securities Act of 1933, asamended.  A total of 4,225,000 shareswere sold to various institutional investors and an additional 1,275,000 shareswere sold to SL Green Operating Partnership, L.P. pursuant to its contractualright to choose to maintain a 25% ownership interest in the outstanding sharesof our common stock.  Of the 5,500,000shares sold, 2,000,000 shares were settled on December 31, 2004 and theremaining 3,500,000 shares were settled on January 3, 2005.

On September 14, 2005, we sold3,833,333 shares of common stock, at a price of $25.80 per share, resulting innet proceeds of approximately $97,830.  Atotal of 2,875,000 shares were sold through public offering and an additional958,333 shares were sold to SL Green Operating Partnership, L.P. pursuant toits contractual right to choose to maintain a 25% ownership interest in ouroutstanding shares of common stock.  Netproceeds were used for loan acquisitions and originations, repayment ofoutstanding

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principal under one of ourrepurchase facilities and general corporate purposes.

On May 16, 2006, we sold3,000,000 shares of common stock, at a price of $26.75 per share, resulting innet proceeds of approximately $79,955.  Atotal of 2,250,000 shares were sold through a public offering and an additional750,000 shares were sold to SL Green Operating Partnership, L.P. pursuant toits contractual right to choose to maintain a 25% ownership interest in ouroutstanding shares of common stock. After this offering, SL Green Operating Partnership, L.P. owned6,418,333 shares of our common stock. Net proceeds were used for loan acquisitions and originations, repaymentof outstanding principal under our repurchase facilities and general corporatepurposes.

In August 2005 our $350,000shelf registration statement was declared effective by the Securities andExchange Commission, or SEC.  This registration statement provides us withthe ability to issue common and preferred stock, depository shares andwarrants.  We currently have $170,850 available under the shelf.

As of June 30, 2006, 25,817,642shares of common stock and no shares of preferred stock were issued andoutstanding.

**Equity Incentive Plan**

As part of our initial public offering, we institutedour Equity Incentive Plan.  The EquityIncentive Plan, as amended, authorizes (i) the grant of stock options thatqualify as incentive stock options under Section 422 of the Internal RevenueCode of 1986, as amended, or ISOs, (ii) the grant of stock options that do notqualify, or NQSOs, (iii) the grant of stock options in lieu of cash directors’fees and (iv) grants of shares of restricted and unrestricted commonstock.  The exercise price of stockoptions will be determined by the compensation committee, but may not be lessthan 100% of the fair market value of the shares of common stock on the date ofgrant.  At June 30, 2006, approximately1,200,931 shares of common stock were available for issuance under the EquityIncentive Plan.

Managementand outsourcing fees paid to our Manager and SL Green Operating Partnership,L.P. are sufficient to reimburse our Manager and SL Green OperatingPartnership, L.P. for the applicable compensation, including payroll taxes, ofthe employees who provide services to Gramercy pursuant to the confirmatoryaddendum to the Management Agreement between Gramercy, our Manager and theOperating Partnership.  These awardeesare considered co-leased employees. Options granted under the Equity Incentive Plan to recipients who areco-leased employees of Gramercy are exercisable at the fair market value on thedate of grant and, subject to termination of employment, expire ten years fromthe date of grant, are not transferable other than on death, and areexercisable in three to four annual installments commencing one year from thedate of grant.  In some instances,options may be granted under the Equity Incentive Plan to persons who providesignificant services to us or our affiliates, but are not considered co-leasedemployees because compensation for their services is not covered by ourmanagement agreement or outsourcing 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.

Asummary of the status of our stock options as of June 30, 2006 and December 31,2005 are presented below:

|                               | ** ** | **June 30, 2006** | ** ** | **December 31, 2005**        | ** ** |
|-------------------------------|------------|-----------------------------|------------|----------------------------------------|------------|
| ** **                    | ** ** | **Options  Outstanding**    | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Options  Outstanding** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
| Balance at  beginning of year |       | 733,584                     |       | $                                      | 16.47      |   | 640,500 |   | $ | 15.05 |   |
| Granted                       |       | 185,000                     |       | $                                      | 23.29      |   | 236,000 |   | $ | 19.62 |   |
| Exercised                     |       | (3,000                      | )          | $                                      | 15.00      |   | (131,249 | ) | $ | 15.01 |   |
| Lapsed or  cancelled          |       | (19,000                     | )          | $                                      | 19.89      |   | (11,667 | ) | $ | 18.20 |   |
| Balance at end of  period     |       | 896,584                     |       | $                                      | 17.81      |   | 733,584 |   | $ | 16.47 |   |

Alloptions were granted within a price range of $15.00 to $25.56.  The remaining weighted average contractuallife of the options was 8.6 years. Compensation expense of $507 will be recorded over the course of thenext 21 months, representing the remaining weighted average vesting period ofthe option awards as of June 30, 2006. Compensation expense of $61 and $147 was recorded for the three and sixmonths ended June 30, 2006, respectively, related to the issuance of stockoptions, compared to $43 and $59 for the three and 

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six months ended June 30, 2005,respectively.

Through June 30, 2006, 350,000restricted shares had been issued under the Equity Incentive Plan, of which 60%have vested.   The unvested shares arenot currently entitled to receive distributions declared by us on our commonstock until such time as the shares have vested.  Unvested shares may be entitled to receivedividends at the discretion of the Compensation Committee of our Board ofDirectors.  Holders of restricted sharesare prohibited from selling such shares until they vest but are provided theability to vote such shares beginning on the date of grant.  Compensation expense of $1,024 will berecorded over the course of the next 15 months, representing the remainingweighted average vesting period of the restricted stock awards as of June 30,2006.  Compensation expense of $295 and$652 was recorded for the three and six months ended June 30, 2006,respectively, related to the issuance of restricted shares, compared to $396 and$648 for the three and six months ended June 30, 2005, respectively.

**Outperformance Plan**

In June 2005, the compensation committee of our board of directorsapproved a long-term incentive compensation program, the 2005 OutperformancePlan.  Participants in the 2005Outperformance Plan, all of whom are co-leased employees, will share in a “performancepool” if our total return to stockholders for the period from June 1, 2005through May 31, 2008 exceeds a cumulative total return to stockholders of 30%during the measurement period over a base share price of $20.21 per share.  The size of the pool will be 10% of 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% and remainsat that level or higher for 30 consecutive days, then a minimum performancepool will be established.  In the eventthe potential performance pool reaches the maximum dilution cap before May 31,2008 and remains at that level or higher for 30 consecutive days, theperformance period will end early and the pool will be formed on the last dayof such 30-day period.  Each participant’saward under the 2005 Outperformance Plan is designated as a specifiedpercentage 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 the performancepool, 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 number of LTIP Units earned, hadthey 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 $293 and $586 wasrecorded for the three and six months ended June 30, 2006, respectively,related to the 2005 Outperformance Plan.

**Deferred Stock Compensation Plan for Directors**

 Underour Independent Director’s Deferral Program, which commenced April 2005,our independent directors may elect to defer up to 100% of their annualretainer fee, chairman fees and meeting fees.  Unless otherwise elected bya participant, fees deferred under the program shall be credited in the form ofphantom stock units.  The phantom stock units are convertible into anequal number of shares of common stock upon such directors’ termination ofservice from the Board of Directors or a change in control by us, as defined bythe program.  Phantom stock units are credited to each independentdirector quarterly using the closing price of our 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 ofJune 30, 2006 there were approximately 10,881 phantom stock units outstanding,of which 4,881 units are vested.

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**Earnings per Share**

Earnings per share for the threeand six months ended June 30, 2006 and 2005 is computed as follows:

|                                              | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|----------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                   | ** ** | **2006**                                        | ** ** | **2005**                                      | ** ** | **2006** | ** ** | **2005** | ** ** |
| **Numerator (Income)**                       |       |                                            |       |                                          |       |   |   |   |   |
| Basic Earnings:                              |       |                                            |       |                                          |       |   |   |   |   |
| Net income  available to common stockholders |       | $                                               | 12,817     |                                          | $          | 7,457 |   | $ | 23,370 |   | $ | 12,022 |   |
| Effect of dilutive  securities               |       | —                                          |       | —                                        |       | — |   | — |   |
| Diluted Earnings:                            |       |                                            |       |                                          |       |   |   |   |   |
| Net income  available to common stockholders |       | $                                               | 12,817     |                                          | $          | 7,457 |   | $ | 23,370 |   | $ | 12,022 |   |
|                                         |       |                                            |       |                                          |       |   |   |   |   |
| **Denominator (Weighted Average  Shares)**   | ** ** | ** **                                      | ** ** | ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| Basic                                        |       |                                            |       |                                          |       |   |   |   |   |
| Shares available  to common stockholders     |       | 24,334                                          |       | 18,833                                        |       | 23,575 |   | 18,833 |   |
| Effect of Diluted  Securities:               |       |                                            |       |                                          |       |   |   |   |   |
| Stock-based  compensation plans              |       | 1,185                                           |       | 199                                           |       | 1,182 |   | 192 |   |
| Phantom stock  units                         |       | 11                                              |       | 1                                             |       | 11 |   | 1 |   |
| Diluted Shares                               |       | 25,530                                          |       | 19,033                                        |       | 24,768 |   | 19,026 |   |

**15. Benefit Plans**

**We do not maintain a defined benefit pension plan,post-retirement health and welfare plan, 401(k) plan or other benefits plans aswe do not have any employees.  Thesebenefits are provided to its employees by our Manager, a majority-ownedsubsidiary of SL Green.**

**16.** Commitments and Contingencies

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

Our corporate offices at 420 Lexington Avenue, New York, NewYork are subject to an operating lease agreement with SLG Graybar Sublease LLC,an affiliate of SL Green, effective May 1, 2005.  The lease is 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 seven thousandsquare feet of approximately $249 per annum for year one rising to $315 perannum in year ten.

The following is a schedule of future minimum lease paymentsunder our operating lease as of June 30, 2006.

|                               | ** ** | **Operating  Lease** | ** ** |
|-------------------------------|------------|----------------------|------------|
| 2006                          |       | $                    | 127        |   |
| 2007                          |       | 256                  |       |
| 2008                          |       | 261                  |       |
| 2009                          |       | 265                  |       |
| 2010                          |       | 283                  |       |
| Thereafter                    |       | 1,351                |       |
| Total minimum  lease payments |       | $                    | 2,543      |   |

**17.  Financial Instruments: Derivatives andHedging**

FASB No. 133, or SFAS 133, “Accounting for DerivativeInstruments and Hedging Activities,” which became effective January 1, 2001,requires Gramercy to recognize all derivatives on the balance sheet at fairvalue.  Derivatives that are not hedgesmust be

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adjusted to fair value through income.  If a derivative is a hedge, depending on thenature of the hedge, changes in the fair value of the derivative will either beoffset against the change in fair value of the hedged asset, liability, or firmcommitment through earnings, or recognized in other comprehensive income untilthe hedged item is recognized in earnings. The ineffective portion of a derivative’s change in fair value will beimmediately recognized in earnings.  SFAS133 may increase or decrease reported net income and stockholders’ equityprospectively, depending on future levels of LIBOR interest rates and other variablesaffecting the fair values of derivative instruments and hedged items, but willhave no effect on cash flows, provided the contract is carried through to fullterm.

The following table summarizes the notional and fair value of ourderivative financial instrument at June 30, 2006.  The notional value is an indication of theextent of our involvement in this instrument at that time, but does notrepresent exposure to credit, interest rate or market risks:

 
| ** **          | ** ** | **Benchmark Rate** | ** ** | **Notional  Value** | ** ** | **Strike  Rate** | ** ** | **Effective  Date** | ** ** | **Expiration  Date** | ** ** | **Fair  Value** | ** ** |
|---------------------|------------|-------------------------|------------|---------------------|------------|------------------|------------|---------------------|------------|----------------------|------------|-----------------|------------|
| Interest Rate  Swap |       | 1 month LIBOR           |       | $                   | 61,603     |             | 4.760      | %                   | 1/2006     |                 | 3/2015     |            | $          | 3,147 |   |
| Interest Rate  Swap |       | 3 month LIBOR           |       | 40,000              |       | 4.420            | %          | 7/2005              |       | 2/2014               |       | 2,643           |       |
| Interest Rate  Swap |       | 1 month LIBOR           |       | 31,686              |       | 3.855            | %          | 7/2005              |       | 11/2009              |       | 1,576           |       |
| Interest Rate Cap   |       | 3 month LIBOR           |       | 23,713              |       | 5.700            | %          | 11/2005             |       | 12/2007              |       | 36              |       |
| Interest Rate Cap   |       | 1 month LIBOR           |       | 20,000              |       | 6.000            | %          | 4/2006              |       | 4/2007               |       | 3               |       |
| Interest Rate Cap   |       | 1 month LIBOR           |       | 14,120              |       | 5.500            | %          | 12/2005             |       | 1/2007               |       | 6               |       |
| Interest Rate  Swap |       | 1 month LIBOR           |       | 6,402               |       | 4.760            | %          | 1/2006              |       | 3/2015               |       | 327             |       |
| Interest Rate  Swap |       | 1 month LIBOR           |       | 3,960               |       | 4.959            | %          | 12/2005             |       | 12/2015              |       | 177             |       |
| Interest Rate  Swap |       | 1 month LIBOR           |       | 3,465               |       | 4.280            | %          | 7/2005              |       | 12/2009              |       | 128             |       |
| Interest Rate  Swap |       | 3 month LIBOR           |       | 3,465               |       | 5.178            | %          | 4/2006              |       | 3/2010               |       | 35              |       |
| Total               |       |                    |       | $                   | 208,414    |             |       |                |       |                 |       |            | $          | 8,078 |   |

AtJune 30, 2006, the derivative instruments were reported as an asset at theirfair value of $8,078.  Offsettingadjustments are represented as deferred gains or losses in Accumulated OtherComprehensive Income.  During the sixmonths ended June 30, 2005 we reclassified through earnings $943 representingthe gains and losses previously reported in Accumulated Other Comprehensive Income,which were reclassified into earnings at the same time that the forecastedtransaction associated with derivative instrument affected earnings.  Over time, the realized and unrealized gainsand losses held in Accumulated Other Comprehensive Income will be reclassifiedinto earnings in the same periods in which the hedged interest payments affectearnings.

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

**18.  IncomeTaxes**

We have elected tobe taxed as a REIT, under Sections 856 through 860 of the Internal Revenue Codebeginning with our taxable year ending December 31, 2004.  To qualify as a REIT, we must meet certainorganizational 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 ourstockholders.  If we fail to qualify as aREIT in any taxable year, we will then be subject to federal income taxes onour taxable income at regular corporate rates and we will not be permitted toqualify for treatment as a REIT for federal income tax purposes for four yearsfollowing the year during which qualification is lost unless the InternalRevenue Service grants us relief under certain statutory provisions.  Such an event could materially adverselyaffect our net income and net cash available for distributions tostockholders.  However, we believe thatwe are organized and will operate in such a manner as to qualify for treatmentas a REIT and we intend to operate in the foreseeable future in such a mannerso that we will qualify as a REIT for federal income tax purposes.  We may, however, be subject to certain stateand local taxes.

For the three and six months ended June 30, 2006, we recorded $335 and$382 of income tax expense in income from continuing operations for incomeattributable our wholly-owned taxable REIT subsidiaries. We have assumed aneffective tax rate for the periods ended June 30, 2006 of 40% taking intoconsideration the anticipated applicable U.S. federal statutory tax rate atJune 30, 2006 of 34% and state and local taxes.

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**19.  Environmental Matters**

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

**20.  Segment Reporting**

**Statementof Financial Accounting Standard No. 131, or “SFAS No. 131,” establishesstandards for the way that public entities report information about operatingsegments in their annual financial statements. We are a REIT focused primarily on originating and acquiring loans andsecurities related to real estate and under the provisions of SFAS No. 131currently operate in only one segment.**

**21. Supplemental Disclosure of Non-Cash Investing and Financing Activities**

Followingthe conversion of the entity that owns 200 Franklin Square Drive into a DST, wesold approximately 75% of our security interests in the DST to a third party,reducing our final ownership interest to 25.0%. We received total cash consideration of $12,800 for these interests andthe buyer assumed 75% of the DST’s underlying mortgage debt.  As a result of the transaction, the propertyis no longer consolidated onto our balance sheet, but instead is accounted foras an equity method investment.

The following table represents non-cashactivities recognized in other comprehensive income:

|                                           | ** ** | **2006** | ** ** | **2005** | ** ** |
|-------------------------------------------|------------|----------|------------|----------|------------|
| Deferred gains  on derivative instruments |       | $        | 6,015      |     | $          | 2,287 |   |
| Change in fair value of  other assets     |       | (700     | )          | —   |       |
|                                           |            |          |            |          |            |  |  |

 

**22.  Subsequent Events**

On August 3, 2006, we priced our second $1,000,000 CDOto be issued by two newly formed subsidiaries. The CDO will consist of $903,750 of investment grade notes, plusnon-investment grade notes, preferred equity and equity which will be retainedby us.  At issuance, the weighted-averageinterest rate of the investment grade notes will be three-month LIBOR plus0.3695%, excluding transaction costs. The CDO will have an expected term of up to 10 years, and provides for a5-year reinvestment period during which we can utilize the proceeds of loanrepayments to finance new investments. We will utilize the proceeds from the CDO issuance to retire outstandingborrowings under our existing repurchase agreements and to fund future debtinvestment activities.

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

**Overview**

We are a nationalcommercial real estate specialty finance company that focuses on the directorigination and acquisition of whole loans, subordinate interests in wholeloans, mezzanine loans, preferred equity, and net lease investments involvingcommercial properties throughout the United States. When evaluatingtransactions, we assess our risk-adjusted return and target transactions withyields that ensure an equitable balance between risks and return.  We conduct substantially all of ouroperations through our operating partnership, GKK Capital LP.  We are externally managed and advised by GKKManager LLC, or the Manager, a majority-owned subsidiary of SL Green RealtyCorp., or SL Green.  We have elected tobe taxed as a REIT under the Internal Revenue Code and generally will not besubject to federal income taxes to the extent we distribute our income to ourstockholders.  However, we may establishTRSs 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 syndicationand securitization executions to achieve excess returns.  By providing a single source of financing fordevelopers and sponsors, we streamline the lending process, provide greatercertainty for borrowers and retain the high yield debt instruments that wemanufacture.  By creating, rather thanbuying whole loans, subordinate interests in whole loans, mezzanine debt andpreferred equity, we strive to deliver superior returns to our stockholders.

Since ourinception, we have completed transactions in a variety of markets and securedby a variety of property types.  Sinceour inception, the market for commercial real estate debt has continued todemonstrate low rates of default, high relative returns and tremendous inflowsof capital.  Consequently, the market fordebt instruments has evidenced moderately declining yields and more flexiblecredit standards and loan structures.  Inparticular, “conduit” originators who package whole loans for resale toinvestors have driven debt yields lower while maintaining substantial liquiditybecause of the strong demand for the resulting securities.  Because of reduced profits in the most liquidsectors of the mortgage finance business, several large institutions have begunoriginating large bridge loans for the purpose of generating interest income,rather than the typical focus on trading profits.  In this environment we have focused on areaswhere we have comparative advantages rather than competing for product merelyon the basis of yield or structure.  Thishas particularly included whole loan origination in markets and transactionswhere we have an advantage due to (i) knowledge or relationships we have, (ii)knowledge or relationships of our largest stockholder, SL Green, and (iii)where we have an ability to better assess and manage risks over time.  When considering investment opportunities insecondary market transactions in tranched debt, we generally avoid first lossrisk in larger transactions due to the high current valuation of the underlyingreal estate relative to historic valuation levels.  Because of the significant increase in thevalue of institutional quality assets relative to historic norms, we typicallyfocus on positions in which a conventional refinancing at loan maturity wouldprovide for a complete return of our investment.

Because of thehigh relative valuation of debt instruments in the current market and agenerally increasing rate environment, we have carefully managed our exposureto interest rate changes that could affect our liquidity.  We generally match our assets and liabilitiesin terms of base interest rate (generally 30-day LIBOR) and expected duration.  We raised $95.0 million of additional equityin December 2004 and January 2005 to reduce our outstanding indebtedness andmaintain sufficient liquidity for our investment portfolio.  We have sold a total of $150.0 million oftrust preferred securities in three $50.0 million issuances in May and August2005 and January 2006 through wholly-owned subsidiaries of the OperatingPartnership with 30 year terms.  Thesecurities issued in May bear interest at a fixed rate of 7.57% for the firstten years ending, the securities issued in August bear interest at a fixed rateof 7.75% for the first ten years and the securities issued in January 2006 bearinterest at a fixed rate of 7.65% for the first ten years.  After the first ten years, the 2005 issuancesbear interest at three-month LIBOR plus 300 basis points while the 2006issuance bears interest at three-month LIBOR plus 270 basis points.  The proceeds from the issuances of the trustpreferred securities were used to fund existing and future investmentopportunities.   In July 2005 we closedon $1.0 billion of collateralized debt obligations, or CDO, which extended theterm of our liabilities and reduced our overall cost of funds with respect todebt investments financed by the CDO and previously financed by our repurchaseagreements, to approximately 49 basis points over LIBOR, excluding transactioncosts.  The proceeds of the CDO were usedto refinance our repurchase facilities and to fund additional investmentactivities.  In September 2005 we sold3,833,333 shares of common stock resulting in net proceeds of approximately$97.8 million and in May 2006 we sold 3,000,000 shares of common stockresulting in net proceeds of approximately $80.0 million.  The proceeds of these offerings were used tofund loan acquisitions and originations, repay outstanding principal amountsunder our repurchase facilities and for general corporate purposes.  In May 2006 we also closed on a $100,000unsecured credit facility with an initial term of three years and interestspreads between 1.90% and 2.10%.

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As of June 30,2006, we held loans and other lending investments of $1,655,566 net of fees,discounts, repayments, asset sales and unfunded commitments with an averagespread to LIBOR of 366 basis points for our floating rate investments and anaverage yield of 9.51% for our fixed rate investments.  As of June 30, 2006, we also held interestsin four CTL investments comprised of a 49.75% interest in 55 Corporate Drive inBridgewater, New Jersey, and three joint venture investments.

**The aggregate carrying values, allocated by producttype and weighted average coupons of our loans and other lending investments asof June 30, 2006 and December 31, 2005 were as follows:**

|                                                      | ** ** | **Carrying Value (1)   ($ in thousands)** | ** ** | **Allocation by  Investment Type** | ** ** | **Fixed Rate:  Average Yield** | ** ** | **Floating Rate:  Average Spread over  LIBOR (2)** | ** ** |
|------------------------------------------------------|------------|--------------------------------------------------------------------|------------|----------------------------------------------|------------|------------------------------------------|------------|------------------------------------------------------------------------|------------|
| ** **                                           | ** ** | **2006**                                                           | ** ** | **2005**                                     | ** ** | **2006**                                 | ** ** | **2005**                                                               | ** ** | **2006** | ** ** | **2005** | ** ** | **2006** | ** ** | **2005** | ** ** |
| Whole loans, floating  rate                          |       | $                                                                  | 938,416    |                                         | $          | 561,388                                  |       | 57                                                                     | %          | 46 | % | — |   | — |   | 303bps |   | 325 bps |   |
| Whole loans, fixed rate                              |       | 115,347                                                            |       | 94,448                                       |       | 7                                        | %          | 8                                                                      | %          | 9.64 | % | 10.64 | % | — |   | — |   |
| Subordinate interests in  whole loans, floating rate |       | 404,789                                                            |       | 362,983                                      |       | 24                                       | %          | 30                                                                     | %          | — |   | — |   | 425bps |   | 443 bps |   |
| Subordinate interests in  whole loans, fixed rate    |       | 48,206                                                             |       | 37,104                                       |       | 3                                        | %          | 3                                                                      | %          | 9.56 | % | 9.19 | % | — |   | — |   |
| Mezzanine loans,  floating rate                      |       | 81,766                                                             |       | 82,793                                       |       | 5                                        | %          | 7                                                                      | %          | — |   | — |   | 724bps |   | 858 bps |   |
| Mezzanine loans, fixed  rate                         |       | 43,291                                                             |       | 43,352                                       |       | 2                                        | %          | 4                                                                      | %          | 8.88 | % | 8.88 | % | — |   | — |   |
| Preferred equity,  floating rate                     |       | 11,850                                                             |       | 11,795                                       |       | 1                                        | %          | 1                                                                      | %          | — |   | — |   | 900bps |   | 900 bps |   |
| Preferred equity, fixed  rate                        |       | 11,901                                                             |       | 11,882                                       |       | 1                                        | %          | 1                                                                      | %          | 10.28 | % | 10.28 | % | — |   | — |   |
| Total / Average                                      |       | $                                                                  | 1,655,566  |                                         | $          | 1,205,745                                |       | 100                                                                    | %          | 100 | % | 9.51 | % | 9.92 | % | 366bps |   | 417 bps |   |

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

**(2)   Spreads over an index other than LIBOR have been adjusted to aLIBOR based equivalent.**

**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 revenues and expenses.  We believe that all of the decisions andassessments upon which our financial statements are based were reasonable atthe time made based upon information available to us at that time.  We evaluate these decisions and assessmentson an ongoing basis.  Actual results maydiffer from these estimates under different assumptions or conditions.  We have identified our most criticalaccounting policies to be the following:

### **Loansand Investments and Loans Held for Sale**

Loans held forinvestment are intended to be held to maturity and, accordingly, are carried atcost, net of unamortized loan origination fees, discounts, repayments, sales ofpartial interests in loans, and unfunded commitments unless such loan orinvestment is deemed to be impaired. Loans held for sale are carried at the lower of cost or market valueusing available market information obtained through consultation with dealersor other originators of such investments. We may originate or acquire preferred equity interests that allow us toparticipate in a percentage of the underlying property’s cash flows fromoperations and proceeds from a sale or refinancing.  Should we make such a preferred equityinvestment, we must determine whether that investment should be accounted foras a loan, joint venture or as an interest in real estate.  Our current preferred equity investments donot entitle us to a percentage of the underlying properties’ cash flows fromoperations or proceeds from a sale or refinancing and are, therefore, accountedfor as loans.

Specific valuation allowances are established forimpaired loans based on the fair value of collateral on an individual loanbasis.  The fair value of the collateralis determined by selecting the most appropriate valuation methodology, ormethodologies, 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

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

If upon completionof the valuation, the fair value of the underlying collateral securing theimpaired loan is less than the net carrying value of the loan, an allowance iscreated with a corresponding charge to the provision for loan losses.  The allowance for each loan is maintained ata level we believe is adequate to absorb probable losses.  We maintained a reserve of $1,530 and $525 atJune 30, 2006 and 2005, respectively.

Our Managerevaluates our assets on a regular basis to determine if they continue to satisfyour investment criteria. Subject to certain restrictions, our Manager may causeus to sell our investments opportunistically and use the proceeds of any suchsale for debt reduction, additional acquisitions or working capital purposes.

#### **Classificationsof Mortgage-Backed Securities**

Mortgage-backedsecurities, or MBS, are classified as available-for-sale securities.  As a result, changes in fair value will berecorded as a balance sheet adjustment to accumulated other comprehensiveincome, which is a component of stockholders equity, rather than through ourstatement of operations.  Ifavailable-for-sale securities were classified as trading securities, therecould be substantially greater volatility in earnings from period-to-period asthese investments would be marked to market and any reduction in the value ofthe securities versus the previous carrying value would be considered anexpense on our statement of operations. We had no investments as of June 30,2006 that were accounted for as trading securities.

#### **Valuationsof Mortgage-Backed Securities**

All MBS arecarried on the balance sheet at fair value. We determine the fair value of MBS based on the types of securities inwhich we have 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 cashflows.  The value of the securities isderived by applying discount rates to such cash flows based on current marketyields.  The yields employed are obtainedfrom our own experience in the market, advice from dealers and/or informationobtained in consultation 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.

When the fairvalue of an available-for-sale security is less than the amortized cost, weconsider whether there is an other-than-temporary impairment in the value ofthe security (for example, whether the security will be sold prior to therecovery of fair value).  If, in ourjudgment, an other-than-temporary impairment exists, the cost basis of thesecurity is written down to the then-current 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 of lossrealization.

#### **CreditTenant Lease Investments**

Consolidated CTL investments are recorded at cost lessaccumulated depreciation.  Costs directlyrelated to the acquisition of such investments are capitalized.  Certain improvements are capitalized whenthey are determined to increase the useful life of the building.  Capitalized items are depreciated using thestraight-line method over the shorter of the useful lives of the capitalizeditem or 40 years for buildings or facilities, the remaining life of the facilityfor facility improvements, four to seven years for personal property andequipment, and the shorter of the remaining lease term or the expected life fortenant improvements.

Results of operations of properties acquired are included inthe Statement of Income from the date of acquisition.

In accordance with FASB No. 144, or SFAS 144, “Accountingfor the Impairment of Disposal of Long-Lived Assets,” a property to be disposedof is reported at the lower of its carrying amount or its estimated fair value,less its cost to sell.  Once an asset isheld for sale, depreciation expense and straight-line rent adjustments are nolonger recorded and historic results are reclassified as DiscontinuedOperations.

Inaccordance with FASB No. 141, or SFAS 141, “Business Combinations,” we allocatethe purchase price of real estate to land and building and, if determined to bematerial, intangibles, such as the value of above, below and at-market leasesand origination costs associated with the in-place leases.  We depreciatethe amount allocated to building and other intangible assets over theirestimated useful lives, which generally range from three to 40 years.  Thevalues of the above and below market leases are amortized and

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recordedas either an increase (in the case of below market leases) or a decrease (inthe case of above market leases) to rental income over the remaining term ofthe associated lease.  The value associated with in-place leases andtenant relationships are amortized over the expected term of the relationship,which includes an estimated probability of the lease renewal, and its estimatedterm.  If a tenant vacates its space prior to the contractual terminationof the lease and no rental payments are being made on the lease, anyunamortized balance of the related intangible will be written off.  Thetenant improvements and origination costs are amortized as an expense over theremaining life of the lease (or charged against earnings if the lease isterminated prior to its contractual expiration date).  We assess fairvalue of the leases based on estimated cash flow projections that utilizeappropriate discount and capitalization rates and available marketinformation.  Estimates of future cash flows are based on a number offactors including the historical operating results, known trends, andmarket/economic conditions that may affect the property.

As of June 30,2006, we had one proportionately consolidated CTL investment representing a49.75% TIC interest in 55 Corporate Drive in Bridgewater, New Jersey.

**Investments in Unconsolidated Joint Ventures**

#### We account forour investments in unconsolidated joint ventures under the equity method ofaccounting since we exercise significant influence, but do not unilaterallycontrol, the entities and are not considered to be the primary beneficiaryunder FIN 46.  In the joint ventures, the rights of the other investor areprotective and participating. Unless we are determined to be the primarybeneficiary, these rights preclude us from consolidating the investments. The investments are recorded initially at cost as an investment inunconsolidated joint ventures, and subsequently are adjusted for equity in netincome (loss) and cash contributions and distributions.  Any differencebetween the carrying amount of the investments on our balance sheet and theunderlying equity in net assets is amortized as an adjustment to equity in netincome (loss) of unconsolidated joint ventures over the lesser of the jointventure term or 40 years.  None of the joint venture debt is recourse tous. As of June 30, 2006, we had investments of $59,243 in threeunconsolidated joint ventures.

#### **RevenueRecognition**

Interest income ondebt investments is recognized over the life of the investment using theeffective 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 as an adjustment to yield. Anticipated exit fees, whose collection is expected, are also recognizedover the term of the loan as an adjustment to yield.  Fees on commitments that expire unused arerecognized at expiration.  Fees receivedin exchange for the credit enhancement of another lender, either subordinate orsenior to us, in the form of a guarantee are recognized over the term of thatguarantee using the straight-line method.

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

In some instanceswe may sell all or a portion of our investments to a third party.  To the extent the fair value received for aninvestment exceeds the amortized cost of that investment and FASB Statement No.140, or SFAS 140, “Accounting for Transfers and Servicing of Financial Assetsand Extinguishments of Liabilities,” criteria is met, under which control ofthe asset that is sold is surrendered making it a “true sale,” a gain on thesale will be recorded through earnings as other income.  To the extent an investment that is sold hasa discount or fees, which were deferred at the time the investment was made andwere being recognized over the term of the investment, the unamortized portionof the discount or fees are recognized at the time of sale and recorded as again on the sale of the investment through other income.  Werecognized $314 in gains from the partial syndication of two floating rate debtinvestments for the three months ended June 30, 2006.  For the six months ended June 30, 2006 werecognized $1,428 in net gains from the sale of two fixed rate debtinvestments, one fixed rate debt commitment and the syndication of portions oftwo floating rate debt investments.

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

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

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**Reserve for Possible Credit Losses**

Theexpense for possible credit losses in connection with debt investments is thecharge to earnings to increase the allowance for possible credit losses to thelevel that management estimates to be adequate considering delinquencies, lossexperience and collateral quality.  Otherfactors considered relate to geographic trends and project diversification, thesize of the portfolio and current economic conditions.  Based upon these factors, we may establishthe provision for possible credit losses by individual asset or category ofasset.  When it is probable that we willbe unable to collect all amounts contractually due, the account is consideredimpaired.

Where impairment isindicated, a valuation write-down or write-off is measured based upon theexcess of the recorded investment amount over the net fair value of the collateral,as reduced by selling costs.  Anydeficiency between the carrying amount of an asset and the net sales price offoreclosed collateral is charged to the allowance for credit losses.  We maintained a reserve for possible creditlosses of $1,530 and $525 against investments with a carrying value of $78,769and $68,690 as of June 30, 2006 and 2005, respectively.

**StockBased Compensation Plans**

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

The Black-Scholes option-pricing model was developed for use inestimating the fair value of traded options, which have no vesting restrictionsand are fully transferable.  In addition,option valuation models require the input of highly subjective assumptionsincluding the 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.

Compensationcost for stock options, if any, is recognized ratably over the vesting periodof the award.  Our policy is to grantoptions with an exercise price equal to the quoted closing market price of ourstock 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.

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

|                                  | ** ** | **2006**  | ** ** | **2005**  | ** ** |
|----------------------------------|------------|-----------|------------|-----------|------------|
| Dividend yield                   |       | 8.0       | %          | 8.4       | %          |
| Expected life of  option         |       | 6.8 years |       | 6.9 years |       |
| Risk-free  interest rate         |       | 4.13      | %          | 4.16      | %          |
| Expected stock price  volatility |       | 21.0      | %          | 19.1      | %          |

**Incentive Distribution (Class B Limited PartnerInterest)**

The Class Blimited partner interests are entitled to receive an incentive return equal to25% of the amount by which funds from operations (as defined in the partnershipagreement of the Operating Partnership which was amended and restated in April2006) plus certain accounting gains exceed the product of our weighted averagestockholders equity (as defined in the amended and restated partnershipagreement of the Operating Partnership) multiplied by 9.5% (divided by 4 toadjust for quarterly calculations).  Wewill record any distributions on the Class B limited partner interests as an incentivedistribution expense in the period when earned and when payment of such amountshas become probable and reasonably estimable in accordance with the partnershipagreement.  These cash distributions willreduce the amount of cash available for distribution to our common unitholdersin our Operating Partnership and to common stockholders.  We incurred approximately $1,578 and $2,771with respect to such Class B limited partner interests for the three and sixmonths ended June 30, 2006, respectively and none for the three and six monthsended June 30, 2005.

**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.**

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**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 offinancial instruments including most derivatives, long-term investments andlong-term debt, standard market conventions and techniques such as discountedcash flow analysis, option-pricing models, replacement cost, and terminationcost are used to determine fair value. All methods of assessing fair value result in a general approximation ofvalue, and such value may never actually be realized.**

In the normalcourse of business, we are exposed to the effect of interest rate changes andlimit these risks by following established risk management policies andprocedures including the use of derivatives. To address exposure to interest rates, we use derivatives primarily tohedge the mark-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 heldfor sale.

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

**FASB No. 133, or SFAS 133, “Accountingfor Derivative Instruments and Hedging Activities,” as amended by FASB No. 149,requires us to recognize all derivatives on the balance sheet at 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,changes in the fair value of the derivative will either be offset against thechange in fair value of the hedged asset, liability, or firm commitment throughearnings, or recognized in other comprehensive income until the hedged item isrecognized in earnings.  The ineffectiveportion of a derivative’s change in fair value will be immediately recognizedin earnings.  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 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 byus are deemed to be highly effective in meeting the hedging objectivesestablished by our corporate policy governing interest rate risk management.

# **Income Taxes**

We elected to betaxed as a REIT, under Sections 856 through 860 of the Internal Revenue Code,beginning with our taxable year ending December 31, 2004.  To qualify as a REIT, we must meet certainorganizational and operational requirements, including a requirement todistribute at least 90% of our ordinary taxable income to stockholders.  As a REIT, we generally will not be subjectto federal income tax on taxable income that we distribute to ourstockholders.  If we fail to qualify as aREIT in any taxable year, we will then be subject to federal income taxes onour taxable income at regular corporate rates and we will not be permitted toqualify for treatment as a REIT for federal income tax purposes for four yearsfollowing the year during which qualification is lost unless the InternalRevenue Service grants us relief under certain statutory provisions.  Such an event could materially adverselyaffect our net income and net cash available for distributions tostockholders.  However, we believe thatwe will be organized and operate in such a manner as to qualify for treatmentas a REIT and we intend to operate in the foreseeable future in such a mannerso that we will qualify as a REIT for federal income tax purposes.  We may, however, be subject to certain stateand local taxes.

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

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# **Resultsof Operations (Amounts in thousands)**

### ***Comparison of thethree months ended June 30, 2006 to the three months ended June 30, 2005***

***Revenues***

|                                                     | ** ** | **2006** | ** ** | **2005** | ** ** | **$ Change** | ** ** |
|-----------------------------------------------------|------------|----------|------------|----------|------------|-------------------|------------|
| Investment income                                   |       | $        | 39,134     |     | $          | 15,689            |       | $ | 23,445 |   |
| Gain on sales and other  income                     |       | 4,371    |       | 3,069    |       | 1,302             |       |
| Total revenues                                      |       | $        | 43,505     |     | $          | 18,758            |       | $ | 24,747 |   |
|                                                |       |     |       |     |       |              |       |
| Equity in net loss of unconsolidated joint ventures |       | $        | (630       | )        | $          | (404              | )          | $ | (226 | ) |

 

Investment incomeis generated on our whole and bridge loans, subordinate interests in wholeloans, mezzanine loans, preferred equity interests and CMBS investments.  For the three months ended June 30, 2006,$5,071 was earned on fixed rate investments while the remaining $34,063 wasearned on floating rate investments.  Theincrease over the prior year is due to a significantly higher number ofinvestments in 2006 versus 2005.

Other income of$4,371 for the three months ended June 30, 2006 is comprised primarily $314 ofgain recorded on the syndication of two floating rate debt investments, and thegain on the sale of security interests in the entity that owns 200 FranklinSquare Drive of $2,632.  The remainingincrease over the prior year is primarily attributable to interest onrestricted cash balances in the CDO (which was not in place in the same periodof 2005) and other cash balances held by us. For the three months ended June 30, 2005, other income of $3,069 wascomprised primarily of income recorded on the sale of senior mortgage interestsor whole loans of $2,967.

**The loss on investments inunconsolidated joint ventures of $630 for the three months ended June 30, 2006represents our proportionate share of the losses generated by our joint ventureinterests including $1,978 of real estate-related depreciation and amortization,which when added back, results in a contribution to FFO of $1,348.  The loss on investments in unconsolidatedjoint venture of $404 for the three months ended June 30, 2005 was generated ononly our investment in One Madison Avenue in New York, New York.  Our use of FFO as an important financialmeasure is discussed in more detail below.**

***Expenses***

|                                        | ** ** | **2006** | ** ** | **2005** | ** ** | **$ Change** | ** ** |
|----------------------------------------|------------|----------|------------|----------|------------|-------------------|------------|
| Interest expense                       |       | $        | 20,777     |     | $          | 6,264             |       | $ | 14,513 |   |
| Management fees                        |       | 3,861    |       | 1,870    |       | 1,991             |       |
| Incentive fee                          |       | 1,578    |       | —   |       | 1,578             |       |
| Depreciation and  amortization         |       | 228      |       | 106      |       | 122               |       |
| Marketing, general and  administrative |       | 2,779    |       | 1,632    |       | 1,147             |       |
| Provision for loan loss                |       | 500      |       | —   |       | 500               |       |
| Provision for taxes                    |       | 335      |       | 500      |       | (165              | )          |
| Total expenses                         |       | $        | 30,058     |     | $          | 10,372            |       | $ | 19,686 |   |

 

Interest expensewas $20,777 for the three months ended June 30, 2006 compared to $6,264 for thethree months ended June 30, 2005. Interest expense for the three months ended June 30, 2006 consistedprimarily of $11,192 of interest on the investment grade tranches of our CDO(which was not in place during the same period in 2005), $5,802 of interest onborrowings on our master repurchase facilities with Wachovia and Goldman, and$2,871 of expense accrued against our three $50,000 issuances of trustpreferred securities.  The $6,264 ofinterest expense during the same period in 2005 was comprised primarily ofinterest on borrowings on the master repurchase facilities with Wachovia andGoldman, interest on only one $50 million issuance of trust preferredsecurities and the amortization of deferred financing costs.

Management feesincreased $1,991 for the three months ended June 30, 2006 to $3,861 versus$1,870 for the same period in 2005 due primarily to an increase in ourstockholder’s equity as a result of additional issuances of common equity andthe issuance of $150,000 of trust preferred securities, on which managementfees are based.  The remaining increaseis comprised of $499 paid or payable to our Manager under the CDO collateralmanagement agreement in lieu of the 0.15% fee otherwise payable to SL GreenOperating Partnership, L.P. on investments in the CDO under the asset servicingagreement, higher fees paid or payable to SL Green Operating Partnership, L.P.under our outsourcing and servicing agreements due to the increase in ourinvestment balances and the scheduled 3% annual increase in the fee payableunder our outsourcing agreement.

We recorded anincentive fee expense of $1,578 during the three months ended June 30, 2006 inaccordance with requirements of the

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partnershipagreement of the Operating Partnership which entitles owners of Class B limitedpartner interests in the Operating Partnership to an incentive return equal to25% of the amount by which funds from operations (as defined in the partnershipagreement of the Operating Partnership) plus certain accounting gains exceedthe product of our weighted average stockholders equity (as defined in thepartnership agreement of the Operating Partnership) multiplied by 9.5% (dividedby 4 to adjust for quarterly calculations). This threshold was not reached during the same period in 2005 and,consequently, no expense was recorded.

The increase inmarketing, general and administrative expenses of $1,147 for the three monthsended June 30, 2006 versus the same period in 2005 was due primarily to higherprofessional fees, stock-based compensation, insurance and general overheadcosts.

### ***Comparison of thesix months ended June 30, 2006 to the six months ended June 30, 2005***

***Revenues***

|                                                     | ** ** | **2006** | ** ** | **2005** | ** ** | **$ Change** | ** ** |
|-----------------------------------------------------|------------|----------|------------|----------|------------|-------------------|------------|
| Investment income                                   |       | $        | 71,013     |     | $          | 25,939            |       | $ | 45,074 |   |
| Rental revenue, net                                 |       | 914      |       | —   |       | 914               |       |
| Gain on sales and other  income                     |       | 8,568    |       | 3,509    |       | 5,059             |       |
| Total revenues                                      |       | $        | 80,495     |     | $          | 29,448            |       | $ | 51,047 |   |
|                                                |       |     |       |     |       |              |       |
| Equity in net loss of unconsolidated joint ventures |       | $        | (1,357     | )        | $          | (404              | )          | $ | (953 | ) |

 

Investment incomeis generated on our whole and bridge loans, subordinate interests in wholeloans, mezzanine loans, preferred equity interests and CMBS investments.  For the six months ended June 30, 2006,$10,223 was earned on fixed rate investments while the remaining $60,790 wasearned on floating rate investments.  Theincrease over the prior year is due to a significantly higher number ofinvestments in 2006 versus 2005.

**Rental revenue of $914 in 2006was earned on 200 Franklin Square Drive, which was acquired in September2005.  This amount includes the effect ofadjustments for straight-line rent and FASB 141 adjustments for below-marketleases.  We did not hold any real estateinvestments during the same period in 2005.**

Other income of$8,568 for the six months ended June 30, 2006 is comprised primarily of incomerecorded on the sale of two fixed rate debt investments and the syndication oftwo floating rate debt investments of $1,428, and the gain on the sale ofsecurity interests in the entity that owns 200 Franklin Square Drive of$4,350.  The remaining increase over theprior year is primarily attributable to interest on restricted cash balances inthe CDO (which was not in place in the same period of 2005) and other cashbalances held by us. For the six months ended June 30, 2005, other income of$3,509 was comprised primarily of the gain on the sale of one fixed rate debtinvestment and senior mortgage interests or whole loans of $3,370 and interestincome on cash balances.

**The loss on investments inunconsolidated joint ventures of $1,357 for the six months ended June 30, 2006represents our proportionate share of the losses generated by our joint ventureinterests including $3,857 of real estate-related depreciation andamortization, which when added back, results in a contribution to FFO of$2,500.  The loss on investments inunconsolidated joint venture of $404 for the six months ended June 30, 2005 wasgenerated on only our investment in One Madison Avenue in New York, NewYork.  Our use of FFO as an importantfinancial measure is discussed in more detail below.**

***Expenses***

|                                        | ** ** | **2006** | ** ** | **2005** | ** ** | **$ Change** | ** ** |
|----------------------------------------|------------|----------|------------|----------|------------|-------------------|------------|
| Interest expense                       |       | $        | 38,499     |     | $          | 9,065             |       | $ | 29,434 |   |
| Management fees                        |       | 7,384    |       | 3,538    |       | 3,846             |       |
| Incentive fee                          |       | 2,771    |       | —   |       | 2,771             |       |
| Depreciation and  amortization         |       | 683      |       | 128      |       | 555               |       |
| Marketing, general and  administrative |       | 5,549    |       | 3,266    |       | 2,283             |       |
| Provision for loan loss                |       | 500      |       | 525      |       | (25               | )          |
| Provision for taxes                    |       | 382      |       | 500      |       | (118              | )          |
| Total expenses                         |       | $        | 55,768     |     | $          | 17,022            |       | $ | 38,746 |   |

 

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Interest expensewas $38,499 for the six months ended June 30, 2006 compared to $9,065 for thesix months ended June 30, 2005. Interest expense for the six months ended June30, 2006 consisted primarily of $21,322 of interest on the investment gradetranches of our CDO (which was not in place during the same period in 2005),$9,307 of interest on borrowings on our master repurchase facilities withWachovia and Goldman, and $5,432 of expense accrued against our three $50,000issuances of trust preferred securities. The $9,065 of interest expense during the same period in 2005 wascomprised primarily of interest on borrowings on the master repurchasefacilities with Wachovia and Goldman, interest on only one $50 million issuanceof trust preferred securities and the amortization of deferred financing costs.

Management feesincreased $3,846 for the six months ended June 30, 2006 to $7,384 versus $3,538for the same period in 2005 due primarily to an increase in our stockholder’sequity as a result of additional issuances of common equity and the issuance of$150,000 of trust preferred securities, on which management fees arebased.  The remaining increase iscomprised of $999 paid or payable to our Manager under the CDO collateralmanagement agreement in lieu of the 0.15% fee otherwise payable to SL GreenOperating Partnership, L.P. on investments in the CDO under the asset servicingagreement, higher fees paid or payable to SL Green Operating Partnership, L.P.under our outsourcing and servicing agreements due to the increase in ourinvestment balances and the scheduled 3% annual increase in the fee payableunder our outsourcing agreement.

We recorded anincentive fee expense of $2,771 during the six months ended June 30, 2006 inaccordance with requirements of the partnership agreement of the OperatingPartnership which entitles owners of Class B limited partner interests in theOperating Partnership to an incentive return equal to 25% of the amount bywhich funds from operations (as defined in the partnership agreement of theOperating Partnership) plus certain accounting gains exceed the product of ourweighted average stockholders equity (as defined in the partnership agreementof the Operating Partnership) multiplied by 9.5% (divided by 4 to adjust forquarterly calculations).  This thresholdwas not reached during the same period in 2005 and, consequently, no expensewas recorded.

The increase inmarketing, general and administrative expenses to $5,549 for the six monthsended June 30, 2006 versus the same period in 2005 was due primarily to higherprofessional fees, stock-based compensation, insurance and general overheadcosts and a nonrecurring charge of $525 for third-party professional expensesin connection with a possible business combination involving the acquisition ofa publicly-traded commercial real estate finance company with business linesconsidered by management to be highly complementary to ours.  The decision to expense these costs was madeonce management concluded the proposed transaction was unlikely to occur onterms advantageous to us.

## **Liquidityand Capital Resources**

## Liquidity is ameasurement of the ability to meet cash requirements, including ongoingcommitments to repay borrowings, fund and maintain loans and investments, paydividends and other general business needs. Our principal sources of working capital and funds for additionalinvestments primarily include: 1) cash flow from operations; 2) borrowingsunder our repurchase and credit facilities; 3) our CDO; 4) other forms offinancing or additional securitizations including CMBS or subsequent CDOofferings; 5) proceeds from common or preferred equity offerings, 6) issuancesof trust preferred securities and, to a lesser extent, 7) the proceeds fromprincipal payments on our investments, and 8) the sale or syndication ofcertain of our debt investments.  Webelieve these sources of financing will be sufficient to meet our short-termliquidity needs.

Our ability tomeet our long-term liquidity and capital resource requirements will be subjectto obtaining additional debt financing and equity capital.  Our inability to renew, replace or expand oursources of financing on substantially similar terms, may have an adverse effecton our business and results of operations.  In addition, an event of default is triggeredunder our repurchase facility with Wachovia if the management agreement withour Manager is terminated.  Depending onmarket conditions, our debt financing will generally be in the range of 70% to80% of the carrying value of our total assets. Any indebtedness we incur will likely be subject to continuing covenantsand we will likely be required to make continuing representations andwarranties in connection with such debt. Our debt financing terms may require us to keep uninvested cash on hand,or to maintain a certain portion of our assets free of liens, each of whichcould serve to limit our borrowing ability. Moreover, our debt may be secured by our assets.  If we default in the payment of interest orprincipal on any such debt, breach any representation or warranty in connectionwith any borrowing or violate any covenant in any loan document, our lender mayaccelerate the maturity of such debt requiring us to immediately repay alloutstanding principal.  If we are unableto make such payment, our lender could foreclose on our assets that are pledgedas collateral to such lender.  The lendercould also sue us or force us into bankruptcy. Any such event would have a material adverse effect on our liquidity andthe value of our common stock.  Inaddition, posting additional collateral to support our credit and repurchasefacilities will reduce our liquidity and limit our ability to leverage ourassets.

**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**

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**that our significant capital resourcesand access to financing will provide us with financial flexibility at levelssufficient to meet current and anticipated capital requirements, includingfunding new lending and investment opportunities.**

## **CashFlows (Amounts in thousands)**

## Net cash from operatingactivities increased $3,740 to $19,087 for the six months ended June 30, 2006compared to cash provided of $15,347 for the six months ended June 30,2005.  Operating cash flow was generated primarily by interest income onour whole and bridge loans, subordinate interests in whole loans, mezzanineloans and preferred equity interests and gains on loan sales.  Increased cash flow from a larger number ofinvestments in 2006 versus 2005 was offset primarily by a $62,213 net use ofcash related to the origination of an investment held for sale at June 30, 2006whereas we did not originate any loans that were held for sale during the sixmonths ended June 30, 2005.

Netcash used in investing activities increased $134,954 to $535,398 for the sixmonths ended June 30, 2006 compared to $400,444 used during the six monthsended June 30, 2005.  The primary reason for the additional use of cash isrelated to increased debt investment originations of $310,304, offset by higherprincipal collections on our debt investments of $225,682.

Netcash provided by financing activities increased $122,189 to $483,790 for thesix months ended June 30, 2006 compared to $361,601 provided during the sameperiod in 2005.  This increase was due primarily to the issuance of $79,955of common stock during the six months ended June 30, 2006 versus only $60,333during the same period in 2005 and higher net proceeds from consolidatedmortgages payable of $94,525, offset by an increase in the dividend paid to ourcommon stockholders.

**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 the date of our formation,April 12, 2004, we had 500,000 shares of common stock outstanding valued atapproximately $200,000.  On August 2,2004 we completed our initial public offering of 12,500,000 shares of commonstock resulting in net proceeds of approximately $172.9 million, which was usedto fund investments and commence our operations.  As of June 30, 2006, 350,000 restrictedshares had also been issued under our 2004 Equity Incentive Plan, or the EquityIncentive Plan.  These shares have avesting period of three to four years and are not entitled to receivedistributions declared by us on our common stock until such time as the shareshave vested, or the shares have been designated to receive dividends by theCompensation Committee of our Board of Directors.

On December 3, 2004, we sold5,500,000 shares of common stock resulting in net proceeds of approximately$93.7 million under a private placement exemption from the registrationrequirements of Section 5 of the Securities Act of 1933, as amended.  A total of 4,225,000 shares were sold tovarious institutional investors and an additional 1,275,000 shares were sold toSL Green Operating Partnership, L.P. pursuant to its contractual right tochoose to maintain a 25% ownership interest in the outstanding shares of ourcommon stock.  Of the 5,500,000 sharessold, 2,000,000 shares were settled on December 31, 2004 and the remaining3,500,000 shares were settled on January 3, 2005.

On September 14, 2005, we sold3,833,333 shares of common stock, at a price of $25.80 per share, resulting innet proceeds of approximately $97.8 million. A total of 2,875,000 shares were sold through public offering and anadditional 958,333 shares were sold to SL Green Operating Partnership, L.P. pursuantto its contractual right to choose to maintain a 25% ownership interest in ouroutstanding shares of common stock.  Netproceeds were used for loan acquisitions and originations, repayment ofoutstanding principal under one of our repurchase facilities and generalcorporate purposes.

On May 16, 2006, we sold3,000,000 shares of common stock, at a price of $26.75 per share, resulting innet proceeds of approximately $80.0 million. A total of 2,250,000 shares were sold through public offering and an additional750,000 shares were sold to SL Green Operating Partnership, L.P. pursuant toits contractual right to choose to maintain a 25% ownership interest in ouroutstanding shares of common stock. After this offering, SL Green Operating Partnership, L.P. owned6,418,333 shares of our common stock. Net proceeds were used for loan acquisitions and originations, repaymentof outstanding principal under our repurchase facilities and general corporatepurposes.

In August 2005 our $350 millionshelf registration statement was declared effective by the Securities andExchange Commission, or

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SEC.  This registrationstatement provides us with the ability to issue common and preferred stock,depository shares and warrants.  We currently have $170.9 million availableunder the shelf.

As of June 30, 2006,25,817,642 shares of common stock and no shares of preferred stock were issuedand outstanding.

**Outperformance Plan (Amounts in thousands except pershare data)**

In June 2005, the compensation committee of our board of directorsapproved a long-term incentive compensation program, the 2005 OutperformancePlan.  Participants in the 2005Outperformance Plan, all of whom are co-leased employees, will share in a “performancepool” if our total return to stockholders for the period from June 1, 2005through May 31, 2008 exceeds a cumulative total return to stockholders of 30%during the measurement period over a base share price of $20.21 per share.  The size of the pool will be 10% of 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% and remainsat that level or higher for 30 consecutive days, then a minimum performancepool will be established.  In the eventthe potential performance pool reaches the maximum dilution cap before May 31,2008 and remains at that level or higher for 30 consecutive days, theperformance period will end early and the pool will be formed on the last dayof such 30 day period.  Each participant’saward under the 2005 Outperformance Plan is designated as a specified percentageof the aggregate performance pool to be allocated to such participant assumingthe 30% benchmark is achieved. Individual awards under the 2005 Outperformance Plan will be made in theform of partnership units, or LTIP Units, that may ultimately becomeexchangeable for shares of our common stock or cash, at our election.  Under the 2005 Outperformance Plan, LTIPUnits have been granted and additional LTIP Units may be granted in the futureprior to the determination of the performance pool; however, these LTIP Unitswill only vest upon satisfaction of performance and other thresholds, and willnot be entitled to distributions until after the performance pool, or minimumperformance pool, is established.  The2005 Outperformance Plan provides that if a pool is established, eachparticipant will also be entitled to the distributions that would have beenpaid on the number of LTIP Units earned, had they been issued at the beginningof the performance period.  Those distributionswill be paid in the form of additional LTIP Units.  Once a performance pool has been established,the earned LTIP Units will receive regular quarterly distributions on a perunit basis equal to the dividends per share paid on our common stock, whetheror not they are vested.  Any LTIP Unitsthat are not earned upon the establishment of the performance pool will beautomatically forfeited, and the LTIP Units that are earned will be subject totime-based vesting, with 50% of the LTIP Units earned vesting in May 2009 andthe balance vesting one year later based on continued employment with ourManager or SL Green.   We willrecord the expense of the restricted stock award in accordance with FASBStatement No. 123(R). Compensation expense of $293 and $586 was recorded forthe three and six months ended June 30, 2006, respectively, related to the 2005Outperformance Plan.

**Deferred Stock Compensation Plan for Directors**

Underour Independent Director’s Deferral Program, which commenced April 2005,our independent directors may elect to defer up to 100% of their annualretainer fee, chairman fees and meeting fees.  Unless otherwise elected bya participant, fees deferred under the program shall be credited in the form ofphantom stock units.  The phantom stock units are convertible into anequal number of shares of common stock upon such directors’ termination ofservice from the Board of Directors or a change in control by us, as defined bythe program.  Phantom stock units are credited to each independentdirector quarterly using the closing price of our 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 an equivalentamount of phantom stock units based on the dividend rate for each quarter orhave dividends paid in cash.

As ofJune 30, 2006 there were approximately 10,881 phantom stock units outstanding,of which 4,881 units are vested.

**MarketCapitalization**

At June 30, 2006,our CDO and borrowings under our repurchase facilities, unsecured revolvingcredit facility and mortgage loans (excluding our share of joint venture debtof $345.8 million) represented 66% of our consolidated market capitalization of$2.0 billion (based on a common stock price of $25.90 per share, the closingprice of our common stock on the New York Stock Exchange on June 30,2006).  Market capitalization includesour consolidated debt and common stock.

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**Indebtedness**

**The table below summarizes borrowingsunder our Wachovia and Goldman repurchase facilities and any consolidatedmortgage debt or term loans at June 30, 2006 and 2005, respectively (amounts inthousands).**

| Debt Summary:                           | ** ** | **June 30, 2006** | ** ** | **December 31,  2005** | ** ** |
|----------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| **Balance:**                                 | ** ** | ** **                  | ** ** | ** **                  | ** ** |
| Fixed rate                                   |       | $                           | 94,525     | (1)                         | $          | 41,000 |   |
| Variable rate                                |       | 393,170                     |       | 117,366                     |       |
| Total                                        |       | $                           | 487,695    |                        | $          | 158,366 |   |
|                                         |       |                        |       |                        |       |
| **Effective interest rate for the  period:** | ** ** | ** **                  | ** ** | ** **                  | ** ** |
| Fixed rate                                   |       | 5.75                        | %          | 4.90                        | %          |
| Variable rate                                |       | LIBOR+1.16                  | %          | LIBOR+1.59                  | %          |

 

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**(1) We have a 49.75% interest in the entity that isthe obligor under the mortgage note.**

**Repurchase Facilities**

We have tworepurchase facilities with an aggregate of $900 million of total debtcapacity.  In August 2004 we closed on a$250 million repurchase facility with Wachovia. This facility was then increased to $350 million on January 3, 2005 andsubsequently increased to $500 million on April 22, 2005.  As part of the April 2005 increase to $500million, the initial term of this facility was modified to reflect a staggeredterm in which $250 million matures in August 2007, $150 million matures inDecember 2007 and the remaining $100 million matures in June 2008.  On March 21, 2006 we further modified thefacility by reducing the interest spreads. As a result of the modifications, the $500,000 facility bears interestat spreads of 1.00% to 2.50% over a 30-day LIBOR and, based on our expectedinvestment activities, provides for advance rates that vary from 60% to 100%based upon the collateral provided under a borrowing base calculation.  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 additional collateralif the estimated market value of the included investments declines. We had noaccrued interest and borrowings of $350,942 at a weighted average spread toLIBOR of 1.15% and $67,717 at a weighted average spread to LIBOR of 1.50% underthis facility at June 30, 2006 and December 31, 2005, respectively.

On January 3,2005, we closed an additional repurchase facility of $200 million withGoldman.  This facility has an initialterm of three years expiring in January 2008 with one six-month extensionoption.  On March 21, 2006 we modifiedthis facility by reducing the interest spreads. As a result of the modifications, the facility bears interest at spreadsof 1.00% to 2.25% over a 30-day LIBOR and, based on our expected investmentactivities, provides for advance rates that vary from 40% to 85% based upon thecollateral provided under a borrowing base calculation.  On May 24, 2006, we increased the facility to$400,000 for a period of six months, with one three-month extension option.  As with the Wachovia repurchase facility, thelender has a consent right to the inclusion of investments in this facility,determines periodically the market value of the investments, and has the rightto require additional collateral if the estimated market value of the includedinvestments declines.  We had accruedinterest of $583 and borrowings of $42,228 at a weighted average spread toLIBOR of 1.25% and accrued interest of $163 and borrowings of $49,649 at aweighted average spread to LIBOR of 1.71% under this facility at June 30, 2006and December 31, 2005, respectively.

The repurchasefacilities require that we 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 us.

In certaincircumstances, we have purchased debt investments from a counterparty andsubsequently financed the acquisition of those debt investments throughrepurchase agreements with the same counterparty.  We currently record the acquisition of thedebt investments as assets and the related repurchase agreements as financingliabilities gross on the consolidated balance sheets. Interest income earned onthe debt investments and interest expense incurred on the repurchaseobligations are reported gross on the consolidated income statements.  However, under a certain technical interpretationof FAS 140, such transactions may not qualify as a purchase by us.  We believe, and it is industry practice, thatwe are accounting for these transactions in an appropriate manner.  However, the result of this technicalinterpretation would prevent us from presenting the debt investments andrepurchase agreements

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and the relatedinterest income and interest expense on a gross basis on our financialstatements.  Instead, we would presentthe net investment in these transactions with the counterparty and a derivativewith the corresponding change in fair value of the derivative being recordedthrough earnings.  The value of thederivative would reflect changes in the value of the underlying debtinvestments and changes in the value of the underlying credit provided by thecounterparty.

**Restrictive Covenants**

The terms of bothof our repurchase facilities include covenants that****(a) limit our maximum total indebtedness to no more than 85%of total assets, (b) require us to maintain minimum liquidity of at least$10,000 for the first two years and $15,000 thereafter, (c) requires our fixedcharge coverage ratio to be at no time less than 1.50 to 1.00, (d) requires ourminimum interest coverage ratio to be at no time less than 1.75 to 1.00, (e)require us to maintain minimum tangible net worth of not less than the greaterof (i) $129,750, or (i) plus (ii) 75% of the proceeds of our subsequent equityissuances and (f) restrict the maximum amount of our total indebtedness.  The covenants also restrict us from makingdistributions in excess of a maximum of 103% of our funds from operations (asdefined by the National Association of Real Estate Investment Trusts) throughJuly 2005 and 100% thereafter, except that we may in any case pay distributionsnecessary to maintain our REIT status.  Under our facility with Wachovia, an event ofdefault will be triggered if GKK Manager LLC ceases to be our Manager.  As of June 30, 2006 and December 31, 2005, wewere in compliance with all such covenants.

**Unsecured RevolvingCredit Facility**

In May 2006 weclosed on a $100,000 senior unsecured revolving credit facility with KeyBankwith an initial term of three years and a one-year extension option.  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.  The facility bears interest at 1.90% over30-day LIBOR to the extent our leverage ratio, defined as total liabilities tototal assets, including our proportionate share of the liabilities and assetsof our unconsolidated subsidiaries, is less than 80% and 2.10% over 30-dayLIBOR to the extent out leverage ratio is equal to or greater than 80%. We hadno outstanding borrowings against this facility as of June 30, 2006.

The terms of theunsecured revolving credit facility include covenants that****(a) limit our maximum total indebtednessto no more than 85% of total assets, (b) require our fixed charge coverageratio to be at no time less than 1.50, (c) require our minimum interestcoverage ratio to be at no time less than 1.70, (d) require us to maintainminimum tangible net worth of not less than $370,000 plus 75% of the netproceeds from equity offerings completed after the closing of the facility and(e) restrict the maximum amount of our total indebtedness.  The covenants also restrict us from makingdistributions in excess of a maximum of 100% of our funds from operations (asdefined by the National Association of Real Estate Investment Trusts), exceptthat we may in any case pay distributions necessary to maintain our REITstatus.  As of June 30, 2006, we were in compliance with all such covenants.

In conjunctionwith the closing of the unsecured revolving credit facility with KeyBank, our$25,000 revolving credit facility with Wachovia was terminated.

#### **Mortgage Loan**

We have oneconsolidated interest-only mortgage loan in an amount equal to our ownershippercentage in the entity multiplied by the outstanding principal balance of themortgage loan, which loan financed the acquisition of 55 Corporate Drive inJune 2006.  The mortgage has an outstandingprincipal balance of $190,000, of which we have consolidated 49.75% or $94,525,with an effective interest rate of 5.75% and a term of ten years.

#### **CollateralizedDebt Obligations**

#### On July 14, 2005, we issued approximately $1.0 billion ofcollateralized debt obligations through two newly-formed indirect subsidiaries,Gramercy Real Estate CDO 2005-1 Ltd., or the Issuer, and Gramercy RealEstate CDO 2005-1 LLC, or the Co-Issuer. The CDO consists of $810.5 million ofinvestment grade notes, and $84.5 million of non-investment grade notes, whichwere co-issued by the Issuer and the Co-Issuer, and $105.0 million of preferredshares, which were issued by the Issuer. We retained all non-investment grade securities, the preferred sharesand the common shares in the Issuer.  TheIssuer holds assets, consisting primarily of whole loans, subordinate interestsin whole loans, mezzanine loans and preferred equity investments, which serveas collateral for the CDO. The investment grade notes were issued with floatingrate coupons with a combined weighted average rate of three-month LIBOR plus0.49%. The CDO may be replenished, pursuant to certain rating agency guidelinesrelating to credit quality and diversification, with substitute collateral forloans that are repaid during the first five years of the CDO. Thereafter, theCDO securities will be retired in sequential order from senior-most tojunior-most as loans are repaid. We incurred approximately $12.0 million ofcosts related to the CDO, which are amortized on a level-yield basis over theaverage life of the CDO. The Issuer is consolidated in our financialstatements. The investment grade notes are treated as a secured financing, andare non-recourse to us.  Proceeds fromthe sale of the investment grade notes issued were used to repay substantially

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#### all outstanding debt under our repurchase agreements and fundadditional investments.

**Junior Subordinated Debentures**

**On January 27, 2006, we completeda third issuance of $50,000 in unsecured trust preferred securities through aseparate newly formed DST, Gramercy Capital Trust III, or GCTIII, that is awholly-owned subsidiary of the Operating Partnership.  The securities bear interest at a fixed rateof 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.**

**In May and August 2005, wecompleted issuances of $50,000 each in unsecured trust preferred securitiesthrough two DST’s, Gramercy Capital Trust I, or GCTI, and Gramercy CapitalTrust II, or GCTII, that are also wholly-owned subsidiaries of the OperatingPartnership.  The securities issued inMay 2005 bear interest at a fixed rate of 7.57% for the first ten years endingJune 2015 and the securities issued in August 2005 bear interest at a fixedrate of 7.75% for the first ten years ending October 2015.  Thereafter the rates will float based on thethree-month LIBOR plus 300 basis points.**

**All issuances of trust preferredsecurities require quarterly interest distributions; however, payments may bedeferred while the interest expense is accrued for a period of up to fourconsecutive quarters if the Operating Partnership exercises its right to defersuch payments.  The trust preferredsecurities are redeemable, at the option of the Operating Partnership, in wholeor in part, with no prepayment premium any time after June 30, 2010, October30, 2010 or January 30, 2011 for the securities issued by GCTI, GCTII andGCTIII, respectively.**

**GCTI, GCTII and GCTIII eachissued $1,550 aggregate liquidation amount of common securities, representing100% of the voting common stock of those entities to the Operating Partnershipfor a total purchase price of $4,650. GCTI, GCTII and GCTIII used the proceeds from the sale of the trustpreferred securities and the common securities to purchase the OperatingPartnership’s junior subordinated notes. The terms of the junior subordinated notes match the terms of the trustpreferred securities.  The notes aresubordinate and junior in right of payment to all present and future seniorindebtedness and certain other of our financial obligations.  We realized net proceeds from each offering ofapproximately $48,956.**

Our interests in GCTI, GCTII and GCTIII areaccounted for using the equity method and the assets and liabilities of thoseentities are not consolidated into our financial statements.  Interest on the junior subordinated notes isincluded in interest expense on our consolidated income statements while thevalue of the junior subordinated notes, net of our investment in the truststhat issued the securities, are presented as a separate item in ourconsolidated balance sheet.

**ContractualObligations**

Combined aggregate principal maturities of our CDO, repurchasefacilities, trust preferred securities, revolving credit facility and ourobligations under our management agreement, outsourcing agreement, CDOcollateral management agreement and operating lease as of June 30, 2006 are asfollows (amounts in thousands):
| ** ** | ** ** | **CDO** | ** ** | **Repurchase  Facilities** | ** ** | **Trust  Preferred  Securities** | ** ** | **Mortgage  Note  Payable(2)** | ** ** | **Revolving  Credit  Facility** | ** ** | **Outsourcing  and  Management  Agreements (1)** | ** ** | **CDO  Collateral  Management  Agreement** | ** ** | **Operating  Lease** | ** ** | **Total** | ** ** |
|------------|------------|---------|------------|----------------------------|------------|----------------------------------|------------|--------------------------------|------------|---------------------------------|------------|-------------------------------------------------------|------------|--------------------------------------------|------------|----------------------|------------|-----------|------------|
| 2006       |       | $       | —     |                       | $          | —                           |       | $                              | —     |                            | $          | —                                                |       | $                                          | —     |                 | $          | 6,066     |       | $ | 1,013 |   | $ | 127 |   | $ | 7,206 |   |
| 2007       |       | —  |       | 350,942                    |       | —                           |       | —                         |       | —                          |       | 12,067                                                |       | 2,026                                      |       | 256                  |       | 365,291   |       |
| 2008       |       | —  |       | 42,228                     |       | —                           |       | —                         |       | —                          |       | 12,107                                                |       | 2,026                                      |       | 261                  |       | 56,622    |       |
| 2009       |       | —  |       | —                     |       | —                           |       | —                         |       | —                          |       | 12,149                                                |       | 2,026                                      |       | 265                  |       | 14,440    |       |
| 2010       |       | —  |       | —                     |       | —                           |       | —                         |       | —                          |       | —                                                |       | 1,092                                      |       | 283                  |       | 1,375     |       |
| Thereafter |       | 810,500 |       | —                     |       | 150,000                          |       | 94,525                         |       | —                          |       | —                                                |       | —                                     |       | 1,351                |       | 1,056,376 |       |
| Total      |       | $       | 810,500    |                       | $          | 393,170                          |       | $                              | 150,000    |                            | $          | 94,525                                                |       | —                                     |       | $                    | 42,389     |      | $          | 8,183 |   | $ | 2,543 |   | $ | 1,501,310 |   |
|            |            |         |            |                            |            |                                  |            |                                |            |                                 |            |                                                       |            |                                            |            |                      |            |           |            |  |  |  |  |  |  |  |  |  |

 

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(1)       Managementfee is calculated as 1.75% of our gross stockholders equity (as defined in theamended and restated management agreement) on June 30, 2006, inclusive of thetrust preferred securities issued on May 20, 2005, August 9, 2005 and January27, 2006.

(2)       We have a 49.75% interestin the entity that holds the mortgage.

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**Off-Balance-SheetArrangements**

We have severaloff-balance-sheet investments, including joint ventures and structured financeinvestments.  These investments all have varying ownershipstructures.  Substantially all of our joint venture arrangements are accountedfor under the equity method of accounting as we have the ability to exercisesignificant influence, but not control over the operating and financialdecisions of these joint venture arrangements.  Our off-balance-sheetarrangements are discussed in Note 4, “Investments in Unconsolidated JointVentures” in the accompanying financial statements.

**Dividends**

To maintain our qualification as a REIT, we must pay annual dividendsto our stockholders 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.

**Related Party Transactions (Amountsin thousands)**

In connection with our initial public offering, we entered into amanagement agreement with our Manager, which was subsequently amended andrestated in April 2006.  The amended andrestated agreement provides for a term through December 2009 with automaticone-year extension options and is subject to certain termination rights.  We pay our Manager an annual management feeequal to 1.75% of our gross stockholders equity (as defined in the amended andrestated management agreement) inclusive of our trust preferredsecurities.  We incurred expense to ourManager under this agreement of an aggregate of approximately $2,501 and $4,739for the three and six months ended June 30, 2006, respectively, and approximately$1,326 and $2,530 for the three and six months ended June 30, 2005,respectively.

To provide an incentivefor our Manager to enhance the value of the common stock, the holders of theClass B limited partner interests of the Operating Partnership are entitled toan incentive return equal to 25% of the amount by which funds from operations(as defined in the partnership agreement of the Operating Partnership which wasamended and restated in April 2006) plus certain accounting gains exceed theproduct of our weighted average stockholders equity (as defined in the amendedand restated partnership agreement of the Operating Partnership) multiplied by9.5% (divided by 4 to adjust for quarterly calculations).  We will record any distributions on the ClassB limited partner interests as an incentive distribution expense in the periodwhen earned and when payments of such amounts have become probable andreasonably estimable in accordance with the partnership agreement.  We incurred approximately $1,578 and $2,771with respect to such Class B limited partner interests for the three and sixmonths ended June 30, 2006, respectively and none for the three and six monthsended June 30, 2005.

We are obligatedto reimburse our Manager for its costs incurred under an asset servicingagreement between our Manager and an affiliate of SL Green OperatingPartnership, L.P. and a separate outsourcing agreement between our Manager andSL Green Operating Partnership, L.P.  Theasset servicing agreement, which was amended and restated in April 2006,provides for an annual fee payable to SL Green Operating Partnership, L.P. byus of 0.05% of the book value of all credit tenant lease assets andnon-investment grade bonds and 0.15% of the book value of all other assets.  The asset servicing fee may be reduced by SLGreen Operating Partnership, L.P. for fees paid directly to outside servicersby us.  The outsourcing agreementcurrently provides for a fee payable by us of $1,288 per year, increasing 3%annually over the prior year on the anniversary date of the outsourcingagreement in August of each year.  Forthe three months ended June 30, 2006 and 2005, we realized expense of $322 and$312, respectively, and for the six months ended June 30, 2006 and 2005, werealized expense of $645 and $625, respectively, to our Manager under theoutsourcing agreement.  For the threemonths ended June 30, 2006 and 2005, we realized expense of $539 and $232,respectively, and for the six months ended June 30, 2006 and 2005, we realizedexpense of $1,000 and $383, respectively, to our Manager under the assetservicing agreement.

In connection with the closing of our CDO in July2005, the Issuer entered into a collateral management agreement with ourManager. Pursuant to the collateral management agreement, our 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 an additionalsubordinate collateral management fee, payable quarterly in accordance with thepriority of payments as set forth in the indenture, equal to 0.25% per annum ofthe net outstanding portfolio balance. Net outstanding portfolio balance is the sum of the (i) aggregateprincipal balance of the collateral debt securities, excluding defaultedsecurities, (ii) aggregate principal balance of all principal proceeds held ascash and eligible investments in certain accounts, and (iii) with respect tothe defaulted securities, the calculation amount of such defaulted securities.

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As compensationfor the performance of its obligations as collateral manager, our Board ofDirectors has allocated to our Manager the subordinate collateral managementfee paid on securities not held by us.  The senior collateral management fee andbalance of the subordinate collateral management fee is allocated to us.  For the three and six months ended June 30,2006 we realized expense of $499 and $1,000, respectively, to our Manager underthe collateral management agreement.

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

In connection withthe 5,500,000 shares of common stock that were sold on December 3, 2004 andsettled on December 31, 2004 and January 3, 2005 in a private placement, weagreed to pay our Manager a fee of $1,000 as compensation for financialadvisory, structuring and costs incurred on our behalf.   This fee was recorded as a reduction in theproceeds of the private placement.  Apartfrom legal fees and stock clearing charges totaling $245, no other fees werepaid by us to an investment bank, broker/dealer or other financial advisor inconnection with the private placement, resulting in total costs of 1.3% oftotal gross proceeds.

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

**On June 7, 2006 we closed on theacquisition of a 49.75% interest, which is held as a tenancy-in-common, or TIC,interest, in 55 Corporate Drive, located in Bridgewater, New Jersey with a .25%interest to be acquired in the future. The remaining 50% of the property is owned as a TIC interest by SL GreenRealty Corp.** The property is comprisedof three buildings totaling approximately six hundred and seventy thousandsquare feet which is 100% net leased to an entity whose obligations areguaranteed by Sanofi-Aventis Group through April 2023. The transaction wasvalued at $236,000 and was financed with a $190,000, 10-year, fixed-rate firstmortgage loan.

Commencing May 1, 2005 we are party to a lease agreementwith SLG Graybar Sublease LLC, an affiliate of SL Green, for our corporateoffices at 420 Lexington Avenue, New York, New York.  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.  For thethree and six months ended June 30, 2006 we paid $63 and $125 under this lease.

**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 and sixmonths ended June 30, 2006 was $2 and $3, respectively, and less than $1 forthe three and six months ended June 30, 2005.**

**SL GreenOperating Partnership, L.P. is an equity holder in the joint venture that isthe borrower on an investment with a book value of $7,190 and $29,026 ,respectively, as of June 30, 2006 and December 31, 2005, respectively.**

**On July14, 2005, we closed on the purchase from an SL Green affiliate of a $40,000mezzanine loan which bears interest at 11.20%. As part of that sale, the seller retained an interest-onlyparticipation.  We have determined thatthe yield on our mezzanine loan after giving effect to the interest-onlyparticipation retained by the seller is at market.  The mezzanine loan is secured by the equityinterests in an office property in New York, New York.**

**On February 27, 2006, we closedon the purchase of a $90,000 whole loan, which bears interest at 30-day LIBORplus 2.15%, to a joint venture in which SL Green is an equity holder.  The loan is secured by 55 Corporate Drive inBridgewater, New Jersey.  The loan wasrepaid in full in June 2006 with the proceeds from new mortgage financingobtained in connection with the sale of the property, 49.75% of which is nowowned by us through a TIC structure.**

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**On March17, 2006, we closed on the purchase of a $25,000 mezzanine loan, which bearsinterest at 30-day LIBOR plus 8.00%, to a joint venture in which SL Green is anequity holder.  The loan was secured byoffice and industrial properties in northern New Jersey.  The loan was repaid in full in May 2006.**

**On May 9,2006 we originated a $90,287 whole loan, which bears interest at 30-day LIBORplus 2.75%, to a joint venture in which SL Green is an equity holder.  The loan is secured by office and industrialproperties in northern New Jersey and has a book value of $89,884 as of June30, 2006.**

**On August1, 2006 we acquired from a financial institution a 50% pari passu interest in a$65,000 preferred equity investment secured by an office property in New York,New York.  An affiliate of SL Greensimultaneously acquired and owns the other 50% pari passu interest.  The investment bears interest at a blendedfixed rate of 10.52%.**

**Duringthe six months ended June 30, 2006, we earned fees of $162,500 from SL Greenrepresenting SL Green’s proportionate share of fees for financing andstructural advisory services related to a specific potential transaction.**

**Funds from Operations**

FFO is a widelyrecognized measure of REIT performance. We compute FFO based on standards established by the NationalAssociation of Real Estate Investment Trusts, or NAREIT, which may not becomparable to FFO reported by other REITs that do not compute FFO in accordancewith the NAREIT definition, or that interpret the NAREIT definition differentlythan we do.  The revised White Paper onFFO approved by the Board of Governors of NAREIT in April 2002 defines FFO asnet income (loss) (computed in accordance with GAAP), excluding gains (orlosses) from debt restructuring and sales of properties, plus real estate-related depreciation and amortization and after adjustments for unconsolidatedpartnerships and joint ventures.  Weconsider gains and losses on the sales of debt investments and real estateinvestments structured as tenancy-in-common investments to be a normal part ofour recurring operations and therefore do not exclude such gains and losseswhen arriving at FFO.  We present FFO because weconsider it an important supplemental measure of our operating performance andbelieve that it is frequently used by securities analysts, investors and otherinterested parties in the evaluation of REITS. We also use FFO as one of several criteria to determineperformance-based bonuses for members of our senior management.  FFO is intended to exclude GAAP historicalcost depreciation and amortization of real estate and related assets, whichassumes that the value of real estate assets diminishes ratably over time.  Historically, however, real estate valueshave risen or fallen with market conditions. Because FFO excludes depreciation and amortization unique to realestate, gains and losses from property dispositions and extraordinary items, itprovides a performance measure that, when compared year over year, reflects theimpact to operations from trends in occupancy rates, rental rates, operatingcosts, interest costs, providing perspective not immediately apparent from netincome.  FFO does not represent cashgenerated from operating activities in accordance with GAAP and should not beconsidered as an alternative to net income (determined in accordance withGAAP), as an indication of our financial performance or to cash flow fromoperating activities (determined in accordance with GAAP) as a measure of ourliquidity, nor is it indicative of funds available to fund our cash needs,including our ability to make cash distributions.

Fundsfrom Operations for the three and six months ended June 30, 2006 and 2005 areas follows (amounts in thousands):

|                                                  | ** ** | **For the Three  Months Ended  June 30, 2006** | ** ** | **For the Three  Months Ended  June 30, 2005** | ** ** | **For the Six  Months Ended  June 30, 2006** | ** ** | **For the Six  Months Ended  June 30, 2005** | ** ** |
|--------------------------------------------------|------------|-------------------------------------------------------------------------|------------|-------------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| Net income  available to common stockholders     |       | $                                                                       | 12,817     |                                                                    | $          | 7,457                                                                 |       | $                                                                     | 23,370     |   | $ | 12,022 |   |
| Add:                                             |       |                                                                    |       |                                                                    |       |                                                                  |       |                                                                  |       |
| Depreciation and amortization                    |       | 1,322                                                                   |       | 537                                                                     |       | 2,744                                                                 |       | 956                                                                   |       |
| FFO adjustment for unconsolidated joint ventures |       | 1,978                                                                   |       | 1,199                                                                   |       | 3,857                                                                 |       | 1,199                                                                 |       |
| Less:                                            |       |                                                                    |       |                                                                    |       |                                                                  |       |                                                                  |       |
| Non real estate depreciation and amortization    |       | (1,322                                                                  | )          | (537                                                                    | )          | (2,505                                                                | )          | (956                                                                  | )          |
| Funds from  operations                           |       | $                                                                       | 14,795     |                                                                    | $          | 8,656                                                                 |       | $                                                                     | 27,466     |   | $ | 13,221 |   |
|                                             | ** ** | ** **                                                              | ** ** | ** **                                                              | ** ** | ** **                                                            | ** ** | ** **                                                            | ** ** |
| Funds from  operations per share - basic         |       | $                                                                       | 0.61       |                                                                    | $          | 0.46                                                                  |       | $                                                                     | 1.17       |   | $ | 0.70 |   |
| Funds from operations  per share - diluted       |       | $                                                                       | 0.58       |                                                                    | $          | 0.45                                                                  |       | $                                                                     | 1.11       |   | $ | 0.69 |   |

 

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**CautionaryNote Regarding Forward-Looking Information**

Thisreport contains “forward-looking statements” within the meaning of Section 27Aof the Securities Act of 1933, as amended, or the Act, and Section 21E of theSecurities 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,”“anticipate,” “estimate,” “believe,” “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:

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

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

·                  the performanceand financial condition of borrowers and corporate customers;

·                  the actions ofour competitors and our ability to respond to those actions;

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

·                  availability ofqualified personnel;

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

·                  the adequacy ofour cash reserves and working capital;

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

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

·                  risks ofstructured finance investments;

·                  GKK Manager LLCremaining as our Manager;

·                  environmentaland/or safety requirements;

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

·                  competition withother companies;

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

·                  changes in governmentalregulations, tax rates and similar matters; and

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

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

The risks included here are not exhaustive.  Other sections of this report may includeadditional factors that could adversely affect our business and financialperformance.  Moreover, we operate in avery competitive and rapidly changing environment.  New risk factors emerge from time to time andit is not possible for management to predict all such risk factors, nor can itassess the impact of all such risk factors on our business or the extent towhich any factor, or combination of factors, may cause actual results to differmaterially from those contained in any forward-looking statements.  Given these risks and uncertainties,investors should not place undue reliance on forward-looking statements as aprediction of actual results.

**RecentlyIssued Accounting Pronouncements**

**Statement of Financial Accounting Standard No.123(R), or SFAS No. 123(R) “Share-Based Payment, a revision of FASB StatementNo. 123, Accounting for Stock-Based Compensation,” requires all share-basedpayments to employees, including grants of employee stock options, to berecognized in the income statement based on their fair value.  The newstandard is effective for interim or annual reporting periods beginning afterJanuary 1, 2006.  The implementation ofSFAS No. 123(R) did not have a material effect on our financial position orresults of operations for the three months ended June 30, 2006.**

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**In March2005, the FASB issued FASB Interpretation No. 47, or FIN 47, “Accounting forConditional Asset Retirement Obligations” an interpretation of FASB StatementNo. 143, or SFAS 143. FIN 47 clarifies the term***conditionalasset retirement obligation* in SFAS 143 as a legal obligation to perform anasset retirement activity in which the timing and/or method of settlement areconditional on a future event that may or may not be within the control of theentity.  FIN 47 clarifies that future expenses to removeasbestos from buildings should be estimated and accrued as a liability at thetime of acquisition with an offset to increase the cost of the associatedstructure.  Uncertainty about thetiming and/or method of settlement of a conditional asset retirement obligationshould be factored into the measurement of a liability when sufficientinformation exists. SFAS No. 143 acknowledges that in some cases, sufficientinformation may not be available to reasonably estimate the fair value of anasset retirement obligation.  FIN 47 also clarifies when an entity wouldhave sufficient information to reasonably estimate the fair value of an assetretirement obligation.  FIN 47 is effective for the year ended December31, 2005 and did not have a material effect on our financial position or resultsof operations for the three and six months ended June 30, 2006.

**In June 2005, the FASB ratifiedthe consensus in EITF Issue No. 04-5, or Issue 04-5, Determining Whether aGeneral Partner, or the General Partners as a Group, Controls a LimitedPartnership or Similar Entity When the Limited Partners Have Certain Rights,which provides guidance in determining whether a general partner controls alimited partnership.  Issue 04-5 states that the general partner in alimited partnership is presumed to control that limited partnership.  Thepresumption may be overcome if the limited partners have either (1) thesubstantive ability to dissolve the limited partnership or otherwise remove thegeneral partner without cause or (2) substantive participating rights, which providethe limited partners with the ability to effectively participate in significantdecisions that would be expected to be made in the ordinary course of thelimited partnership’s business and thereby preclude the general partner fromexercising unilateral control over the partnership.  If the criteria inIssue 04-5 are met, a company could be required to consolidate certain of itsexisting unconsolidated joint ventures.  Our adoption of Issue 04-5 fornew or modified limited partnership arrangements effective June 30, 2005 andexisting limited partnership arrangements effective January 1, 2006 did nothave a material effect on our financial position or results of operations forthe three and six months ended June 30, 2006.**

In February 2006, the FASB issued Statement ofFinancial Accounting Standard No. 155, or SFAS No. 155, “Accounting for CertainHybrid Financial Instruments – an amendment of FASB Statements No. 133 and 140”.SFAS No. 155 (1) permits fair value re-measurement for any hybrid financial instrumentthat contains an embedded derivative that would otherwise require bifurcation,(2) clarifies which interest-only strips and principal-only strips are notsubject to the requirements of FASB Statement No. 133, (3) establishes arequirement to evaluate interests in securitized financial assets to identifyinterests that are freestanding derivatives or that are hybrid financialinstruments that contain an imbedded derivative requiring bifurcation, (4)clarifies that concentrations of credit risk in the form of subordination arenot embedded derivatives, and (5) amends FASB Statement No. 140 to eliminatethe prohibition on a qualifying special-purpose entity from holding aderivative financial instrument that pertains to a beneficial interest in otherthan another derivative financial instrument. SFAS No. 155 is effective January1, 2007 and we are currently evaluating the effect, if any, that thispronouncement will have on our future financial results.

In July 2006, the FASB issued Interpretation No. 48,or FIN 48, “Accounting for Uncertainty in Income Taxes”. This interpretation,among other things, creates a two-step approach for evaluating uncertain taxpositions. Recognition (step one) occurs when an enterprise concludes that atax position, based solely on its technical merits, is more-likely-than-not tobe sustained upon examination. Measurement (step two) determines the amount ofbenefit that more-likely-than-not will be realized upon settlement.Derecognition of a tax position that was previously recognized would occur whena company subsequently determines that a tax position no longer meets themore-likely-than-not threshold of being sustained. FIN 48 specificallyprohibits the use of a valuation allowance as a substitute for derecognition oftax positions, and it has expanded disclosure requirements.  FIN 48 is effective for fiscal yearsbeginning after December 15, 2006, in which the impact of adoption should beaccounted for as a cumulative-effect adjustment to the beginning balance ofretained earnings. We are currently evaluating the effect, if any, that thispronouncement will have on our future financial results.

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

##### **Market Risk**

Market riskincludes risks that arise from changes in interest rates, commodity prices,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 and interest rate risks.

#### **Real Estate Risk**

Commercial andmulti-family property values and net operating income derived from suchproperties are subject to volatility and may be affected adversely by a numberof factors, including, but not limited to, national, regional and localeconomic conditions which may be adversely affected by industry slowdowns andother factors), local real estate conditions (such as an oversupply of retail,industrial, office or other commercial or multi-family space), changes orcontinued weakness in specific industry segments, construction quality, age anddesign, demographic factors, retroactive changes to building or similar codes,and increases in operating expenses (such as energy costs).  In the event 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 thetime a 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 riskis highly sensitive to many factors, including governmental monetary and taxpolicies, domestic and international economic and political considerations andother factors beyond our control.

Our operatingresults will depend in large part on differences between the income from ourassets and our borrowing costs.  Most ofour assets and borrowings are variable-rate instruments that we finance withvariable rate debt.  The objective ofthis strategy is to minimize the impact of interest rate changes on the spreadbetween the yield on our assets and our cost of funds.  We enter into hedging transactions withrespect to all liabilities relating to fixed rate assets.  If we were to finance fixed rate assets withvariable rate debt and the benchmark for our variable rate debt increased, ournet income would decrease.  Furthermore,as most of our available financing provides for an ability of the lender tomark-to-market our assets and make margin calls based on a change in the valueof our assets, financing fixed rate assets with this debt creates the risk thatan increase in fixed rate benchmarks (such as “swap” yields) would decrease thevalue of our fixed rate assets.  We haveentered into certain swap transactions in anticipation of drawing upon ourmark-to-market debt to hedge against this risk. Some of our 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 borrowing andhedging activities, our net income will generally increase if LIBOR increasesand decreases if LIBOR decreases, but this may not always be true in thefuture.  Our exposure to interest rateswill also be affected by our overall corporate leverage, which we generallytarget to be 70% to 80% of the carrying value of our assets, although ouractual 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 credit 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.

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**The aggregate carrying values, allocated by producttype and weighted average coupons of our loans and other lending investments asof June 30, 2006 and December 31, 2005 were as follows:**

|                                                      | ** ** | **Carrying Value (1)  ($ in thousands)** | ** ** | **Allocation by  Investment Type** | ** ** | **Fixed Rate:  Average Yield** | ** ** | **Floating Rate:  Average Spread over  LIBOR (2)** | ** ** |
|------------------------------------------------------|------------|--------------------------------------------------------------|------------|----------------------------------------------|------------|------------------------------------------|------------|------------------------------------------------------------------------|------------|
| ** **                                           | ** ** | **2006**                                                     | ** ** | **2005**                                     | ** ** | **2006**                                 | ** ** | **2005**                                                               | ** ** | **2006** | ** ** | **2005** | ** ** | **2006** | ** ** | **2005** | ** ** |
| Whole loans,  floating rate                          |       | $                                                            | 938,416    |                                         | $          | 561,388                                  |       | 57                                                                     | %          | 46 | % | — |   | — |   | 303bps |   | 325 bps |   |
| Whole loans,  fixed rate                             |       | 115,347                                                      |       | 94,448                                       |       | 7                                        | %          | 8                                                                      | %          | 9.64 | % | 10.64 | % | — |   | — |   |
| Subordinate  interests in whole loans, floating rate |       | 404,789                                                      |       | 362,983                                      |       | 24                                       | %          | 30                                                                     | %          | — |   | — |   | 425bps |   | 443 bps |   |
| Subordinate  interests in whole loans, fixed rate    |       | 48,206                                                       |       | 37,104                                       |       | 3                                        | %          | 3                                                                      | %          | 9.56 | % | 9.19 | % | — |   | — |   |
| Mezzanine loans,  floating rate                      |       | 81,766                                                       |       | 82,793                                       |       | 5                                        | %          | 7                                                                      | %          | — |   | — |   | 724bps |   | 858 bps |   |
| Mezzanine loans,  fixed rate                         |       | 43,291                                                       |       | 43,352                                       |       | 2                                        | %          | 4                                                                      | %          | 8.88 | % | 8.88 | % | — |   | — |   |
| Preferred equity,  floating rate                     |       | 11,850                                                       |       | 11,795                                       |       | 1                                        | %          | 1                                                                      | %          | — |   | — |   | 900bps |   | 900 bps |   |
| Preferred equity,  fixed rate                        |       | 11,901                                                       |       | 11,882                                       |       | 1                                        | %          | 1                                                                      | %          | 10.28 | % | 10.28 | % | — |   | — |   |
| Total / Average                                      |       | $                                                            | 1,655,566  |                                         | $          | 1,205,745                                |       | 100                                                                    | %          | 100 | % | 9.51 | % | 9.92 | % | 366bps |   | 417 bps |   |

** **

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

**(2)   Spreads over an index other than LIBOR have been adjusted to aLIBOR based equivalent.**

As of June 30,2006, our investment portfolio had the following maturity characteristics:
| Year of Maturity     | ** ** | **Number of  Investments  Maturing** | ** ** | **Current  Carrying Value** | ** ** | **% of Total** | ** ** |
|--------------------------------|------------|-------------------------------------------|------------|----------------------------------|------------|--------------------------|------------|
| ** **                     | ** ** | ** **                                | ** ** | **(In thousands)**          | ** ** | ** **               | ** ** |
| 2006                           |       | 8                                         |       | $                                | 223,548    |                     | 13         | % |
| 2007                           |       | 28                                        |       | 627,645                          |       | 38                       | %          |
| 2008                           |       | 13                                        |       | 491,625                          |       | 30                       | %          |
| 2009                           |       | 8                                         |       | 134,945                          |       | 8                        | %          |
| 2010                           |       | 2                                         |       | 6,612                            |       | 1                        | %          |
| 2011                           |       | 2                                         |       | 56,901                           |       | 3                        | %          |
| Thereafter                     |       | 5                                         |       | 114,290                          |       | 7                        | %          |
| Total                          |       | 66                                        |       | $                                | 1,655,566  |                     | 100        | % |
|                           |       |                                      |       |                             |       |                     |       |
| Weighted average  maturity (1) |       |                                      |       | 2.1 years                        |       |                     |       |

 

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

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Combined aggregateprincipal maturities of our consolidated CDO, repurchase facilities, trustpreferred securities, mortgage note payable and revolving credit facility as ofJune 30, 2006 are as follows:

|            | ** ** | **Collateralized  Debt  Obligations** | ** ** | **Repurchase  Facilities** | ** ** | **Trust  Preferred  Securities** | ** ** | **Mortgage  Note  Payable** | ** ** | **Unsecured  Revolving  Credit  Facility** | ** ** | **Total** | ** ** |
|------------|------------|---------------------------------------|------------|----------------------------|------------|----------------------------------|------------|-----------------------------|------------|--------------------------------------------|------------|-----------|------------|
| 2006       |       | $                                     | —     |                       | $          | —                           |       | $                           | —     |                                       | $          | —    |       | $ | — |   | $ | — |   |
| 2007       |       | —                                |       | 350,942                    |       | —                           |       | —                      |       | —                                     |       | 350,942   |       |
| 2008       |       | —                                |       | 42,228                     |       | —                           |       | —                      |       | —                                     |       | 42,228    |       |
| 2009       |       | —                                |       | —                     |       | —                           |       | —                      |       | —                                     |       | —    |       |
| 2010       |       | —                                |       | —                     |       | —                           |       | —                      |       | —                                     |       | —    |       |
| 2011       |       | —                                |       | —                     |       | —                           |       | —                      |       | —                                     |       | —    |       |
| Thereafter |       | 810,500                               |       | —                     |       | 150,000                          |       | 94,525                      | (1)        | —                                     |       | 1,055,025 |       |
| Total      |       | $                                     | 810,500    |                       | $          | 393,170                          |       | $                           | 150,000    |                                       | $          | 94,525    |       | — |   | $ | 1,448,195 |   |
|            |            |                                       |            |                            |            |                                  |            |                             |            |                                            |            |           |            |  |  |  |  |  |  |

 

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(1) Wehave a 49.75% interest in the entity that is the obligor under the mortgagenote.

The following table summarizes the notional and fairvalue of our derivative financial instrument at June 30, 2006.  The notional value is an indication of theextent of our involvement in this instrument at that time, but does notrepresent exposure to credit, interest rate or market risks:

|                     | ** ** | **Benchmark Rate** | ** ** | **Notional  Value** | ** ** | **Strike  Rate** | ** ** | **Effective  Date** | ** ** | **Expiration  Date** | ** ** | **Fair  Value** | ** ** |
|---------------------|------------|-------------------------|------------|---------------------|------------|------------------|------------|---------------------|------------|----------------------|------------|-----------------|------------|
| Interest Rate  Swap |       | 1 month LIBOR           |       | $                   | 61,603     |             | 4.760      | %                   | 1/2006     |                 | 3/2015     |            | 3,147      |   |
| Interest Rate  Swap |       | 3 month LIBOR           |       | 40,000              |       | 4.420            | %          | 7/2005              |       | 2/2014               |       | $               | 2,643      |   |
| Interest Rate  Swap |       | 1 month LIBOR           |       | 31,686              |       | 3.855            | %          | 7/2005              |       | 11/2009              |       | 1,576           |       |
| Interest Rate Cap   |       | 3 month LIBOR           |       | 23,713              |       | 5.700            | %          | 11/2005             |       | 12/2007              |       | 36              |       |
| Interest Rate Cap   |       | 1 month LIBOR           |       | 20,000              |       | 6.000            | %          | 4/2006              |       | 4/2007               |       | 3               |       |
| Interest Rate Cap   |       | 1 month LIBOR           |       | 14,120              |       | 5.500            | %          | 12/2005             |       | 1/2007               |       | 6               |       |
| Interest Rate  Swap |       | 1 month LIBOR           |       | 6,402               |       | 4.760            | %          | 1/2006              |       | 3/2015               |       | 327             |       |
| Interest Rate  Swap |       | 1 month LIBOR           |       | 3,960               |       | 4.959            | %          | 12/2005             |       | 12/2015              |       | 177             |       |
| Interest Rate  Swap |       | 1 month LIBOR           |       | 3,465               |       | 4.280            | %          | 7/2005              |       | 12/2009              |       | 128             |       |
| Interest Rate  Swap |       | 3 month LIBOR           |       | 3,465               |       | 5.178            | %          | 4/2006              |       | 3/2010               |       | 35              |       |
| Total               |       |                    |       | $                   | 208,414    |             |       |                |       |                 |       |            | $          | 8,078 |   |

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**ITEM 4. Controls and Procedures**

**Evaluation of Disclosure Controls and Procedures**

Wemaintain disclosure controls and procedures that are designed to ensure thatinformation required to be disclosed in our Exchange Act reports is recorded,processed, summarized and reported within the time periods specified in the SEC’srules and forms, and that such information is accumulated and communicated toour management, including our Chief Executive Officer and Chief FinancialOfficer, as appropriate, to allow timely decisions regarding requireddisclosure based closely on the definition of “disclosure controls and procedures”in Rule 13a-15(e).  Notwithstanding theforegoing, a control system, no matter how well designed and operated, canprovide only reasonable, not absolute, assurance that it will detect or uncoverfailures within the Company to disclose material information otherwise requiredto be set forth in the Company’s periodic reports.  Also, we may have investments in certainunconsolidated entities.  As we do notcontrol these entities, our disclosure controls and procedures with respect tosuch entities are necessarily substantially more limited than those we maintainwith respect to our consolidated subsidiaries.

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

**Changes inInternal 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 duringGramercy’s last fiscal quarter that have materially affected, or are reasonablylikely to materially**affect, Gramercy’s internalcontrol over financial reporting.

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**PART II                 OTHER INFORMATION**

##### **ITEM 1.                  LEGAL PROCEEDINGS**

We incorporate byreference the information required by this Item 1 of Part II to the informationregarding litigation in Note 16 to the Consolidated Financial Statementscontained in Part I of this report.

##### **ITEM 1A.               RISKFACTORS**

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

##### **ITEM 2.                  UNREGISTEREDSALES OF EQUITY SECURITIES AND USE OF PROCEEDS**

None

#### **ITEM 3.                  DEFAULTSUPON SENIOR SECURITIES**

None

#### **ITEM 4.                  SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS**

On May 17, 2006,we held our annual meeting of stockholders (the “Meeting”) in New York, NewYork for the purpose of: (i) electing two Class II directors to serve on theBoard until our 2009 annual meeting of stockholders and until their successorsare duly elected and qualified; and (ii) ratifying the appointment ofErnst & Young LLP as our independent registered public accounting firm forthe fiscal year ending December 31, 2006. The total number of shares of common stock entitled to vote at theMeeting was 22,805,642, of which 21,100,996 shares, or 92.5%, were present inperson or by proxy.

The following setsforth the results of the election of directors:

| Name of Class II Nominees | ** ** | **For**    | ** ** | **Withheld** | ** ** |
|-----------------------------------------------|------------|------------|------------|--------------|------------|
| Stephen L. Green                              |       | 21,060,431 |       | 40,565       |       |
| Allan J. Baum                                 |       | 20,418,246 |       | 682,750      |       |

 

There was no solicitation in opposition to theforegoing nominees by stockholders.  Theterms of office for Marc Holliday, Paul J. Konigsberg and Charles S. Laven, ourClass I directors, and Hugh F. Hall and Jeffrey E. Kelter, our Class IIIdirectors, continued after the Meeting.

Theratification of the appointment of Ernst & Young LLP as our independentregistered public accounting firm for the fiscal year ending December 31, 2006was approved by our stockholders with 21,095,229 votes “For,” 3,542 votes “Against”and 2,225 votes “Abstained,” none of which such Abstentions were actuallybroker non-votes that were treated as Abstentions (as discussed in our ProxyStatement).

Furtherinformation regarding the proposals is contained in our Proxy Statement, datedApril 17, 2006.

#### **ITEM 5.                  OTHERINFORMATION**

On May 10, 2006 weentered into a Sales Agreement (the “Cantor Fitzgerald & Co. SalesAgreement”) with Cantor Fitzgerald & Co., as sales agent (the “Sales Agent”).In accordance with the terms of the Agreement, the Company may offer and sellup to 1,000,000 shares of its common stock (the “Cantor Fitzgerald & Co.Shares”) from time to time through the Sales Agent (collectively, the “CantorFitzgerald & Co. Transaction”). Sales of the Cantor Fitzgerald & Co.Shares, if any, may be made in privately negotiated transactions and/or anyother method permitted by law, including but not limited to sales at other thana fixed price made on or through the facilities of the New York Stock Exchangeor sales made to or through a market maker or in any other manner that may bedeemed to be an at-the-market offering as defined in Rule 415 of the

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Securities Act of1933, as amended.  The Sales Agent willmake all sales on a best efforts basis using commercially reasonable effortsconsistent with its normal trading and sales practices, on mutually agreedterms between the Sales Agent and the Company. The Sales Agent will be entitledto a commission equal to two and one half percent (2.5%) of the initial CantorFitzgerald & Co. Shares sold pursuant to the terms of the Sales Agreement.In July 2005, the Company filed a registration statement (File No. 333-126938)on Form S-3 with the SEC, which was declared effective in August 2005 (theprospectus contained therein is referred to as the “Prospectus”). In connectionwith the Cantor Fitzgerald & Co. Transaction, we will file a supplement tothe Prospectus (the “Cantor Fitzgerald & Co. Prospectus Supplement”) withthe SEC.

On May 10, 2006 wealso entered into a separate Sales Agreement (the “Merrill Lynch SalesAgreement”) with Merrill Lynch & Co., Merrill Lynch, Pierce, Fenner &Smith Incorporated, as sales agent (the “Sales Agent”). In accordance with theterms of the Agreement, the Company may offer and sell up to 1,000,000 sharesof its common stock (the “Merrill Lynch Shares”) from time to time through theSales Agent (collectively, the “Merrill Lynch Transaction”). Sales of theMerrill Lynch Shares, if any, may be made in privately negotiated transactionsand/or any other method permitted by law, including but not limited to sales atother than a fixed price made on or through the facilities of the New YorkStock Exchange or sales made to or through a market maker or in any othermanner that may be deemed to be an at-the-market offering as defined in Rule415 of the Securities Act of 1933, as amended. The Sales Agent will make all sales on a best efforts basis usingcommercially reasonable efforts consistent with its normal trading and salespractices, on mutually agreed terms between the Sales Agent and the Company.The Sales Agent will be entitled to a commission equal to two and one halfpercent (2.5%) of the initial Merrill Lynch Shares sold pursuant to the termsof the Sales Agreement. In July 2005, the Company filed a registrationstatement (File No. 333-126938) on Form S-3 with the SEC, which was declaredeffective in August 2005 (the prospectus contained therein is referred to asthe “Prospectus”). In connection with the Merrill Lynch Transaction, we willfile a supplement to the Prospectus (the “Merrill Lynch Prospectus Supplement”)with the SEC.

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**ITEM 6.****                  EXHIBITS**

(a)   Exhibits:

1.1           UnderwritingAgreement, dated May 11, 2006, among the Company, GKK Capital LP, GKK ManagerLLC and Wachovia Capital Markets, LLC (incorporated by reference to Exhibit 1.1of the Company’s Form 8-K, dated and filed with the Commission on May 17,2006).

3.1           Articlesof Incorporation of the Company (incorporated by reference to Exhibit 3.1 ofthe 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 declaredeffective by the Commission on July 27, 2004).

3.2           Bylawsof the Company (incorporated by reference to Exhibit 3.2 of the Company’sAmendment No. 2 to its Registration Statement on Form S-11/A (No. 333-114673),which was filed with the Commission on June 23, 2004 and declared effective bythe Commission on July 27, 2004).

10.1         Formof Amended and Restated Management Agreement, dated as of April 19, 2006, byand between the Company and GKK Manager LLC (incorporated by reference to Exhibit10.1 of the Company’s Form 8-K filed with the Commission on April 20, 2006).

10.2         Formof Amended and Restated Origination Agreement, dated as of April 19, 2006, byand between the Company and SL Green Realty Operating Partnership, L.P.(incorporated by reference to Exhibit 10.2 the Company’s Form 8-K filed withthe Commission on April 20, 2006).

10.3         Formof Second Amended and Restated Registration Rights Agreement, dated as of April19, 2006, by and between the Company and SL Green Operating Partnership, L.P.(incorporated by reference to Exhibit 10.3 of the Company’s Form 8-K filed withthe Commission on April 20, 2006).

10.4         Formof Amended and Restated Asset Servicing Agreement, dated as of April 19, 2006,by and between GKK Manager LLC and SLG Gramercy Services LLC (incorporated byreference to Exhibit 10.4 of the Company’s Form 8-K filed with the Commissionon April 20, 2006).

10.5         Formof Third Amended and Restated Agreement of Limited Partnership of GKK CapitalLP, dated as of April 19, 2006 (incorporated by reference to Exhibit 10.5 theCompany’s Form 8-K filed with the Commission on April 20, 2006).

10.6         Amendedand Restated Outsourcing Agreement, dated as of April 19, 2006, by and betweenGKK Manager LLC and SL Green Operating Partnership, L.P. (incorporated byreference to Exhibit 10.8 of the Company’s Quarterly Report on Form 10-Q forthe quarter ended March 31, 2006, which was filed with the Commission on May10, 2006).

10.7         Formof Sales Agreement, dated May 10, 2006, by and among the Company, GKK CapitalLP, GKK Manager LLC and Cantor Fitzgerald & Co. (incorporated by referenceto Exhibit 10.11 of the Company’s Quarterly Report on Form 10-Q for the quarterended March 31, 2006, which was filed with the Commission on May 10, 2006).

10.8         Formof Sales Agreement, dated May 10, 2006, by and among the Company, GKK CapitalLP, GKK Manager LLC and Merrill Lynch & Co., Merrill Lynch, Pierce, Fenner& Smith Incorporated  (incorporatedby reference to Exhibit 10.12 of the Company’s Quarterly Report on Form 10-Qfor the quarter ended March 31, 2006, which was filed with the Commission onMay 10, 2006).

10.9         FourthAmendment, dated as of May 23, 2006, by and among Gramercy Warehouse Funding IILLC, GKK Trading Warehouse II LLC and Goldman Sachs Mortgage Company, to theMaster Repurchase Agreement, dated as of January 3, 2005 (incorporated byreference to Exhibit 10.1 of the Company’s Form 8-K filed with the Commissionon May 26, 2006).

10.10       SecondAmendment, dated as of July 13, 2006, among Wachovia Bank, NationalAssociation, Gramercy Warehouse Funding I LLC and GKK Trading Warehouse I LLC,to the Second Amended and Restated Master Repurchase Agreement, dated as ofApril 21, 2005 (filed herewith).

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31.1         Certificationby the Chief Executive Officer pursuant to Section 302 of the Sarbanes-OxleyAct of 2002 (filed herewith).

31.2         Certificationby the Chief Financial Officer pursuant to Section 302 of the Sarbanes-OxleyAct of 2002 (filed herewith).

32.1         Certification by the Chief Executive Officer pursuant to 18U.S.C. section 1350, as adopted pursuant to Section 906 of the Sarbanes-OxleyAct of 202 (filed herewith).

32.2         Certification by the Chief Financial Officer pursuant to 18U.S.C. section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Actof 2002 (filed herewith).

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**SIGNATURES**

Pursuant to the requirements of the Securities Exchange Act of 1934, theregistrant has duly caused this report to be signed on its behalf by theundersigned thereunto duly authorized.
|                                                          | GRAMERCY CAPITAL CORP. |
|----------------------------------------------------------|------------------------|
|                                                     |                   |
|                                                     |                   |
|                                                     | By:                    | /s/ Robert R.  Foley |   |
|                                                     |                   | Robert R. Foley |
|                                                     |                   | Chief Financial Officer |
|                                                     |                   |   |
|                                                     |                   |   |
| Date:      August  9, 2006 |                   |   |

 

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