UNITED STATES
SECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549



FORM 10-Q



ý

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the quarterly period ended September 30, 2008o

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the transition period
from                             to           
                  .


Commission File Number: 001-32248



GRAMERCY CAPITAL CORP.(Exact name of registrant as specified in its charter)



Maryland(State or other jurisdiction of incorporation or organization)

06-1722127(I.R.S. Employer Identification No.)420 Lexington Avenue, New York, New York 10170(Address of principal executive offices) (Zip Code)(212) 297-1000(Registrant's telephone number, including area code)




Indicate
by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past
90 days. Yes ý    No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting
company. See definition of "large accelerated filer," "accelerated filer," "non-accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.

Large accelerated filer o

Accelerated filer ý

Non-accelerated filer o (Do not check if a smaller reporting company)

Smaller reporting company o


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

The number of shares outstanding of the registrant's common stock, $0.001 par value, was 51,640,526 as of November 10, 2008.



---





GRAMERCY CAPITAL CORP.    INDEX

PART I. FINANCIAL INFORMATION

ITEM 1.    FINANCIAL STATEMENTS

PAGECondensed Consolidated Balance Sheets as of September 30, 2008 (unaudited) and December 31, 2007

1Condensed Consolidated Statements of Income for the three and nine months ended September 30, 2008 and 2007
(unaudited)

2Condensed Consolidated Statement of Stockholders' Equity and Comprehensive Income for the nine months ended September 30,
2008 (unaudited)

3Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2008 and 2007 (unaudited)

4Notes to Condensed Consolidated Financial Statements (unaudited)

6ITEM 2.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

68ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

113ITEM 4.

CONTROLS AND PROCEDURES

116PART II.

OTHER INFORMATION

118ITEM 1.

LEGAL PROCEEDINGS

118ITEM 1A.

RISK FACTORS

118ITEM 2.

UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

120ITEM 3.

DEFAULTS UPON SENIOR SECURITIES

120ITEM 4.

SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

120ITEM 5.

OTHER INFORMATION

120ITEM 6.

EXHIBITS

121SIGNATURES

124


---





PART I. FINANCIAL INFORMATION

ITEM 1.    Financial Statements

Gramercy Capital Corp.        Condensed Consolidated Balance Sheets        (Unaudited, amounts in thousands, except share and per share data)

September 30,
2008

December 31,
2007Assets:Real estate investments, at cost:Land

$
739,278

$
88,720Building and improvements


2,631,386


79,549Less: accumulated depreciation


(36,356
)

(2,015
)Total real estate investments, net


3,334,308


166,254Cash and cash equivalents


95,195


293,126Restricted cash


263,340


135,957Pledged government securities, net


102,607


Loans and other lending investments, net


2,230,770


2,441,747Commercial mortgage-backed securities


857,402


791,983Investments in joint ventures


93,087


49,440Assets held for sale


204,314


194,998Tenant and other receivables, net


52,276


Derivative instruments, at fair value


437


Accrued interest


22,027


32,587Acquired lease assets, net of accumulated amortization of $15,730 and $0


399,903


Deferred costs, net of accumulated amortization of $27,054 and $16,962


74,256


56,109Other assets


63,262


42,877Total assets

$
7,793,184

$
4,205,078Liabilities and Stockholders' Equity:Mortgage notes payable

$
1,947,710

$
153,624Mezzanine loans payable


598,063


Unsecured credit facility


172,301


Term loan, credit facility and repurchase facility


107,994


200,197Collateralized debt obligations


2,662,955


2,735,145Total secured and other debt


5,489,023


3,088,966Accounts payable and accrued expenses


97,261


35,188Management and incentive fees payable


5,089


5,617Dividends payable


2,341


93,992Accrued interest payable


24,224


Deferred revenue


86,017


Below-market lease liabilities, net of accumulated amortization of $33,562 and $0


708,186


Leasehold interests, net of accumulated amortization of $1,474 and $0


21,759


Liabilities related to real estate held for sale


9,626


Derivative instruments, at fair value


83,718


72,495Other liabilities


12,376


10,085Junior subordinated deferrable interest debentures held by trusts that issued trust preferred securities


150,000


150,000Total liabilities


6,689,620


3,456,343Commitments and contingenciesMinority interest


2,463


Stockholders' Equity:Common stock, par value $0.001, 100,000,000 shares authorized, 51,316,586 and 34,850,577 shares issued and outstanding at September 30,
2008 and December 31, 2007, respectively


51


34Series A cumulative redeemable preferred stock, par value $0.001, liquidation preference $115,000, 4,600,000 shares authorized, issued and
outstanding at September 30, 2008 and December 31, 2007, respectively


111,205


111,205Additional paid-in-capital


1,081,055


685,958Accumulated other comprehensive loss


(82,991
)

(65,658
)(Accumulated deficit) retained earnings


(8,219
)

17,196Total stockholders' equity


1,101,101


748,735Total liabilities and stockholders' equity

$
7,793,184

$
4,205,078


The accompanying notes are an integral part of these financial statements.

1

---





Gramercy Capital Corp.        Condensed Consolidated Statements of Income        (Unaudited, amounts in thousands, except per share data)

Three Months Ended
September 30,

Nine Months Ended
September 30,2008

2007

2008

2007RevenuesRental revenue

$
80,597

$
2,523

$
163,350

$
6,109Investment income


60,552


85,796


197,882


218,593Operating expense reimbursements


33,442





64,993


Gain on sales and other income


5,441


1,895


14,551


11,949Total revenues


180,032


90,214


440,776


236,651Property Operating ExpensesOther property operating expenses


20,041





40,121


Real estate taxes


9,892





19,806


Utilities


11,792





21,457


Ground rents and leasehold obligations


4,864





8,956


Direct billable expenses


3,294





5,039


Total property operating expenses


49,883





95,379


Net operating income


130,149


90,214


345,397


236,651Other ExpensesInterest expense


78,586


50,601


197,785


126,271Provision for loan losses


18,875


2,500


50,089


6,648Depreciation and amortization


22,335


1,188


46,625


2,947Management fees


8,025


5,923


24,275


16,176Incentive fee





22,868


5,100


29,469Marketing, general and administrative


5,100


3,145


11,989


11,068Total expenses


132,921


86,225


335,863


192,579Income (loss) before equity in net income of joint ventures, provision for taxes, minority interest and discontinued operations


(2,772
)

3,989


9,534


44,072Equity in net income from joint ventures


1,416


1,264


6,117


1,053Income (loss) before provision for taxes, minority interest and discontinued operations


(1,356
)

5,253


15,651


45,125Gain on extinguishment of debt


11,681





33,378


Gain from sale from unconsolidated joint venture interest





92,235





92,235Provision for taxes


(36
)

(338
)

(47
)

(1,301
)Net income from continuing operations before minority interests


10,289


97,150


48,982


136,059Minority interest


24





(217
)

Net income from continuing operations


10,313


97,150


48,765


136,059Net loss from discontinued operations


(654
)




(1,239
)

Net Income


9,659


97,150


47,526


136,059Preferred stock dividends


(2,336
)

(2,336
)

(7,008
)

(4,231
)Net income available to common stockholders

$
7,323

$
94,814

$
40,518

$
131,828Basic earnings per share:Net income from continuing operations

$
0.16

$
3.60

$
0.92

$
5.04Net loss from discontinued operations


(0.02
)




(0.03
)

Net income available to common stockholders

$
0.14

$
3.60

$
0.89

$
5.04Diluted earnings per share:Net income from continuing operations

$
0.15

$
3.43

$
0.91

$
4.79Net loss from discontinued operations


(0.01
)




(0.03
)

Net income available to common stockholders

$
0.14

$
3.43

$
0.88

$
4.79Dividends per common share

$


$
0.63


1.26

$
1.82Basic weighted average common shares outstanding


51,307


26,339


45,736


26,139Diluted weighted average common shares and common share equivalents outstanding


51,356


27,638


45,814


27,527


The accompanying notes are an integral part of these financial statements.

2

---





Gramercy Capital Corp.        Condensed Consolidated Statement of Stockholders' Equity and Comprehensive Income        (Unaudited, amounts in thousands)

Common StockAccumulated
Other
Comprehensive
Income (Loss)

(Accumulated
Deficit)/
Retained
EarningsShares

Par
Value

Series A
Preferred
Stock

Additional
Paid-
In-Capital

Total

Comprehensive
IncomeBalance at December 31, 2007


34,850

$
34

$
111,205

$
685,958

$
(65,658
)
$
17,196

$
748,735Net income

















47,526


47,526


47,526Change in net unrealized loss on derivative instruments














(10,986
)




(10,986
)

(10,986
)Reclassification adjustments from cash flow hedges included in net income














(6,789
)




(6,789
)

(6,789
)Change in net unrealized loss on commercial mortgage-backed securities previously available for sale














442





442


442Issuance of common stock in connection with American Financial Realty Trust acquisition


16,280


16





389,869








389,885Issuance of stockstock purchase plan


5








46








46Proceeds from stock option exercises


86


1





1,305








1,306Stock-based compensationfair value











2,952








2,952Deferred compensation plan, net


95








925








925Dividends declared on common stock

















(65,933
)

(65,933
)Dividends declared on preferred stock

















(7,008
)

(7,008
)Balance at September 30, 2008


51,316

$
51

$
111,205

$
1,081,055

$
(82,991
)
$
(8,219
)
$
1,101,101

$
30,193


The accompanying notes are an integral part of these financial statements

3

---





Gramercy Capital Corp.        Condensed Consolidated Statements of Cash Flows        (Unaudited, amounts in thousands)

Nine Months Ended September 30,2008

2007Operating ActivitiesNet income

$
47,526

$
136,059Adjustments to net cash provided by operating activities:Depreciation and amortization


42,546


9,219Minority Interest


219


Amortization of acquired leases to rental income


(17,833
)

Amortization of deferred costs


6,903


Amortization of discount, net, and other fees


(21,568
)

(19,707
)Deferred revenue


(10,617
)

(5,621
)Straight-line rent adjustment


9,808


Equity in net (income) loss of joint ventures


(6,117
)

(1,053
)Gain on extinguishment of debt


(33,378
)

Amortization of stock compensation


3,878


4,180Provision for loan loss


50,089


6,648Unrealized gain on derivative instruments


(6,733
)

(792
)Net realized gain on loans held for sale


(10
)

(4,354
)Changes in operating assets and liabilities:Restricted cash


31,146


Tenant and other receivables


(5,879
)

New investments in loans held for sale





(151,638
)Proceeds from sale of loans and loan commitments and loans held for sale





177,414Payment of capitalized tenant leasing costs


(539
)

Accrued interest


(1,083
)

(8,292
)Other assets


20,285


469Management and incentive fees payable


(528
)

22,142Settlement of derivative instruments





(460
)Accounts payable, accrued expenses and other liabilities


13,175


11,238Net cash provided by operating activities


121,290


82,295Investing ActivitiesTransaction costs of business combination


(108,199
)

Cash consideration paid for business combination, net of cash acquired of $155,356


(586,900
)

Capital expenditures and leasehold costs


(6,773
)

Proceeds from sale of real estate


63,878


New investment originations and funded commitments


(305,066
)

(1,575,531
)Principal collections on investments


410,508


932,043Proceeds from loan syndications


92,090


112,375Investment in commercial real estate





(74,800
)Investment in commercial mortgage-backed securities


(61,736
)

(780,041
)Investment in joint venture


(2,071
)

(41,918
)Decrease in accrued interest income


57


Purchase of marketable investments


(5,354
)

Sale of marketable investments


3,402


Change in restricted cash from investing activities


(50,625
)

11,336Deferred investment costs


(1,856
)

(1,615
)Net cash used in investing activities


(558,645
)

(1,271,486
)


4

---



Gramercy Capital Corp.

Condensed Consolidated Statements of Cash Flows (Continued)

(Unaudited, amounts in thousands)

Nine Months Ended September 30,2008

2007Financing ActivitiesProceeds from repurchase facilities


35,946


1,265,461Repayments of repurchase facilities


(128,149
)

(1,246,427
)Proceeds from unsecured revolving credit facility


172,301


129,000Change in restricted cash from financing activities


20,928


190,479(Repurchase) issuance of collateralized debt obligations


(38,922
)

1,043,572Proceeds from stock options exercised


1,352


1,077Proceeds from acquisition financing


1,114,743


Repayment of mortgage notes and credit facilities


(742,034
)

(144,000
)Payment for deferred financing and derivative instruments


(32,195
)

Net proceeds from sale of common stock


46


Net proceeds from sale of preferred stock





111,205Dividends paid


(164,592
)

(47,094
)Net cash provided by financing activities


239,424


1,476,637Net (decrease) increase in cash and cash equivalents


(197,931
)

287,446Cash and cash equivalents at beginning of period


293,126


19,314Cash and cash equivalents at end of period


95,195

$
306,760Non-cash activityDeferred losses and other non-cash activity related to derivatives

$
(17,441
)
$
Issuance of common stock for acquisition advisory costs

$
11,213

$
Issuance of common stock in business combination

$
378,672

$
Assumptions of mortgage loans

$
1,316,004

$
SFAS 141 mark-to-market of debt assumed

$
24,743

$
Supplemental cash flow disclosuresInterest paid

$
144,254

$
112,583Income taxes paid

$
393

$
854


The accompanying notes are an integral part of these financial statements.

5

---





Gramercy Capital Corp.        Notes To Condensed Consolidated Financial Statements        (Unaudited, amounts in thousands, except share and per share data)        September 30, 2008

1. Business and Organization

Gramercy Capital Corp. (the "Company" or "Gramercy") is an integrated commercial real estate finance and property investment company. The Company was formed in April 2004 and commenced
operations upon the completion of its initial public offering in August 2004. On April 1, 2008, the Company completed the acquisition of American Financial Realty Trust (NYSE: AFR) ("American
Financial") in a transaction with a total value of approximately $3.3 billion, including the assumption of approximately $1.3 billion of American Financial's secured debt. The
acquisition transformed the Company from a pure specialty finance company into a diversified enterprise with complementary business lines consisting of commercial real estate finance and property
investments.

The
Company's commercial real estate finance business, which operates under the name Gramercy Finance, focuses on the direct origination and acquisition of whole loans, subordinate
interests in whole loans, mezzanine loans, preferred equity, commercial mortgage-backed securities, or CMBS, and other real estate related securities. The Company's property investment business, which
operates under the name Gramercy Realty, focuses on the acquisition and management of commercial properties net leased primarily to regulated financial institutions and affiliated users throughout the
United States. These institutions are, for the most part, deposit-taking commercial banks, thrifts and credit unions, which the Company generally refers to as "banks." The Company's portfolio of
wholly-owned and jointly-owned bank branches and office buildings is leased to large banks such as Bank of America, N.A., Wachovia Bank, National Association, Regions Financial Corporation and
Citizens Financial Group, Inc. and to mid-sized and community banks. Neither Gramercy Finance nor Gramercy Realty is a separate legal entity but are divisions of the Company through
which the Company's commercial real estate finance and property investment businesses are conducted.

Substantially
all of the Company's operations are conducted through GKK Capital LP, a Delaware limited partnership, or the Operating Partnership. The Company, as the sole general
partner of, and
currently the holder of 100% of the common units of the Operating Partnership, has responsibility and discretion in the management and control of the Operating Partnership, and the limited partners of
the Operating Partnership have no authority to transact business for, or participate in the management activities of the Operating Partnership. Accordingly, the Company consolidates the accounts of
the Operating Partnership.

The
Company is externally managed and advised by GKK Manager LLC, or the Manager, a majority-owned subsidiary of SL Green Realty Corp., or SL Green. At September 30, 2008,
SL Green Operating Partnership, L.P. owned approximately 15.8% of the outstanding shares of the Company's common stock. The Company qualified as a real estate investment trust, or REIT, under
the Internal Revenue Code commencing with its taxable year ended December 31, 2004 and the Company expects to qualify for the current fiscal year. To maintain the Company's tax status as a
REIT, the Company plans to distribute at least 90% of taxable income.

As
of September 30, 2008, Gramercy Finance held loans and other lending investments and CMBS of $3,088,172 net of fees, discounts, and unfunded commitments with an average spread
to 30-day LIBOR of 455 basis points for its floating rate investments, and an average yield of approximately 7.09% for its fixed rate investments. As of September 30, 2008, Gramercy
Finance also held interests in three credit tenant net lease investments, or CTL investments, two interests in joint ventures holding

6

---



Gramercy Capital Corp.

Notes To Condensed Consolidated Financial Statements (Continued)

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

September 30, 2008

1. Business and Organization (Continued)

fee
positions on properties subject to long-term ground leases and a 100% fee interest in a property subject to a long-term ground lease.

As
of September 30, 2008, Gramercy Realty's portfolio consisted of 744 bank branches, 344 office buildings and 11 land parcels, of which 84 bank branches and one office building
were partially owned through joint ventures. Gramercy Realty's wholly-owned properties aggregated approximately 27.5 million rentable square feet and its partially-owned properties aggregated
approximately 0.8 million rentable square feet, including 0.4 million rentable square feet in an unconsolidated joint venture. As of September 30, 2008, the occupancy of Gramercy
Realty's wholly-owned properties was 87.5% and the occupancy for its partially-owned properties was 99.9%. Gramercy Realty's two largest tenants are Bank of America, N.A. and Wachovia Bank, National
Association and as of September 30, 2008, they represented approximately 39.0% and 14.2%, respectively, of the rental income of Gramercy Realty's portfolio and occupied approximately 45.1% and
19.2%, respectively, of Gramercy Realty's total rentable square feet.

Due
to the nature of the business of Gramercy Realty's tenant base, Gramercy Realty typically enters into long-term leases with its tenants. As of September 30, 2008,
the weighted average remaining term of Gramercy Realty's leases was 10.6 years and approximately 80.4% of its base revenue was derived from net leases. With in-house capabilities in
acquisitions, asset management, property management and leasing, Gramercy Realty is focused on maximizing the value of its portfolio through strategic sales, effective and efficient property
management, and leasing.

The
Company relies on the credit and equity markets to finance and grow its business. During the second half of 2007 and the first three quarters of 2008, severe credit and liquidity
issues in the sub-prime residential lending and single family housing sectors negatively impacted the asset-backed and corporate fixed income markets, as well as the equity securities of
financial institutions and real estate companies. As the severity of residential sector issues increased, nearly all securities markets experienced reduced liquidity and greater risk premiums as
concerns about the outlook for the U.S. and world economic growth increased. These concerns continue and risk premiums in many capital markets remain at or near all-time highs with
liquidity extremely low compared to historical standards or virtually non-existent. As a result, most commercial real estate finance and financial services industry participants, including
the Company, have reduced new investment activity until the capital markets become more stable, the macroeconomic outlook becomes clearer and market liquidity increases. In this environment, the
Company is focused on actively managing portfolio credit, generating and recycling liquidity from existing assets, leasing vacant space and reducing corporate overhead as a percentage of its total
assets and total revenues.

Basis of Quarterly Presentation

The accompanying unaudited condensed financial statements have been prepared in accordance with accounting principles generally
accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they
do not include all of the information and footnotes required by accounting principles generally accepted in the United States, or GAAP, for complete financial statements. In management's opinion, all
adjustments (consisting of normal recurring accruals) considered necessary for fair presentation have been included.

7

---



Gramercy Capital Corp.

Notes To Condensed Consolidated Financial Statements (Continued)

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

September 30, 2008

1. Business and Organization (Continued)

The
2008 operating results for the periods presented are not necessarily indicative of the results that may be expected for the year ending December 31, 2008. These financial statements should
be read in conjunction with the financial statements and accompanying notes included in the Company's Annual Report on Form 10-K for the year ended December 31, 2007.

The
balance sheet at December 31, 2007 has been derived from the audited financial statement at that date, but does not include all the information and footnotes required by GAAP
for complete financial statements.

2. Significant Accounting Policies

Principles of Consolidation

The consolidated financial statements include the Company's accounts and those of the Company's subsidiaries which are wholly-owned or
controlled by the Company, or entities which are variable interest entities in which the Company is the primary beneficiary under FASB Interpretation No. 46R, or FIN 46R, "Consolidation
of Variable Interest Entities." FIN 46R requires a variable interest entity, or VIE, to be consolidated by its primary beneficiary. The primary beneficiary is the party that absorbs a majority
of the VIE's anticipated losses and/or a majority of the expected returns. The Company has evaluated its investments for potential classification as variable interests by evaluating the sufficiency of
each entity's equity investment at risk to absorb losses, and determined that the Company is the primary beneficiary for one variable interest entity and has included the accounts of this entity in
the consolidated financial statements. Entities which the Company does not control and entities which are VIE's, but where the Company is not the primary beneficiary, are accounted for under the
equity method. All significant intercompany balances and transactions have been eliminated.

Variable Interest Entities

The Company's ownership of the subordinated classes of CMBS from a single issuer may provide the Company with the right to control the
foreclosure/workout process on the underlying loans. There are certain exceptions to the scope of FIN 46R, one of which provides that an investor that holds a variable interest in a qualifying
special-purpose entity ("QSPE") does not consolidate that entity unless the investor has the unilateral ability to cause the entity to liquidate. FASB Statement No. 140, or SFAS No. 140,
"Accounting for Transfers and Servicing of Financial Assets
and Extinguishments of Liabilities," provides the requirements for an entity to qualify as a QSPE. To maintain the QSPE exception, the special-purpose entity must initially meet the QSPE criteria and
must continue to satisfy such criteria in subsequent periods. A special-purpose entity's QSPE status can be affected in future periods by activities by its transferors or other involved parties,
including the manner in which certain servicing activities are performed. To the extent that the Company's CMBS investments were issued by a special-purpose entity that meets the QSPE requirements,
the Company records those investments at the purchase price paid. To the extent the underlying special-purpose entities do not satisfy the QSPE requirements, the Company follows the guidance set forth
in FIN 46R as the special-purpose entities would be determined to be VIEs.

8

---



Gramercy Capital Corp.

Notes To Condensed Consolidated Financial Statements (Continued)

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

September 30, 2008

2. Significant Accounting Policies (Continued)

The
Company has analyzed the pooling and servicing agreements governing each of its controlling class CMBS investments and the Company believes that the terms of those agreements conform
to industry standards and are consistent with the QSPE criteria.

In
April of 2008, the FASB voted to eliminate the scope exception for QSPEs from the guidance in SFAS No. 140 and to remove the scope exception for QSPEs from FIN 46R. This
will require that VIEs previously accounted for as QSPEs be analyzed for consolidation according to FIN 46R. While the revised standards have not been finalized, and deferred for potential
application until 2010, this change may affect the Company's financial statements.

At
September 30, 2008, the Company owned securities of three controlling class CMBS trusts with a carrying value of $39,225. The total par amounts of CMBS issued by the three CMBS
trusts was $921,654. Using the fair value approach to calculate expected losses or residual returns, the Company has concluded that it would not be the primary beneficiary of any of the underlying
special-purpose entities. At September 30, 2008, the Company's maximum exposure to loss as a result of its investment in these QSPEs totaled $39,225, which equals the book value of these
investments as of September 30, 2008.

The
financing structures that the Company offers to the borrowers on certain of its real estate loans involve the creation of entities that could be deemed VIEs and, therefore, could be
subject to FIN 46R. The Company's management has evaluated these entities and has concluded that none of such entities are VIEs that are subject to the consolidation rules of FIN 46R.

Real Estate and CTL Investments

The Company records acquired real estate and CTL investments at cost less accumulated depreciation. Costs directly related to the
acquisition of such investments are capitalized. Certain improvements are capitalized when they are determined to increase the useful life of the building. Depreciation is computed using the
straight-line method over the shorter of the estimated useful life of the capitalized item or 40 years for buildings, five to 10 years for building equipment and fixtures,
and the lesser of the useful life or the remaining lease term for tenant improvements and leasehold interests. Maintenance and repair expenditures are charged to expense as incurred.

In
leasing office space, the Company may provide funding to the lessee through a tenant allowance. In accounting for tenant allowances, the Company determines whether the allowance
represents funding for the construction of leasehold improvements and evaluates the ownership, for accounting purposes, of such improvements. If the Company is considered the owner of the leasehold
improvements for accounting purposes, the Company capitalizes the amount of the tenant allowance and depreciates it over the shorter of the useful life of the leasehold improvements or the lease term.
If the tenant allowance represents a payment for a purpose other than funding leasehold improvements, or in the event the Company is not considered the owner of the improvements for accounting
purposes, the allowance is considered to be a lease incentive and is recognized over the lease term as a reduction of rental revenue. Factors considered during this evaluation usually include
(i) who holds legal title to the improvements, (ii) evidentiary requirements concerning the spending of the tenant allowance, and (iii) other controlling rights provided by the
lease agreement (e.g. unilateral

9

---



Gramercy Capital Corp.

Notes To Condensed Consolidated Financial Statements (Continued)

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

September 30, 2008

2. Significant Accounting Policies (Continued)

control
of the tenant space during the build-out process.) Determination of the accounting for a tenant allowance is made on a case-by-case basis, considering the
facts and circumstances of the individual tenant lease.

Results
of operations of properties acquired are included in the Condensed Consolidated Statements of Income from the date of acquisition.

In
accordance with FASB Statement No. 144, or SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," a property to be disposed of is
reported at the lower of its carrying amount or its estimated fair value, less its cost to sell. Once an asset is classified as held for sale, depreciation expense is no longer recorded and historic
results are reclassified as Discontinued Operations.

The
Company also reviews the recoverability of the property's carrying value when circumstances indicate a possible impairment of the value of a property. The review of recoverability is
based on an estimate of the future undiscounted cash flows, excluding interest charges, expected to result from the property's use and eventual disposition. These estimates consider factors such as
expected future operating income, market and other applicable trends and residual value, as well as the effects of leasing demand, competition and other factors. If management determines impairment
exists due to the inability to recover the carrying value of a property, an impairment loss is recorded to the extent that the carrying value exceeds the estimated fair value of the property for
properties to be held and used and for assets held for sale, an impairment loss is recorded to the extent that the carrying value exceeds the fair value less estimated cost to dispose for assets held
for sale. These assessments are recorded as an impairment loss in the consolidated statement of income in the period the determination is made.

In
accordance with FASB Statement No. 141, or SFAS No. 141, "Business Combinations," the Company allocates the purchase price of real estate to land, building and
improvements and intangibles, such as the value of above-, below- and at-market leases and origination costs associated with the in-place leases. The Company
depreciates the amount allocated to building and other intangible assets over their estimated useful lives, which generally range from three to 40 years. The values of the above-, and
below-market leases are amortized and recorded as either an increase (in the case of below-market leases) or a decrease (in the case of above-market leases) to rental income over the remaining term of
the associated lease. The value associated with in-place leases are amortized over the expected term, which includes an estimated probability of the lease renewal, and its estimated term.
If a tenant vacates its space prior to the contractual termination of the lease and no rental payments are being made on the lease, any unamortized balance of the related intangible will be written
off. The tenant improvements and origination costs are amortized as an expense over the remaining life of the lease or charged against earnings if the lease is terminated prior to its contractual
expiration date. The Company assesses fair value of the leases based on estimated cash flow projections that utilize appropriate discount and capitalization rates and available market information.
Estimates of future cash flows are based on a number of factors including the historical operating results, known trends and market/economic conditions that may affect the property.

10

---



Gramercy Capital Corp.

Notes To Condensed Consolidated Financial Statements (Continued)

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

September 30, 2008

2. Significant Accounting Policies (Continued)

The
Company has not yet obtained all the information necessary to finalize its estimates to complete the purchase price allocations in accordance with SFAS No. 141 related to the
American Financial acquisition. The purchase price allocations will be finalized once the information indentified has been received, which should not be longer than one year from the date of
acquisition.

Leasehold Interests

Leasehold interest assets and liabilities are recorded based on the difference between the fair value of management's estimate of the
net present value of cash flows expected to be paid and earned from the subleases over the non-cancelable lease terms and any payments received in consideration for assuming the leasehold
interests. Factors used in determining the net present value of cash flows include contractual rental amounts, costs of tenant improvements, costs of capital expenditures and amounts due under the
corresponding operating lease assumed. Amounts allocated to leasehold interests, based on their respective fair values, are amortized on a straight-line basis over the remaining lease
term.

Investments in Unconsolidated Joint Ventures

The Company accounts for its investments in unconsolidated joint ventures under the equity method of accounting since it exercises
significant influence, but does not unilaterally control, the entities and are not considered to be the primary beneficiary under FIN 46R. In the joint ventures, the rights of the other
investors are protective and participating. Unless the Company is determined to be the primary beneficiary, these rights preclude it from consolidating the investments. The investments are recorded
initially at cost as an investment in unconsolidated joint ventures, and subsequently are adjusted for equity in net income (loss) and cash contributions and distributions. Any difference between the
carrying amount of the investments on the Company's balance sheet and the underlying equity in net assets is amortized as an adjustment to equity in net income (loss) of unconsolidated joint ventures
over the lesser of the joint venture term or 40 years. None of the joint venture debt is recourse to the Company. As of September 30, 2008 and December 31, 2007, the Company had
investments of $93,087 and $49,440 in unconsolidated joint ventures, respectively.

Cash and Cash Equivalents

The Company considers all highly liquid investments with maturities of three months or less when purchased to be cash equivalents.

Restricted Cash

Restricted cash at September 30, 2008 consists of $101,553 on deposit with the trustee of the Company's collateralized debt
obligations, or CDOs, representing the proceeds of repayments from loans serving as collateral in the Company's CDOs, which will be used to fund investments to replace those trust assets which are
repaid or sold by the trust, interest payments received by the trustee on investments that serve as collateral for the Company's CDOs, which are remitted to the Company on a quarterly basis, and
future funding obligations on certain investments. The remaining balance consists of $64,766 held as collateral for letters of credit, $7,253 of interest reserves held on behalf of borrowers

11

---



Gramercy Capital Corp.

Notes To Condensed Consolidated Financial Statements (Continued)

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

September 30, 2008

2. Significant Accounting Policies (Continued)

and
$89,768 which represents amounts escrowed pursuant to mortgage agreements securing the Company's real estate investments and CTL investments for insurance, taxes, repairs and maintenance, tenant
improvements, interest, and debt service and amounts held as collateral under security and pledge agreements relating to leasehold interests, including the Company's proportionate share of the
reserves of 55 Corporate Drive.

Assets Held for Sale



Loans held for investment are intended to be held to maturity and, accordingly, are carried at cost, net of unamortized loan
origination fees, discounts, repayments, sales of partial interests in loans, and unfunded commitments unless such loan or investment is deemed to be impaired. Loans held for sale are carried at the
lower of cost or market value using available market information obtained through consultation with dealers or other originators of such investments. During the three months ended September 30,
2008, the Company redesignated loans with a carrying value of $154,409 from assets held for sale to loans and other lending investments. The Company may originate or acquire preferred equity interests
that allow it to participate in a percentage of the underlying property's cash flows from operations and proceeds from a sale or refinancing. Should the Company make such a preferred equity
investment, the Company must determine whether that investment should be accounted for as a loan, joint venture or as an interest in real estate.



The results of operations from real estate investments or CTL investments sold or held for sale in the current and prior periods are
classified as "Loss from discontinued operations" on the Company's consolidated statements of income.

Commercial Mortgage-Backed Securities

The Company designates its CMBS investments pursuant to FASB Statement No. 115, or SFAS No. 115, "Accounting for Certain
Investments in Debt and Equity Securities," on the date of acquisition of the investment. Held to maturity investments are stated at cost plus any premiums or discounts which are amortized through the
consolidated statements of income using the level yield method. CMBS securities that the Company does not hold for the purpose of selling in the near-term but may dispose of prior to
maturity, are designated as available-for-sale and are carried at estimated fair value with the net unrealized gains or losses recorded as a component of accumulated other
comprehensive income (loss) in stockholders' equity. Unrealized losses on securities that, in the judgment of management, are other than temporary are charged against earnings as a loss on the
consolidated statements of income. In November 2007, subsequent to financing the Company's CMBS investments in its CDOs, the Company redesignated all of its available-for-sale
CMBS investments with a book value of approximately $43.6 million to held to maturity. As of September 30, 2008 and December 31, 2007, the unrealized loss on the redesignated CMBS
investments included in other comprehensive income (loss) was $5,134 and $5,575, respectively.

12

---



Gramercy Capital Corp.

Notes To Condensed Consolidated Financial Statements (Continued)

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

September 30, 2008

2. Significant Accounting Policies (Continued)

The
Company accounts for CMBS (other than those of high credit quality or sufficiently collateralized to ensure that the possibility of credit loss is remote) under Emerging Issues Task
Force 99-20, "Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets," or EITF 99-20.
Accordingly, on a quarterly basis, when significant changes in estimated cash flows from the cash flows previously estimated occur due to actual prepayment and credit loss experience, and the present
value of the revised cash flow is less than the present value previously estimated, an other-than-temporary impairment is deemed to have occurred. The security is written down
to fair value with the resulting charge against earnings and a new cost basis is
established. The Company calculates a revised yield based on the current amortized cost of the investment (including any other-than-temporary impairments recognized to date)
and the revised yield is then applied prospectively to recognize interest income.

The
Company determines the fair value of CMBS based on the types of securities in which the Company has invested. For liquid, investment-grade securities, the Company consults with
dealers of such securities to periodically obtain updated market pricing for the same or similar instruments. For non-investment grade securities, the Company actively monitors the
performance of the underlying properties and loans and updates the Company's pricing model to reflect changes in projected cash flows. The value of the securities is derived by applying discount rates
to such cash flows based on current market yields. The yields employed are obtained from the Company's own experience in the market, advice from dealers and/or information obtained in consultation
with other investors in similar instruments. Because fair value estimates may vary to some degree, the Company must make certain judgments and assumptions about the appropriate price to use to
calculate the fair values for financial reporting purposes. Different judgments and assumptions could result in materially different presentations of value.

In
accordance with SFAS No. 115, when the estimated fair value of the security classified as available-for-sale has been below amortized cost for a
significant period of time and the Company concludes that it no longer has the ability or intent to hold the security for the period of time over which the Company expects the values to recover to
amortized cost, the investment is written down to its fair value, and this loss is realized and charged against earnings. The determination of other-than-temporary impairment
is a subjective process, and different judgments and assumptions could affect the timing of loss realization. In addition, it is possible that the Company in the future, may need to recognize an
other-than-temporary impairment not withstanding its continued determination that no credit loss has occurred and estimated cash flows remain stable, due to the duration that
the estimated fair value remains below book value.

Pledged Government Securities

The Company maintains a portfolio of treasury securities that are pledged to provide principal and interest payments for mortgage debt
previously collateralized by properties in its real estate portfolio. These securities are carried at amortized cost because the Company has both positive intent and the ability to hold the securities
to maturity. These securities had a carrying value of $102,607, a fair value of $100,889 and unrealized losses of $1,718 at September 30, 2008, and have maturities that extend

13

---



Gramercy Capital Corp.

Notes To Condensed Consolidated Financial Statements (Continued)

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

September 30, 2008

2. Significant Accounting Policies (Continued)

through
November 2013. The Company did not maintain a portfolio of pledged treasury securities at December 31, 2007.

Tenant and Other Receivables

Tenant and other receivables are primarily derived from the rental income that each tenant pays in accordance with the terms of its
lease, which is recorded on a straight-line basis over the initial term of the lease. Since many leases provide for rental increases at specified intervals, straight-line basis
accounting requires the Company to record a receivable, and include in revenues, unbilled rent receivables that will only be received if the tenant makes all rent payments required through the
expiration of the initial term of the lease. Tenant and other receivables also include receivables related to tenant reimbursements for common area maintenance expenses and certain other recoverable
expenses that are recognized as revenue in the period in which the related expenses are incurred.

Tenant
and other receivables are recorded net of the allowances for doubtful accounts, which as of September 30, 2008 and December 31, 2007, were $5,457 and $0,
respectively. The Company continually reviews receivables related to rent, tenant reimbursements and unbilled rent receivables and determines collectability by taking into consideration the tenant's
payment history, the financial condition of the tenant, business conditions in the industry in which the tenant operates and economic conditions in the area in which the property is located. In the
event that the collectability of a receivable is in doubt, the Company increases the allowance for doubtful accounts or records a direct write-off of the receivable in the consolidated
statements of income.

Intangible Assets

Pursuant to SFAS No. 141, the Company follows the purchase method of accounting for all business combinations. To ensure that
intangible assets acquired and liabilities assumed in a purchase method business combination are recognized and reported apart from goodwill, the Company applies criteria specified in SFAS
No. 141.

The
Company allocates the purchase price of acquired properties to tangible and identifiable intangible assets acquired based on their respective fair values. Tangible assets include
land, buildings and improvements on an as-if vacant basis. The Company utilizes various estimates, processes and information to determine the as-if vacant property value.
Estimates of value are made using customary methods, including data from appraisals, comparable sales, discounted cash flow analyses and other methods. Identifiable intangible assets include amounts
allocated to acquired leases for above- and below-market lease rates and the value of in-place leases.

Above-market
and below-market in-place lease values for properties acquired are recorded based on the present value (using an interest rate which reflects the risks
associated with the leases acquired) of the difference between the contractual amount to be paid pursuant to each in-place lease and management's estimate of the fair market lease rate for
each such in-place lease, measured over a period equal to the remaining non-cancelable term of the lease. The capitalized above-market lease values are amortized as a reduction
of rental income over the remaining non-cancelable terms of the respective leases. The capitalized below-market lease values are amortized as an increase to rental income over the initial
term and any fixed-rate renewal periods in the respective leases.

14

---



Gramercy Capital Corp.

Notes To Condensed Consolidated Financial Statements (Continued)

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

September 30, 2008

2. Significant Accounting Policies (Continued)

The aggregate value of intangible assets related to in-place leases is primarily the difference between the property valued with existing in-place leases adjusted
to market rental rates and the property valued as-if vacant. Factors considered by management in its analysis of the in-place lease intangibles include an estimate of carrying
costs during the expected lease-up period for each property taking into account current market conditions and costs to execute similar leases. In estimating carrying costs, management
includes real estate taxes, insurance and other operating expenses and estimates of lost rentals at market rates during the anticipated lease-up period, which is expected to average six
months. Management also estimates costs to execute similar leases including leasing commissions, legal and other related expenses.

The
value of in-place leases is amortized to expense over the initial term of the respective leases, which range primarily from two to 20 years. In no event does the
amortization period for intangible assets exceed the remaining depreciable life of the building. If a tenant terminates its lease, the unamortized portion of the in-place lease value is
charged to expense.

In
making estimates of fair values for purposes of allocating purchase price, management utilizes a number of sources, including independent appraisals that may be obtained in connection
with the acquisition or financing of the respective property and other market data. Management also considers information obtained about each property as a result of its pre-acquisition
due diligence, as well as subsequent marketing and leasing activities, in estimating the fair value of the tangible and intangible assets acquired and intangible liabilities assumed. The allocation
presented in the accompanying consolidated balance sheet as of September 30, 2008 is substantially complete; however, there are certain items that the Company will finalize once additional
information is received. Accordingly, this allocation is subject to revision when final information is available, although future revisions are not expected to have a significant impact on the
financial position or results of operations.

Intangible
assets and acquired lease obligations consist of the following:

September 30, 2008Intangible assets:In-place leases, net of accumulated amortization of $9,620

$
272,995Above-market leases, net of accumulated amortization of $6,110


126,908Total intangible assets

$
399,903Intangible liabilities:Below-market leases, net of accumulated amortization of $33,562

$
708,186Total intangible liabilities

$
708,186


Deferred Costs

Deferred costs include deferred financing costs that represent commitment fees, legal and other third party costs associated with
obtaining commitments for financing which result in a closing of such financing. These costs are amortized over the terms of the respective agreements and the amortization is reflected as interest
expense. Unamortized deferred financing costs are expensed when the associated

15

---



Gramercy Capital Corp.

Notes To Condensed Consolidated Financial Statements (Continued)

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

September 30, 2008

2. Significant Accounting Policies (Continued)

debt
is refinanced or repaid before maturity. Costs incurred in seeking financing transactions that do not close are expensed in the period in which it is determined that the financing will not close.

Deferred
costs also consist of fees and direct costs incurred to originate new investments and are amortized using the effective yield method over the related term of the investment and
also consist of fees and direct costs incurred to initiate or renew operating leases and are amortized on a straight-line basis over the related lease term.

Other Assets

The Company makes payments for certain expenses such as insurance and property taxes in advance of the period in which it receives the
benefit. These payments are classified as other assets and amortized over the respective period of benefit relating to the contractual arrangement. The Company also escrows deposits related to pending
acquisitions and financing arrangements, as required by a seller or lender, respectively. Prepaid acquisition costs represent a portion of the total purchase price of a property and are reclassified
into real estate investments and related intangible assets, as appropriate, at the time the acquisition is completed. If such costs are related to an acquisition that will not be consummated and the
deposit is not recoverable, the respective amounts are charged to expenses in the accompanying consolidated statements of income. Costs prepaid in connection with securing financing for a property are
reclassified into deferred financing costs at the time the transaction is completed.

Valuation of Financial Instruments

The Company measures derivatives at fair value. Investments in loans and other lending investments and loans held for sale are held at
lower of cost or fair value and lower of cost or fair value less cost to sell. Pledged government securities and CMBS are classified as held to maturity and therefore recorded at the fair value at the
date of redesignation.

Effective
January 1, 2008, the Company adopted FASB Statement No. 157, or SFAS No. 157, "Fair Value Measurements," which among other things requires additional
disclosures about financial instruments carried at fair value. SFAS No. 157 establishes a hierarchical disclosure framework associated with the level of pricing observability utilized in
measuring financial instruments at fair value. Considerable judgment is necessary to interpret market data and develop estimated fair values. Accordingly, fair values are not necessarily indicative of
the amounts the Company could realize on disposition of the financial instruments. Financial instruments with readily available active quoted prices or for which fair value can be measured from
actively quoted prices generally will have a higher degree of pricing observability and will require a lesser degree of judgment to be utilized in measuring fair value. Conversely, financial
instruments rarely traded or not quoted will generally have less, or no, pricing observability and will require a higher degree of judgment to be utilized in measuring fair value. Pricing
observability is generally affected by such items as the type of financial instrument, whether the financial instrument is new to the market and not yet established, the characteristics specific to
the transaction and overall market conditions. The use of different market assumptions and/or estimation methodologies may have a material effect on estimated fair value amounts.

SFAS
No. 157 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the
measurement date, or

16

---



Gramercy Capital Corp.

Notes To Condensed Consolidated Financial Statements (Continued)

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

September 30, 2008

2. Significant Accounting Policies (Continued)

an
exit price. The level of pricing observability generally correlates to the degree of judgment utilized in measuring the fair value of financial instruments. Less judgment is utilized in measuring
fair value financial instruments such as with readily available active quoted prices or for which fair value can be measured from actively quoted prices in active markets generally have more pricing
observability. Conversely, financial instruments rarely traded or not quoted have less observability and are measured at fair value using valuation models that require more judgment. Impacted by a
number of factors, pricing observability is generally affected by such items as including the type of financial instrument, whether the financial instrument is new to the market and not yet
established, the characteristics specific to the transaction and overall market conditions.

The
three broad levels defined by the SFAS No. 157 hierarchy are as follows:



For
a further discussion regarding the measurement of financial instruments see Note 14, "Fair Value of Financial Instruments."

Revenue Recognition



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

Income
recognition is generally suspended for debt investments at the earlier of the date at which payments become 90 days past due or when, in the opinion of management, a full
recovery of income

17

---



Gramercy Capital Corp.

Notes To Condensed Consolidated Financial Statements (Continued)

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

September 30, 2008

2. Significant Accounting Policies (Continued)

and
principal becomes doubtful. Income recognition is resumed when the loan becomes contractually current and performance is demonstrated to be resumed.

The
Company designates loans as non-performing at such time as: (1) the loan becomes 90 days delinquent or (2) the loan has a maturity default other than
if subject to a forbearance agreement. All non-performing loans are placed on non-accrual status and income is recognized only upon actual cash receipt. At September 30,
2008, the Company had three first mortgage loans with an aggregate carrying value of $169,809, one second lien loan with a carrying value of $18,900 and one third lien loan with a carrying value of
$0, which were classified as non-performing loans. In April 2008, the first lien lenders commenced a foreclosure action with respect to the collateral supporting the second lien and third
lien loans referenced above and such loans changed from being classified as sub-performing loans as of March 31, 2008 to non-performing loans as of each of
June 30, 2008 and September 30, 2008. The first and second lien loans are secured by land in California, which is intended primarily for residential development. Given the significant
deterioration in the United States residential real estate markets, the Company believes that the successful restructuring of these loans is speculative, additional loan loss reserves are possible and
any such restructuring will take longer than a more customary restructuring. Therefore, there is uncertainty surrounding the possible outcome of these loans. In September 2008, the borrower and its
subsidiaries were put into an involuntary bankruptcy which resulted in an automatic stay of the foreclosure action instituted by the senior lender. In April 2008, the borrower under a first
mortgage loan classified as non-performing as of September 30, 2008 with a carrying value of $100,054 filed legal action in connection with the Company's alleged wrongful
administration of the loan. The Company believes the borrower's claim is without merit. The Company has filed a counterclaim in the form a foreclosure action to enforce its rights under the
loan documents as a result of the borrower's default. The Company's action has been stayed by the borrower's bankruptcy filing. In May 2008, the borrowers (controlled by the same sponsor) under
two of the non-performing first mortgage loans referenced above with an aggregate value of $69,755 filed a petition in bankruptcy under Chapter 11. The Company is currently
evaluating its options to protect its interest, including foreclosure and the pursuit of a guaranty provided by the sponsor for all principal due. At December 31, 2007, the Company had one
non-performing loan with a carrying value of $29,058, which was subsequently repaid in full on March 14, 2008, along with accrued interest and substantially all other fees and
charges due to the Company.

The
Company classifies loans as sub-performing if they are not performing in material accordance with their terms, but they do not qualify as non-performing
loans. The specific facts and circumstances of these loans may cause them to develop into non-performing loans should certain events occur. Management evaluates the specific facts and
circumstances of each subperforming loan, and considers factors including, but not limited to: the performance of the underlying collateral; the adequacy of reserves (e.g. for operating
deficits, interest, tenant improvements, leasing commissions), the remaining term to maturity; the likelihood that
the borrower will or will not satisfy conditions to extend the loan; and the financial condition of borrower and sponsor. At September 30, 2008, three first mortgage loans with a total carrying
value of $73,625 and three mezzanine loans with a carrying value of $100,873 were classified as sub-performing. At December 31, 2007, one first mortgage loan with a carrying value
of $10,403, and one 40% participation interest in a first mortgage loan with a carrying value of $22,000, were classified as sub-performing.

18

---



Gramercy Capital Corp.

Notes To Condensed Consolidated Financial Statements (Continued)

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

September 30, 2008

2. Significant Accounting Policies (Continued)

In
some instances, the Company may sell all or a portion of its investments to a third party. To the extent the fair value received for an investment exceeds the amortized cost of that
investment and the SFAS No.140 criteria are met, under which 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 has a discount or fees, which were deferred at the time the investment was made and were being recognized over the term of the investment, the
unamortized portion of the discount or fees are recognized at the time of sale and recorded as a gain on the sale of the investment through other income. For the three and nine months ended
September 30, 2008 and 2007, the Company recognized $(186) and $294 and $0 and $4,354, respectively, in net gains from the sale of debt investments or commitments.



Rental income from leases is recognized on a straight-line basis regardless of when payments are contractually due. Certain
lease agreements also contain provisions that require tenants to reimburse the Company for real estate taxes, common area maintenance costs and the amortized cost of capital expenditures with
interest. Such amounts are included in both revenues and operating expenses when the Company is the primary obligor for these expenses and assumes the risks and rewards of a principal under these
arrangements. Under leases where the tenant pays these expenses directly, such amounts are not included in revenues or expenses.

Deferred
revenue represents rental revenue and management fees received prior to the date earned. Deferred revenue also includes rental payments received in excess of rental revenues
recognized as a result of straight-line basis accounting.

Other
income includes fees paid by tenants to terminate their leases, which are recognized when fees due are determinable, no further actions or services are required to be performed by
the Company, and collectability is reasonably assured. In the event of early termination, the unrecoverable net book values
of the assets or liabilities related to the terminated lease are recognized as depreciation and amortization expense in the period of termination.

The
Company recognizes sales of real estate properties only upon closing, in accordance with SFAS No. 66, "Accounting for Sales of Real Estate." Payments received from purchasers
prior to closing are recorded as deposits. Profit on real estate sold is recognized using the full accrual method upon closing when the collectability of the sale price is reasonably assured and the
Company is not obligated to perform significant activities after the sale. Profit may be deferred in whole or part until the sale meets the requirements of profit recognition on sale of real estate
under SFAS No. 66.

Rent Expense

Rent expense is recognized on a straight-line basis regardless of when payments are due. Accounts payable and accrued
expenses in the accompanying consolidated balance sheet as of September 30, 2008 includes an accrual for rental expense recognized in excess of amounts due at that time. Rent expense related to
leasehold interests is included in property operating expenses, and rent expense related to office rentals is included in marketing, general and administrative expense.

19

---



Gramercy Capital Corp.

Notes To Condensed Consolidated Financial Statements (Continued)

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

September 30, 2008

2. Significant Accounting Policies (Continued)

Reserve for Possible Loan Losses

Specific valuation allowances are established for possible loan losses on loans in instances where it is deemed possible that the
Company may be unable to collect all amounts of principal and interest due according to the contractual terms of the loan. The Company considers the estimated value of the collateral securing the
loan, and compares it to the carrying value of the loan. The estimated value of the collateral is determined by selecting the most appropriate valuation methodology, or methodologies, among several
generally available and accepted in the commercial real estate industry. The determination of the most appropriate valuation methodology is based on the key characteristics of the collateral type,
collateral location, quality and prospects of the sponsor, the amount and status of any senior debt, and other factors. These methodologies include the evaluation of operating cash flow from the
property during the projected holding period, and the estimated sales value of the collateral computed by applying an expected capitalization rate to the stabilized net operating income of the
specific property, less selling costs, all of which are discounted at market
discount rates. Because the determination of estimated value is based upon projections of future economic events, which are inherently subjective, amounts ultimately realized from loans and
investments may differ materially from the net carrying value at the balance sheet date.

If,
upon completion of the valuation, the estimated fair value of the underlying collateral securing the loan is less than the net carrying value of the loan, an allowance is created
with a corresponding charge to the provision for possible loan losses. The allowance for each loan is maintained at a level the Company believes is adequate to absorb possible losses. Impairment
losses are recognized as a direct write-down of the loan investment with a corresponding charge-off to the allowance. During the nine months ended September 30, 2008,
the Company incurred charge-offs totaling $10,655 related to two defaulted loans the Company foreclosed upon which had a carrying value totaling $31,760 and two additional loans, one of
which was sold at a loss and the other was retired. During the year ended December 31, 2007, the Company incurred a charge-off totaling $3,200 related to a defaulted loan the
Company foreclosed upon which had a carrying value of $19,911 and $19,155 at September 30, 2008 and December 31, 2007, respectively, and is recorded in other assets. The Company
maintained a reserve for possible loan losses of $48,092 against ten separate investments with a carrying value of $367,083 as of September 30, 2008, and a reserve for possible loan losses of
$8,658 against eleven investments with a carrying value of $264,612 as of December 31, 2007. A substantial majority of the loan loss reserve recognized in 2008 is attributable to a broadly
syndicated second and third lien financing, secured by residential land in Southern California. The Company has reserved against the entire $15,000 third lien and $26,100 of the $45,000 second lien.
The Company continues to work with its co-lenders, the senior lending group and the borrower for a favorable resolution, but successful restructuring of these loans is speculative,
additional reserves are possible and any such restructuring will take longer than customary restructuring.

Stock Based Compensation Plans

The Company has a stock-based compensation plan, described more fully in Note 15. The Company accounts for this plan using the
fair value recognition provisions of FASB Statement No. 123(R), "Share-Based Payment, a revision of FASB Statement No. 123, Accounting for Stock-Based Compensation."

20

---



Gramercy Capital Corp.

Notes To Condensed Consolidated Financial Statements (Continued)

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

September 30, 2008

2. Significant Accounting Policies (Continued)

The
Black-Scholes option-pricing model was developed for use in estimating the fair value of traded options, which have no vesting restrictions and are fully transferable. In addition,
option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's plan has characteristics significantly different from
those of traded options and
because changes in the subjective input assumptions can materially affect the fair value estimate, in the Company's opinion, the existing models do not necessarily provide a reliable single measure of
the fair value of the Company's stock options.

Compensation
cost for stock options, if any, is recognized ratably over the vesting period of the award. The Company's policy is to grant options with an exercise price equal to the
quoted closing market price of its stock on the business day preceding the grant date. Awards of stock or restricted stock are expensed as compensation over the benefit period.

The
fair value of each stock option granted is estimated on the date of grant for options issued to co-leased employees, and quarterly awards to non-employees,
using the Black-Scholes option pricing model with the following weighted average assumptions for grants in 2008 and 2007.

2008

2007Dividend yield


8.8%


7.9%Expected life of option


5.8 years


5.9 yearsRisk-free interest rate


3.21%


4.32%Expected stock price volatility


35.0%


28.0%


Incentive Distribution (Class B Limited Partner Interest)

The Class B limited partner interests are entitled to receive an incentive return equal to 25% of the amount by which funds from
operations, or FFO, plus certain accounting gains (as defined in the partnership agreement of the Operating Partnership) exceed the product of the Company's weighted average stockholders equity (as
defined in the partnership agreement of the Operating Partnership) multiplied by 9.5% (divided by four to adjust for quarterly calculations). The Company records any distributions on the
Class B limited partner interests as an incentive distribution expense in the period when earned and when payment of such amounts has become probable and reasonably estimable in accordance with
the partnership agreement. These cash distributions will reduce the amount of cash available for distribution to the common unit holders in the Operating Partnership and to the Company's common
stockholders. In October 2008, the Company entered into a letter agreement with the Class B limited partners to waive the incentive distribution that would have otherwise been earned for the
period July 1, 2008 through December 31, 2008 and provide that starting January 1, 2009, the incentive distribution can be paid, at the Company's option, in cash or shares of
common stock of the Company. The Company incurred approximately $0 and $5,100 and $22,868 and $29,469 with respect to such Class B limited partner interests for the three and nine months ended
September 30, 2008 and 2007, respectively.

21

---



Gramercy Capital Corp.

Notes To Condensed Consolidated Financial Statements (Continued)

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

September 30, 2008

2. Significant Accounting Policies (Continued)

Derivative Instruments

In the normal course of business, the Company uses a variety of commonly used derivative instruments that are considered conventional,
or"plain vanilla" derivatives, including interest rate swaps, caps, collars and floors, to manage, or hedge, interest rate risk. The Company requires
that hedging derivative instruments be effective in reducing the interest rate risk exposure that they are designated to hedge. This effectiveness is essential for qualifying for hedge accounting.
Some derivative instruments are associated with an anticipated transaction. In those cases, hedge effectiveness criteria also require that it be probable that the underlying transaction will occur.
Instruments that meet these hedging criteria are formally designated as hedges at the inception of the derivative contract. The Company expressly prohibits the use of unconventional derivative
instruments and using derivative instruments for trading or speculative purposes. Further, the Company has a policy of only entering into contracts with major financial institutions based upon their
credit ratings and other factors.

To
determine the fair value of derivative instruments, the Company uses a variety of methods and assumptions that are based on market conditions and risks existing at each balance sheet
date. For the majority of financial instruments including most derivatives, long-term investments and long-term debt, standard market conventions and techniques such as
discounted cash flow analysis, option-pricing models, replacement cost, and termination cost are used to determine fair value. All methods of assessing fair value result in a general approximation of
value, and such value may never actually be realized.

In
the normal course of business, the Company is exposed to the effect of interest rate changes and limits these risks by following established risk management policies and procedures
including the use of derivatives. To address exposure to interest rates, the Company uses derivatives primarily to hedge the cash flow variability caused by interest rate fluctuations of its
liabilities. The Company may also use derivatives to hedge variability in sales proceeds to be received upon the sale of loans held for sale.

FASB
Statement No. 133, or SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," as amended by FASB No. 149, requires the Company to
recognize all derivatives on the balance sheet at fair value. Derivatives that are not hedges must 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 the change in fair value of the hedged asset, liability, or firm commitment through earnings, or recognized in other
comprehensive income until the hedged item is recognized in earnings. The ineffective portion of a derivative's change in fair value will be immediately
recognized in earnings. SFAS No. 133 may increase or decrease reported net income and stockholders' equity prospectively, depending on future levels of LIBOR, swap spreads and other variables
affecting the fair values of derivative instruments and hedged items, but will have no effect on cash flows, provided the contract is carried through to full term.

The
Company may employ swaps, forwards or purchased options to hedge qualifying forecasted transactions. Gains and losses related to these transactions are deferred and recognized in net
income as interest expense or other income in the same period or periods that the underlying transaction occurs expires or is otherwise terminated.

22

---



Gramercy Capital Corp.

Notes To Condensed Consolidated Financial Statements (Continued)

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

September 30, 2008

2. Significant Accounting Policies (Continued)

All
hedges held by the Company are deemed effective based upon the hedging objectives established by the Company's corporate policy governing interest rate risk management. The effect of
the Company's derivative instruments on its financial statements is discussed more fully in Note 18.

Income Taxes

The Company elected to be taxed as a REIT, under Sections 856 through 860 of the Internal Revenue Code, beginning with its
taxable year ended December 31, 2004. To qualify as a REIT, the Company must meet certain organizational and operational requirements, including a requirement to distribute at least 90% of its
ordinary taxable income to stockholders. As a REIT, the Company generally will not be subject to federal income tax on taxable income that the Company distributes to its stockholders. If the Company
fails to qualify as a REIT in any taxable year, it will then be subject to federal income taxes on taxable income at regular corporate rates and will not be permitted to qualify for treatment as a
REIT for federal income tax purposes for four years following the year during which qualification is lost unless the Internal Revenue Service grants the Company relief under certain statutory
provisions. Such an event could materially adversely affect the Company's net income and net cash available for distributions to stockholders. However, the Company believes that it will be organized
and operate in such a manner as to qualify for treatment as a REIT and the Company intends to operate in the foreseeable future in such a manner so that it will qualify as a REIT for federal income
tax purposes. The Company is subject to certain state and local taxes.

The
Company's taxable REIT subsidiaries individually referred to as a TRS, are subject to federal, state and local taxes.

For
the three and nine months ended September 30, 2008 and 2007, the Company recorded $36 and $47 and $338 and $1,301 of income tax expense, respectively, in net income from
continuing operations for income attributable to the Company's wholly-owned TRSs. The Company has assumed an effective tax rate for the three and nine months ended September 30, 2008 of 43%
taking into consideration the anticipated applicable U.S. federal statutory tax rate at September 30, 2008 of 34% and state and local taxes.

Underwriting Commissions and Costs

Underwriting commissions and costs incurred in connection with the Company's stock offerings are reflected as a reduction of additional
paid-in-capital.

Earnings Per Share

The Company presents both basic and diluted earnings per share, or EPS. Basic EPS excludes dilution and is computed by dividing net
income available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted EPS reflects the potential dilution that could occur if securities or
other contracts to issue common stock were exercised or converted into common stock, where such exercise or conversion would result in a lower EPS amount.

23

---



Gramercy Capital Corp.

Notes To Condensed Consolidated Financial Statements (Continued)

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

September 30, 2008

2. Significant Accounting Policies (Continued)

Use of Estimates

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

Concentrations of Credit Risk

Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash investments, debt
investments and accounts receivable. The Company places its cash investments in excess of insured amounts with high quality financial institutions. The Manager performs ongoing analysis of credit risk
concentrations in the Company's loan and other lending investment portfolio by evaluating exposure to various markets, underlying property types, investment structure, term, sponsors, tenants and
other credit metrics. Six investments, including a non-performing loan with a carrying value of $100,054, accounted for 22.6% of the total carrying value of the Company's loan and other
lending investments as of September 30, 2008. Six investments, including a non-performing loan with a carrying value of $100,054, accounted for approximately 16.3% and 15.9% of the
revenue earned on the Gramercy Finance's loan and other lending investments for the three and nine months ended September 30, 2008, respectively, compared to four investments which accounted
for approximately 22.0% and 19.0% of the revenue earned on the Company's loan and other lending investments for the three and nine months ended September 30, 2007, respectively. The largest
sponsor accounted for approximately 5.5% and 4.7% of the revenue earned on the Gramercy Finance's loan and other lending investments for the three and nine months ended September 30, 2008,
respectively, compared to approximately 2.8% and 3.4% of the revenue earned on the Company's loan and other lending investments for the three and nine months ended September 30, 2007.

Additionally,
two tenants, Bank of America, N.A. and Wachovia Bank, National Association, accounted for approximately 39.4% and 14.5% and 39.0% and 14.2% of Gramercy Real Estate's rental
revenue for the three and nine months ended September 30, 2008, respectively.

Recently Issued Accounting Pronouncements

In February 2007, the FASB issued Statement No. 159, or SFAS No. 159, "The Fair Value Option for Financial Assets and
Financial Liabilities." SFAS No. 159 permits entities to choose to measure many financial instruments and certain other items at fair value. SFAS No. 159 also establishes presentation
and disclosure requirements designed to facilitate comparisons between entities that choose different measurement attributes for similar types of assets and liabilities. SFAS No. 159 applies to
reporting periods beginning after November 15, 2007. The Company did not elect FAS No. 159 for any of its financial assets and financial liabilities as of September 30, 2008.

In
June 2007, the American Institute of Certified Public Accountants, or AICPA, issued Statement of Position ("SOP") 07-01 "Clarification of the Scope of the Audit and
Accounting Guide for Investment Companies and Accounting by Parent Companies and Equity Method Investors for Investments in Investment Companies." SOP 07-1 clarifies the scope of
accounting for investment companies and provides guidance for determining whether an entity is within the scope of the AICPA Audit and Accounting Guide for Investment Companies or the Guide. For those
entities that are

24

---



Gramercy Capital Corp.

Notes To Condensed Consolidated Financial Statements (Continued)

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

September 30, 2008

2. Significant Accounting Policies (Continued)

investment
companies under SOP 07-1, the specialized industry accounting principles of the Guide (referred to as Investment Company accounting) should be retained by a parent
company when it consolidates its interest in the investment company or by an equity method investor when it records its interest in the investment company. The SOP also provides for certain disclosure
requirements for parent companies and equity method investors in investment companies that continue investment company accounting in the parent's consolidated financial statements or the financial
statements of the equity method investor. The SOP was to be effective for fiscal years beginning on or after December 15, 2007; however in a meeting on October 17, 2007, the FASB voted
to indefinitely defer the effective date and add to the FASB's technical agenda, consideration of amending certain provisions of the SOP. The Company maintains an exemption from the Investment Company
Act of 1940, as amended, and is therefore not regulated as an investment company and as a REIT, the Company is not subject to the AICPA's Investment Company Accounting and Auditing Guide. The Company
continues to monitor the AICPA's developments with respect to SOP 07-1.

In
December 2007, the FASB issued Statement No. 141 (revised), "Business Combinations," or SFAS No. 141(R), which attempts to improve the relevance, representational
faithfulness, and comparability of the information that a reporting entity provides in its financial reports about a business combination and its effects. This Statement replaces SFAS No. 141,
"Business Combinations." SFAS No. 141(R) retains the fundamental requirements in Statement No. 141 that the acquisition method of accounting (which Statement No. 141 called the
purchase method) be used for all business combinations and for an acquirer to be identified for each business combination. This Statement also retains the guidance in SFAS No. 141 for
identifying and recognizing intangible assets separately from goodwill. The most significant changes in SFAS No. 141(R) are: (1) acquisition and restructuring costs would be now
expensed; (2) stock consideration will be measured based on the quoted market price as of the acquisition date instead of the date the deal is announced; (3) contingent consideration
arising from contractual and noncontractual contingencies that meet the more-likely-than-not recognition threshold will be measured and recognized as an asset or
liability at fair value at the acquisition date using a probability-weighted discounted cash flows model, with subsequent changes in fair value reflected in earnings (noncontractual contingencies that
do not meet the more-likely-than-not criteria will continue to be recognized when they are probable and reasonably estimable) and (4) acquirer records 100%
step-up to fair value for all assets and liabilities, including the minority interest portion and goodwill which is recorded as if a 100% interest was acquired. SFAS No. 141(R) is
effective for fiscal years beginning after December 15, 2008. The Company is currently evaluating the effect, if any, that this pronouncement will have on its future financial position and
results of operations.

In
December 2007, the FASB issued Statement No. 160, "Non-Controlling Interest on Consolidated Financial
Statements"an amendment of Accounting Research Bulletin, or ARB No. 51. This Statement amends ARB No. 51 to establish
accounting and reporting standards for the non-controlling interest in a subsidiary and for the deconsolidation of a subsidiary. It clarifies that a non-controlling interest in
a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements. Additionally, this Statement requires that consolidated net
income include the amount attributable to both the parent and the non-controlling interest. This Statement is effective for interim periods beginning on or after December 15, 2008.
The

25

---



Gramercy Capital Corp.

Notes To Condensed Consolidated Financial Statements (Continued)

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

September 30, 2008

2. Significant Accounting Policies (Continued)

Company
is currently evaluating the impact, if any, that the adoption of this Statement will have on the consolidated financial statements of the Company.

In
February 2008, the FASB issued Staff Position No. 140-3, or FSP No. 140-3, "Accounting for Transfers of Financial Assets and Repurchase Financing
Transactions." FSP No. 140-3 provides guidance on the accounting for a purchase of a financial asset from a counterparty and contemporaneous financing of the acquisition through
repurchase agreements with the same counterparty. Under this guidance, the purchase and related financing are linked, unless all of the following conditions are met at the inception of the
transaction: (1) the purchase and corresponding financing are not contractually contingent; (2) the repurchase financing provides recourse; (3) the financial asset and repurchase
financing are readily obtainable in the marketplace and are executed at market rates; and (4) the maturity of financial asset and repurchase are not coterminous. A linked transaction would
require a determination under FAS No. 140 to conclude if the transaction meets the requirements for sale accounting. If the linked transaction does not meet sale accounting requirements, the
net investment in the linked transaction is to be recorded as a derivative with the corresponding change in fair value of the derivative being recorded through earnings. The value of the derivative
would reflect changes in the value of the underlying debt investments and changes in the value of the underlying credit provided by the counterparty. The Company currently presents these transactions
gross, with the acquisition of the financial assets in total assets and the related repurchase agreements as financing in total liabilities on the consolidated balance sheet and the interest income
earned on the debt investments and interest expense incurred on the repurchase obligations are reported gross on the consolidated income statements. FSP No. 140-3 is effective for
financial statements issued for fiscal years beginning after November 15, 2008. The Company is currently evaluating the effect, if any, that this pronouncement will have on its future financial
position and results of operations.

In
February 2008, the FASB issued FASB Staff Position 157-1, "Application of FASB Statement No. 157 to FASB Statement No. 13 and Other Accounting
Pronouncements That Address Fair Value Measurements for Purposes of Lease Classification or Measurement under Statement 13" ("FSP 157-1") and FSP 157-2,
"Effective Date of FASB Statement No. 157" ("FSP 157-2"). FSP 157-1 amends SFAS No. 157 to remove certain leasing transactions from
its scope. FSP 157-2 provides a one-year deferral of the effective date of SFAS No. 157 for all non-financial assets and
non-financial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis. These non-financial items include
assets and liabilities such as reporting units measured at fair value in a goodwill impairment test and
non-financial assets acquired and liabilities assumed in a business combination. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after
November 15, 2007 and was adopted by the Company, as it applies to its financial instruments, effective January 1, 2008. The adoption of SFAS No. 157 as it relates to
financial instruments did not have a significant impact on the Company's Consolidated Financial Statements. The Company will adopt the provisions of SFAS No. 157 as it relates to its
non-financial assets and non-financial liabilities effective January 1, 2009, and the Company is currently evaluating the effect, if any, that this pronouncement will
have on its future financial position and results of operations.

In
March 2008, the FASB issued Statement No. 161, or SFAS No. 161, "Disclosures about Derivative Instruments and Hedging Activities," an amendment of FASB Statement
No. 133. SFAS No. 161 is intended to improve financial reporting about derivative instruments and hedging activities

26

---



Gramercy Capital Corp.

Notes To Condensed Consolidated Financial Statements (Continued)

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

September 30, 2008

2. Significant Accounting Policies (Continued)

by
requiring enhanced disclosures to enable investors to better understand how and why an entity uses derivative instruments and their effects on an entity's financial position, financial performance
and cash flows. SFAS No. 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008 with early adoption encouraged. The
Company is currently evaluating the effect, if any, that this pronouncement will have on its future financial position and results of operations.

In
April 2008, the FASB directed the FASB Staff to issue FSP No. FAS 142-3, "Determination of the Useful Life of Intangible Assets." FSP FAS
No. 142-3 amends the factors that should be considered in developing a renewal or extension assumptions used for purposes of determining the useful life of a recognized intangible
asset under FASB Statement No. 142, "Goodwill and Other Intangible Assets," or SFAS No. 142. FSP FAS No. 142-3 is intended to improve the consistency between the
useful life of a recognized intangible asset under SFAS No. 142 and the period of expected cash flows used to measure the fair value of the asset under SFAS No. 141(R) and other U.S.
generally accepted accounting principles. FSP FAS No. 142-3 is effective for fiscal years beginning after December 15, 2008. Earlier application is not permitted. The Company
believes the impact of adopting FSP FAS No. 142-3 will not have a material effect on the consolidated financial statements.

In
April of 2008, the FASB voted to eliminate QSPEs from the guidance in SFAS No.140 and to remove the scope exception for QSPEs from FIN 46R. This will require that VIEs
previously accounted for as QSPEs will need to be analyzed for consolidation according to FIN 46R. While the revised standards have not been finalized and deferred for potential application
until 2010, this change may affect the Company's consolidated financial statements.

In
October 2008, the FASB issued Staff Position 157-3, Determining the Fair Value of a Financial Asset in a Market That Is Not Active ("FSP 157-3"), which
clarifies the application of SFAS 157 in an inactive market and provides an illustrative example to demonstrate how the fair value of a financial asset is determined when the market for that
financial asset is not active.
The guidance provided by FSP 157-3 is consistent with the Company's approach to valuing financial assets for which there are no active markets.

27

---



Gramercy Capital Corp.

Notes To Condensed Consolidated Financial Statements (Continued)

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

September 30, 2008

3. Loans and Other Lending Investments

The aggregate carrying values, allocated by product type and weighted-average coupons, of the Company's loan, and other lending investments and CMBS investments as of
September 30, 2008 and December 31, 2007, including loans held for sale, were as follows:

Carrying Value(1)

Allocation by
Investment Type

Fixed Rate:
Average Yield

Floating Rate:
Average Spread over
LIBOR(2)2008

2007

2008

2007

2008

2007

2008

2007Whole loans, floating rate

$
1,245,982

$
1,594,338


55.9
%

60.5
%







372 bps


332 bpsWhole loans, fixed rate


164,618


204,192


7.4
%

7.7
%

7.10
%

7.79
%




Subordinate interests in whole loans, floating rate


101,179


146,901


4.5
%

5.6
%







401 bps


447 bpsSubordinate interests in whole loans, fixed rate


62,832


61,890


2.8
%

2.3
%

9.26
%

8.78
%




Mezzanine loans, floating rate


432,117


413,813


19.4
%

15.7
%







670 bps


607 bpsMezzanine loans, fixed rate


212,052


203,753


9.5
%

7.7
%

9.49
%

8.91
%




Preferred equity, fixed rate


11,990


11,858


0.5
%

0.5
%

10.22
%

10.09
%




Subtotal/ Weighted average


2,230,770


2,636,745


100.0
%

100.0
%

8.61
%

8.45
%

446 bps


395 bpsCMBS, floating rate


69,460


23,817


8.1
%

3.0
%







687 bps


593 bpsCMBS, fixed rate


787,942


768,166


91.9
%

97.0
%

6.22
%

6.13
%




Subtotal/ Weighted average


857,402


791,983


100.0
%

100.0
%

6.22
%

6.13
%

687 bps


593 bpsTotal

$
3,088,172

$
3,428,728


100.0
%

100.0
%

7.09
%

7.02
%

455 bps


397 bps


---

28

---



Gramercy Capital Corp.

Notes To Condensed Consolidated Financial Statements (Continued)

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

September 30, 2008

3. Loans and Other Lending Investments (Continued)

As of September 30, 2008, the Company's loans and other lending investments, excluding CMBS investments had the following maturity
characteristics:

Year of Maturity

Number of Investments Maturing

Current Carrying Value (In thousands)

% of Total2008


7

$
232,009


10.4
%2009


38


1,208,962


54.2
%2010


13


390,473


17.5
%2011


2


30,890


1.4
%2012


2


63,086


2.8
%Thereafter


10


305,350


13.7
%Total


72

$
2,230,770


100.0
%Weighted-average maturity(1)





1.9 years


---

For
the three and nine months ended September 30, 2008 and 2007, the Company's investment income from loan and other lending investments and CMBS investments, including loans held
for sale, was generated by the following investment types:

Three months ended
September 30, 2008

Three months ended
September 30, 2007Investment Type

Investment
Income

% of
Total

Investment
Income

% of
TotalWhole loans

$
27,416


45.3
%
$
47,962


56
%Subordinate interests in whole loans


2,154


3.6
%

4,050


5
%Mezzanine loans


16,529


27.3
%

25,813


30
%Preferred equity


316


0.5
%

416


1
%CMBS


14,137


23.3
%

7,555


8
%Total

$
60,552


100.0
%
$
85,796


100.0
%


29

---



Gramercy Capital Corp.

Notes To Condensed Consolidated Financial Statements (Continued)

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

September 30, 2008

3. Loans and Other Lending Investments (Continued)



Nine months ended
September 30, 2008

Nine months ended
September 30, 2007Investment Type

Investment
Income

% of
Total

Investment
Income

% of
TotalWhole loans

$
98,699


50.0
%
$
125,576


57
%Subordinate interests in whole loans


7,549


3.8
%

19,086


9
%Mezzanine loans


49,445


25.0
%

63,119


29
%Preferred equity


943


0.4
%

2,832


1
%CMBS


41,246


20.8
%

7,980


4
%Total

$
197,882


100.0
%
$
218,593


100.0
%


At
September 30, 2008 and December 31, 2007, the Company's loans and other lending investments excluding the CMBS investments, had the following geographic diversification:

September 30, 2008

December 31, 2007Region

Carrying
Value

% of
Total

Carrying
Value

% of
TotalNortheast

$
1,097,021


49.2
%
$
1,130,799


42.9
%West


611,031


27.4
%

714,045


27.1
%South


21,417


1.0
%

405,410


15.4
%Midwest


40,608


1.8
%

79,750


3.0
%Southwest


81,329


3.6
%

103,217


3.9
%Mid-Atlantic


74,586


3.3
%

150,300


5.7
%Various


231,276


10.4
%

53,224


2.0
%Southeast


69,755


3.1
%




Other


3,747


0.2
%




Total

$
2,230,770


100.0
%
$
2,636,745


100.0
%


30

---



Gramercy Capital Corp.

Notes To Condensed Consolidated Financial Statements (Continued)

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

September 30, 2008

3. Loans and Other Lending Investments (Continued)

At
September 30, 2008 and December 31, 2007, the Company's loans and other lending investments, excluding the CMBS investments, by property type are as follows:

September 30, 2008

December 31, 2007Property Type

Carrying
Value

% of
Total

Carrying
Value

% of
TotalOffice

$
872,167


39.1
%
$
970,362


36.8
%Hotel(1)


348,354


15.6
%

468,604


17.8
%Multifamily


325,711


14.6
%

366,665


13.9
%Retail(2)


254,337


11.4
%

217,223


8.2
%Land-commercial


208,053


9.3
%

200,445


7.6
%Land-residential(3)


82,775


3.7
%

138,771


5.3
%Condominium


59,556


2.7
%

126,771


4.8
%Mixed-use


22,813


1.0
%

80,784


3.1
%Industrial


53,008


2.2
%

50,730


1.9
%Other


4,303


0.2
%

16,390


0.6
%Total

$
2,230,770


100.0
%
$
2,636,745


100.0
%


---

31

---



Gramercy Capital Corp.

Notes To Condensed Consolidated Financial Statements (Continued)

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

September 30, 2008

3. Loans and Other Lending Investments (Continued)



The
Company recorded provisions for loan losses of $18,875 and $50,089 and $2,500 and $6,648 for the three and nine months ended September 30, 2008, and 2007, respectively. These
provisions represent increases in loan loss reserves based on management's estimates considering delinquencies, loss experience and collateral quality by individual asset or category of asset.

During
the nine months ended September 30, 2008, the Company incurred charge-offs totaling $10,655 related to two defaulted loans the Company foreclosed upon which had
a carrying value totaling $31,760 and two additional loans, one of which was sold at a loss and the other was retired. During the year ended December 31, 2007, the Company incurred a
charge-off totaling $3,200, relating to one defaulted loan which the Company foreclosed upon which had a carrying value of $19,911 and $19,155 at September 30, 2008 and
December 31, 2007, respectively.

Changes
in the reserve for possible loan losses were as follows:

Reserve for possible loan losses, December 31, 2006

$
2,460Additional provision for loan losses


9,398Charge-offs


(3,200
)Reserve for possible loan losses, December 31, 2007


8,658Additional provision for loan losses


50,089Charge-offs


(10,655
)Reserve for possible loan losses, September 30, 2008

$
48,092


The
following is a summary of the Company's CMBS investments at September 30, 2008:

Description

Number of
Securities

Face Value

Carrying
Value

Gross
Unrealized
Gain

Gross
Unrealized
Loss

Fair
ValueHeld to maturity:Floating rate CMBS


8

$
73,664

$
69,460




$
(11,034
)
$
58,426Fixed rate CMBS


63


815,578


787,942


267


(208,004
)

580,205Total


71

$
889,242

$
857,402


267

$
(219,038
)
$
638,631


32

---





Gramercy Capital Corp.        Notes To Condensed Consolidated Financial Statements        (Unaudited, amounts in thousands, except share and per share data)        September 30, 2008

3. Loans and Other Lending Investments (Continued)

The
following is a summary of the underlying credit ratings of the Company's CMBS investments at September 30, 2008:

Book Value

PercentageAAA

$
788,597


92.0
%AA


29,580


3.4BBB-


11,856


1.4BB+


7,432


0.9BB


4,815


0.6B+


4,652


0.5B


4,226


0.5B-


5,216


0.6Not rated


1,029


0.1Total

$
857,402


100.0
%


The
Company evaluates CMBS investments to determine if there has been an other-than-temporary impairment. Substantially all of the Company's CMBS investments have
an unrealized loss (the carrying value is in excess of the fair value) which has existed longer than twelve months. These unrealized losses are primarily the result of market factors other than credit
impairment which is generally indicated by a significant change in estimated cash flows from the cash flows previously estimated based on actual prepayments and credit loss experience. The carrying
value of all CMBS investments is in excess of their market values. This difference can be caused by changes in interest rates, changes in credit spreads, realized losses in the underlying collateral,
or general market conditions. The Company evaluates CMBS investments on a quarterly basis and has determined that there have been no changes in expected cash flows. The Company's assessment of cash
flows, which is supplemented by third-party research reports and dialogue with market participants, combined with the Company's ability and intent to hold its CMBS investments to maturity, at which
point the Company expects to recover its carrying value, is the basis for its conclusion that these investments are not other-than-temporarily impaired, despite the difference
between the carrying value the and fair value. The Company attributes the current difference between carrying value and fair value to current market conditions. The Company believes the carrying value
of the securities are fully recoverable over their expected holding period. The Company possesses both the intent and the ability to hold the securities until it has
recovered the amortized costs. Accordingly, the Company does not believe any of the securities are other-than-temporarily impaired. In the future, certain interpretations of
the accounting rules may require the Company, notwithstanding these determinations, to recognize an other-than-temporary impairment due solely to the duration of time that the
carrying values are less than book value.

In
connection with a preferred equity investment, which was repaid in October 2006, the Company has guaranteed a portion of the outstanding principal balance of the first mortgage loan
that is a financial obligation of the entity in which the Company has invested in the event of a borrower default under such loan. The loan matures in 2032. This guarantee is considered to be an
off-balance-sheet

33

---



Gramercy Capital Corp.

Notes To Condensed Consolidated Financial Statements (Continued)

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

September 30, 2008

3. Loans and Other Lending Investments (Continued)

arrangement
and will survive until the repayment of the first mortgage loan. As compensation, the Company received a credit enhancement fee of $125 from the borrower, which is recognized as the fair
value of the guarantee and has been recorded on its consolidated Balance Sheet as a liability. The liability will be amortized over the life of the guarantee using the straight-line method
and corresponding fee income will be recorded. The Company's maximum exposure under this guarantee is approximately $1,411 as of September 30, 2008. Under the terms of the guarantee, the
investment sponsor is required to reimburse the Company for the entire amount paid under the guarantee until the guarantee expires.

4. Property Acquisitions



On April 1, 2008, the Company completed the acquisition of American Financial Realty Trust (NYSE: AFR), or American Financial,
in a transaction with a total value of approximately $3.3 billion, including the assumption of approximately $1.3 billion of American Financial's secured debt. The following table
represents the cost of the acquired entity, and the consideration paid:

Cash consideration ($5.50 per share)

$
710,910Common stock consideration(1)


378,672Additional cash consideration equal to a portion of Gramercy's special common stock dividend declared(2)


31,271Purchase of minority interest in American Financial


14,497Estimated merger costs


150,396Total consideration


1,285,746Repayment of American Financial's convertible notes and credit facilities at closing


707,650Assumption of American Financial's liabilities


1,316,004Total purchase price

$
3,309,400






34

---



Gramercy Capital Corp.

Notes To Condensed Consolidated Financial Statements (Continued)

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

September 30, 2008

4. Property Acquisitions (Continued)



The
Company has not yet obtained all the information necessary to finalize its estimates to complete the purchase price allocations in accordance with SFAS No. 141 related to the
American Financial acquisition. The purchase price allocations will be finalized once the information indentified has been received, which should not be longer than one year from the date of
acquisition.

Pro Forma

The following table summarizes, on an unaudited pro forma basis, the Company's combined results of operations for the nine months ended
September 30, 2008 and 2007 as though the acquisition of American Financial was completed on January 1, 2007. The supplemental pro forma operating data is not necessarily indicative of
what the actual results of operations would have been assuming the transaction had been completed as set forth above, nor do they purport to represent the Company's results of operations for future
periods. In addition, the following supplement pro forma operating data does not present the sale of assets through September 30, 2008. The Company accounted for the acquisition of assets
utilizing the purchase method of accounting.

2008

2007Pro forma revenues

$
550,633

$
592,239Pro forma net income available to common stockholders

$
47,462

$
170,922Pro forma earnings per common share-basic

$
0.93

$
4.04Pro forma earnings per common share-diluted

$
0.93

$
3.86Pro forma common shares-basic


51,226


42,265Pro forma common share-diluted


51,304


44,304


35

---



Gramercy Capital Corp.

Notes To Condensed Consolidated Financial Statements (Continued)

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

September 30, 2008

5. Dispositions and Assets Held for Sale

During the three and nine months ended September 30, 2008, the Company sold 16 and 36 properties, respectively, for net sales proceeds of $19,308 and $63,877, respectively. The
sales transactions resulted in no gains or losses for either of the three or nine months ended September 30, 2008.

In
accordance with the provisions of SFAS No. 144, the Company classified 143 properties as held for sale as of September 30, 2008. The following table summarizes
information for these properties:

September
30, 2008Assets held for sale:Real estate investments, at cost:Land

$
38,389Buildings and improvements


152,456Total real estate investments, at cost


190,844Less accumulated depreciation


190,844Other assets, net


2,700Real estate held for sale


193,544Loans held for sale


Real estate owned


10,770Total assets held for sale:


204,314Liabilities related to assets held for sale:Accrued expenses


5,313Deferred revenue


4,252Tenant security deposits


61Total liabilities related to assets held for sale


9,626Net assets held for sale

$
194,688


36

---



Gramercy Capital Corp.

Notes To Condensed Consolidated Financial Statements (Continued)

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

September 30, 2008

5. Dispositions and Assets Held for Sale (Continued)

The
following operating results of the properties held for sale as of September 30, 2008, and the properties sold during the three and nine months ended September 30, 2008
are included in discontinued operations for all periods presented:

Three Months Ended September 30, 2008

Nine Months Ended September 30, 2008Operating results:Revenues

$
4,969


11,023Operating expenses


5,710


11,780Interest expense


82


78Depreciation and amortization


2


2Loss from operations before minority interest


(661
)

(681
)Minority interest


7


(2
)Loss from operations, net


(654
)

(683
)Yield maintenance fees





(556
)Net loss from discontinued operations

$
(654
)

(1,239
)


Discontinued
operations have not been segregated in the consolidated statements of cash flows.

6. Investments in Unconsolidated Joint Ventures



In April 2005, the Company closed on a $57,503 initial investment in a joint venture with SL Green to acquire, own and operate the
South Building located at One Madison Avenue, New York, New York, or the South Building. The joint venture was owned 45% by a wholly-owned subsidiary of the Company and 55% by a wholly-owned
subsidiary of SL Green. The joint venture interests are pari-passu. The joint venture completed the acquisition of the South Building from Metropolitan Life Insurance Company for the
purchase price of approximately $802,800 plus closing costs, financed in part through a $690,000 first mortgage loan on the South Building. The first mortgage was non-recourse to the
Company. The South Building comprises approximately 1.2 million square feet and is almost entirely net leased to Credit Suisse Securities (USA) LLC, or CS, pursuant to a lease with a
15-year remaining term. In July 2007, the Company entered into an agreement to sell its entire investment in the One Madison Avenue joint venture to SL Green. In August 2007, an affiliate
of SL Green loaned approximately $147,000 to the Operating Partnership. This loan was to be repaid, with interest at an annual rate of 5.80%, on the earlier of September 1, 2007 or the
closing of the sale of the Company's 45% interest in One Madison Avenue to SL Green. The sale transaction closed on August 17, 2007, at which time the Company realized a gain of $92,235
and simultaneously repaid the entire loan amount with interest due through such date. The Company recorded its pro rata share of net losses of the joint venture of $130 and $759 for the three
and nine months ended September 30, 2007.

37

---



Gramercy Capital Corp.

Notes To Condensed Consolidated Financial Statements (Continued)

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

September 30, 2008

6. Investments in Unconsolidated Joint Ventures (Continued)



The Company owns a 25% interest in an equity owner and a fee interest in 200 Franklin Square Drive, a 200,000 square foot building
located in Somerset, New Jersey which is 100% net leased to Philips Holdings, USA Inc, a wholly-owned subsidiary of Royal Phillips Electronics through December 2021. As of September 30, 2008
and December 31, 2007, the investment has a carrying value of $2,269 and $2,269, respectively. The Company recorded its pro rata share of net income of the joint venture of $26 and $63 and $27
and $86 for the three and nine months ended September 30, 2008 and 2007, respectively.



In November 2005, the Company closed on the purchase of a 50% interest in an office building in Pasadena, CA. The Company also acquired
an interest in certain related assets as part of the transaction. The 345,000 square foot office property, which is net leased to Bank of America through September 2015, assuming the exercise of
options, and related collateral were acquired for $52,000 plus closing costs, using a non-recourse, $50,000, ten-year fixed-rate first mortgage loan. For the three
and nine months ended September 30, 2008 and 2007, the Company recorded its pro rata share of net losses of the joint ventures of $336 and $1,037 and $351 and $1,092, respectively.



In April 2007, the Company purchased for $103,200 a 45% Tenant-In-Common, or TIC, interest to acquire the fee
interest in a parcel of land located at 2 Herald Square, located along 34th Street in New York, New York. The acquisition was financed with a $86,063 ten-year fixed rate mortgage
loan. The property is subject to a long-term ground lease with an unaffiliated third party for a term of 70 years. The remaining TIC interest is owned by a wholly-owned subsidiary
of SL Green. The TIC interests are pari-passu. As of September 30, 2008 and December 31, 2007, the investment had a carrying value of $24,881 and $20,390, respectively. For
the three and nine months ended September 30, 2008 and 2007 the Company recorded its pro rata share of net income of $1,237 and $3,991 and $772 and $1,871, respectively.



In July 2007, the Company purchased for $144,240 an investment in a 45% TIC interest to acquire a 79% fee interest and 21% leasehold
interest in the fee position in a parcel of land located at 885 Third Avenue, on which is situated The Lipstick Building. The transaction was financed with a $120,443 ten-year
fixed-rate mortgage loan. The property is subject to a 70-year leasehold ground lease with an unaffiliated third party. The remaining TIC interest is owned by a wholly-owned
subsidiary of SL Green. The TIC interests are pari-passu. As of September 30, 2008 and December 31, 2007, the investment had a carrying value of $34,866 and $28,332
respectively. The Company recorded its pro rata share of net income of $1,476 and $4,815 for the three and nine months ended September 30, 2008, respectively.

38

---



Gramercy Capital Corp.

Notes To Condensed Consolidated Financial Statements (Continued)

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

September 30, 2008

6. Investments in Unconsolidated Joint Ventures (Continued)



The Company, through its acquisition of American Financial on April 1, 2008, obtained an interest in a joint venture with UBS.
The joint venture, as of September 30, 2008, owns and manages 84 bank branches totaling approximately 415,000 square feet. These branches are fully occupied, on a triple net basis, by Citizens
Bank, N.A. and Charter One Bank, N.A., two bank subsidiaries of Citizens Financial Group, Inc. The investment had a carrying value of $12,122 at September 30, 2008. The Company recorded
its pro rata share of net loss of $674 and $1,402 for the three months and nine months ended September 30, 2008, respectively.

7. Junior Subordinated Debentures

In May 2005, August 2005 and January 2006, the Company completed issuances of $50,000 each in unsecured trust preferred securities through three Delaware Statutory Trusts, or DSTs,
Gramercy Capital Trust I, or GCTI, Gramercy Capital Trust II, or GCTII, and Gramercy Capital Trust III, or GCT III, that are also wholly-owned subsidiaries of the Operating Partnership. The securities
issued in May 2005 bear interest at a fixed rate of 7.57% for the first ten years ending June 2015. The securities issued in August 2005 bear interest at a fixed rate of 7.75% for the first ten years
ending October 2015. Thereafter, the rates on the 2005 issuances will float based on the three-month LIBOR plus 300 basis points. The securities issued in January 2006 bear interest at a fixed rate of
7.65% for the first ten years ending January 2016, with an effective rate of 7.43% when giving effect to the swap arrangement previously entered into in contemplation of this financing. Thereafter,
the rate will float based on the three-month LIBOR plus 270 basis points.

All
issuances of trust preferred securities require quarterly interest distributions; however, payments may be deferred while the interest expense is accrued for a period of up to four
consecutive quarters if the Operating Partnership exercises its right to defer such payments, which it may elect to do on more than one occasion. The trust preferred securities are redeemable, at the
option of the Operating Partnership, in whole or in part, with no prepayment premium any time after June 30, 2010, October 30, 2010 or January 30, 2011 for the securities issued
by GCTI, GCTII and GCTIII, respectively.

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

The
Company's interests in GCTI, GCTII and GCTIII are accounted for using the equity method and the assets and liabilities of those entities are not consolidated into its financial
statements. Interest on the junior subordinated notes is included in interest expense on the Company's consolidated

39

---



Gramercy Capital Corp.

Notes To Condensed Consolidated Financial Statements (Continued)

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

September 30, 2008

7. Junior Subordinated Debentures (Continued)

statements
of income while the value of the junior subordinated notes, net of the Company's investment in the trusts that issued the securities, are presented on the consolidated balance sheet.

8. Collateralized Debt Obligations

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

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

In
August 2007, the Company issued $1,100,000 of CDOs through two newly-formed indirect subsidiaries, Gramercy Real Estate CDO 2007-1 Ltd., or the 2007 Issuer, and
together with the 2005 Issuer and the 2006 Issuer, the Issuers, and Gramercy Real Estate CDO 2007-1 LLC, or the 2007 Co-Issuer, and together with the 2005
Co-Issuer and the 2006 Co-Issuer, the Co-Issuers. The CDO consists of $1,045,550 of investment grade notes, $22,000 of non-investment grade notes, which
were co-issued by the 2007 Issuer and the 2007 Co-Issuer, and $32,450 of preferred shares, which were issued by the 2007 Issuer. The investment grade notes were issued with
floating rate coupons with a combined weighted average rate of three-month LIBOR plus 0.46%. The Company incurred approximately $16,816 of costs related to Gramercy Real Estate CDO 2007-1,
which are amortized on a level-yield basis over the average life of the CDO.

The
Company retained all non-investment grade securities, the preferred shares and the common shares in the Issuers and Co-Issuers of each CDO. The Issuer in each
CDO holds assets, consisting primarily of whole loans, subordinate interests in whole loans, mezzanine loans and preferred equity investments and CMBS, which serve as collateral for the CDO. Each CDO
may be replenished, pursuant to certain rating agency guidelines relating to credit quality and diversification, with substitute collateral for loans that are repaid during the first five years of the
CDO. Thereafter, the CDO securities will be retired in sequential order from senior-most to junior-most as loans are repaid. The financial statements of the Issuer of each CDO
are consolidated in the Company's financial statements. The investment grade notes are treated as a secured financing, and are non-recourse to the Company.

40

---



Gramercy Capital Corp.

Notes To Condensed Consolidated Financial Statements (Continued)

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

September 30, 2008

8. Collateralized Debt Obligations (Continued)

Proceeds
from the sale of the investment grade notes issued in each CDO were used to repay substantially all outstanding debt under the Company's repurchase agreements and to fund additional
investments.

During
the three months ended September 30, 2008, the Company repurchased, at a discount, $9,000 of investment grade notes of the 2005 issuer, and $12,000 of investment grade
notes of the 2006 Issuer. During the nine months ended September 30, 2008, the Company repurchased, at a discount, $25,900 of investment grade notes of the 2005 Issuer, $24,000 of investment
grade notes of the 2006 issuer, and $22,400 of investment grade notes of the 2007 Issuer. The Company recorded a net gain of $11,681 and $33,378 for the three and nine months ended
September 30, 2008, respectively, in connection with the repurchase of notes of such Issuers.

9. Debt Obligations

Term Loan, Credit Facility and Repurchase Facility

The repurchase facility with Wachovia Capital Markets, LLC or one or more of its affiliates, or Wachovia, was initially
established as a $250,000 facility, was increased to $350,000 from $250,000 effective January 2005, and was subsequently increased to $500,000 effective April 2005. In June 2007, the facility was
modified further by reducing the credit spreads. In July 2008, the repurchase facility was terminated and a new facility was executed by subsidiaries of the Company with Wachovia to provide for a
total credit availability of $215,680, comprised of a term loan equal to $115,680 and a revolving loan equal to $100,000 with a credit spread of 242.5 basis points (which will be increased to 267.5
basis points upon an extension of the maturity of the credit facility). The term of the credit facility is two years and the borrowers may extend the term for an additional twelve-month period if
certain conditions are met. Advance rates for assets acquired pursuant to the credit facility vary from 50% to 80% of purchase price, depending on the type and structure of the asset. The lender has a
consent right with respect to the inclusion of investments in this facility, determines periodically the market value of the investments, and has the right to require a pay down to the corresponding
loan with respect to a reduction in an investment's market value. Wachovia's ability to mark an asset, however, is limited to situations where an asset's value has been affected by credit issues with
respect to the related underlying property. Wachovia cannot mark an asset based on credit spreads or other criteria outside of property-level credit issues. The Company had no accrued interest and
borrowings of $76,139 at a weighted average spread to LIBOR of 2.27% as of September 30, 2008, and no accrued interest and borrowings of $165,286 on the repurchase facility at a weighted
average spread to LIBOR of 1.33% as of December 31, 2007. The Company has guaranteed a portion of its consolidated subsidiaries' obligations under this facility.

41

---



Gramercy Capital Corp.

Notes To Condensed Consolidated Financial Statements (Continued)

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

September 30, 2008

9. Debt Obligations (Continued)

Borrowings
under the Wachovia facility at September 30, 2008 and December 31, 2007 were secured by the following investments:

Carrying ValueInvestment Type

2008

2007Whole loans

$
74,482

$
276,869Mezzanine loans


117,993


148,164Total

$
192,475

$
425,033


Subsidiaries
of the Company also have entered into a repurchase facility with Goldman Sachs Mortgage Company, or Goldman. In October 2006, this facility was increased from $200,000 to
$400,000 and its maturity date extended until September 2009. In June 2007, the facility was modified further by reducing the credit spreads. In August 2008, the facility was amended to reduce the
borrowing capacity to $200,000 and to provide for an extension of the maturity to December 2010 for a fee, provided that no event of default has occurred. The facility bears interest at spreads of
2.00% to 2.30% over one-month LIBOR and, based on its expected investment activities, provides for advance rates that vary from 65% to 75% based upon the collateral provided under a
borrowing base calculation. The lender has a consent right to the inclusion of investments in this facility, determines periodically the market value of the investments, and has the right to require
additional collateral, a partial repayment of the facility (margin call), or a reduction in unused availability under the facility, sufficient to rebalance the facility if the estimated market value
of the included investments declines. The Company had accrued interest of $120 and borrowings of $31,855 at a weighted average spread to LIBOR of 2.50% as of September 30, 2008, and accrued
interest of $189 and borrowings of $34,911 at a weighted average spread to LIBOR of 1.07% under this facility at December 31, 2007. The Company has guaranteed a portion of its consolidated
subsidiaries' obligations under this facility.

Borrowings
under the Goldman facility at September 30, 2008 and December 31, 2007 were secured by the following investments:

Carrying ValueInvestment Type

2008

2007Whole loans

$
62,147

$
151,679Total

$
62,147

$
151,679


42

---



Gramercy Capital Corp.

Notes To Condensed Consolidated Financial Statements (Continued)

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

September 30, 2008

9. Debt Obligations (Continued)

The terms of the Wachovia credit facility and Goldman repurchase facility (together with the related guarantees) includes covenants that (a) limit the Company's maximum total
indebtedness to no more than 85% of total assets, (b) require the Company to maintain minimum liquidity of at least $15,000, (c) require the Company's fixed charge coverage ratio to be
at no time less than 1.25 to 1.00, (d) require the Company's minimum interest coverage ratio to be at no time less than 1.35 to 1.00, and (e) require the Company to maintain minimum
tangible net worth of not less than (i) $650,000 for the Wachovia credit facility and $400,000 for the Goldman repurchase facility, plus (ii) 75% of the net proceeds of the Company's
equity offerings completed subsequent to the date of the June 2007 amendments. The covenants also restrict the Company from making annual distributions to stockholders in excess of a maximum of 100%
of the Company's FFO (as defined therein) for the previous four quarters under the Wachovia credit facility, except that the Company may in any case pay distributions necessary to maintain the
Company's REIT status. An event of default can be triggered on the Goldman repurchase facility and the Wachovia credit facility if, among other things, GKK Manager LLC is terminated as
the Manager. As of September 30, 2008 and December 31, 2007, the Company was in compliance with all such covenants.

The
Goldman repurchase facility and the Wachovia credit facility require that borrowings under these facilities be paid down as principal payments on the loans and investments pledged to
these facilities are received. Assets pledged as collateral under these facilities may include stabilized and transitional whole loans, subordinate interests in whole loans, mezzanine loans, and rated
CMBS or commercial real estate CDO securities originated or acquired by the Company.

Unsecured Credit Facility

In May 2006, the Company closed on a $100,000 senior unsecured revolving credit facility with KeyBank National Association, or KeyBank,
with an initial term of three years and a one-year extension option. The initial facility was supported by a negative pledge of an identified asset base (involving substitution rights)
with advance rates that vary from 30% to 90% of the asset value provided under a borrowing base calculation. The facility bore interest at 1.90% over one-month LIBOR to the extent the
Company's leverage ratio, defined as total liabilities to total assets, including the Company's proportionate share of the liabilities and assets of the Company's unconsolidated subsidiaries, was less
than 80% and 2.10% over one-month LIBOR to the extent the Company's leverage ratio was equal to or greater than 80%. In June 2007, the facility was increased to $175,000 and interest
spreads on the facility were reduced. The facility is supported by a negative pledge 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 the inclusion of assets in the borrowing base calculation. Following the modifications in June 2007, the facility bears interest at
1.65% over one-month LIBOR. The Company had accrued interest of $333 and borrowings of $172,301 as of September 30, 2008, and no accrued interest and borrowings under this facility
at December 31, 2007.

The
terms of the unsecured revolving credit facility include covenants that (a) limit the Company's maximum total indebtedness to no more than 85% of total assets,
(b) require the Company's fixed charge coverage ratio to be at no time less than 1.30 to 1.00, and (c) require the Company to maintain

43

---



Gramercy Capital Corp.

Notes To Condensed Consolidated Financial Statements (Continued)

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

September 30, 2008

9. Debt Obligations (Continued)

minimum
tangible net worth of not less than $450,000 plus 75% of the net proceeds from equity offerings completed subsequent to the date of the June 2007 amendment. The covenants also restrict the
Company from making annual distributions to shareholders in excess of a maximum of 100% of FFO (as defined by the National Association of Real Estate Investment Trusts, or NAREIT) for the previous
four quarters, except that the Company may in any case pay distributions necessary to maintain the Company's REIT status. An event of default can be triggered on the unsecured revolving credit
facility if, among other things, GKK Manager LLC is terminated as the Manager. As of September 30, 2008 and December 31, 2007, the Company was in compliance with all such
covenants.

In
connection with the acquisition of American Financial on April 1, 2008, the Company's indirect wholly-owned subsidiaries, First States Investors DB I L.P. (formerly
known as First States Investors DB I LLC) and American Financial TRS, Inc., and certain of their direct or indirect subsidiaries, collectively, the DB Loan Borrowers entered into an
amendment and restatement of an assumed American Financial credit facility, or the DB Loan Agreement with Deutsche Bank AG, Cayman Islands Branch, or Deutsche Bank, as agent for certain lenders. As
part of the amendment and restatement of the DB Loan Agreement, the available amount under the DB Loan Agreement was reduced from $400,000 to $100,000, or the DB Loan. In addition, amounts were paid
to reduce the outstanding borrowings under the former facility to $95,000. The DB Loan Agreement provided the DB Loan Borrowers with a one year facility that matures on March 31, 2009, and
permits, subject to certain conditions, a six-month extension at the DB Loan Borrowers' option which is subject to certain conditions. Advances made under the DB Loan bear interest at
3.00% plus the greater of (i) 3.50% or (ii) LIBOR. The DB Loan allows for prepayment in whole or in part on any payment date; provided, however, that any such prepayment shall be
accompanied by all accrued interest on the portion of the DB Loan being prepaid. In September 2008, two of the Company's CDOs purchased the DB Loan from the lender and simultaneously amended the
maturity date to be March 2011. The loan is eliminated in the consolidation of the Company's CDOs. At the purchase date, the DB Loan had an outstanding balance of approximately $88.5 million.
The Company recorded costs related to the purchase of $0.8 million, which is recorded against other income.

The
obligations under the DB Loan, now owned by two of the Company's CDOs, are secured by equity pledges of the shares in certain DB Loan Borrowers and mortgages over the various
properties owned by certain DB Loan Borrowers. The DB Loan is guaranteed by the Company. The DB Loan Agreement contains customary events of default, the occurrence of which could result in the
acceleration of all amounts payable there under.

The
DB Loan requires the Company to establish and fund certain reserve accounts to be used for the payment of taxes and insurance, rollover and replacement expenses, payment of tenant
improvements and leasing commissions and the funding of debt service shortfalls.

Mortgage Loans

Certain real estate assets are subject to mortgage liens. As of September 30, 2008, 728 of the Company's real estate assets were
encumbered with mortgages and mezzanine loans with a cumulative outstanding balance of $2,545,773. The Company's mortgage notes payable typically require that

44

---



Gramercy Capital Corp.

Notes To Condensed Consolidated Financial Statements (Continued)

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

September 30, 2008

9. Debt Obligations (Continued)

specified
loan-to-value and debt service coverage ratios be maintained with respect to the financed properties before the Company can exercise certain rights under the loan
agreements relating to such properties. If the specified criteria are not satisfied, in addition to other conditions that the Company may have to observe, the Company's ability to release properties
from the financing may be restricted and the lender may be able to "trap" portfolio cash flow until the required ratios are met on an ongoing basis. As of September 30, 2008, one of the
Company's mortgage loans was operating under a cash flow trap, which is not an event of default under the applicable loan agreement. The cash flow trap has been in effect since a date prior to the
assumption of the loan by the Company as part of the American Financial acquisition.



On April 1, 2008, certain subsidiaries of the Company, collectively, the Goldman Loan Borrowers, entered into a mortgage loan
agreement with Goldman Sachs Commercial Mortgage Capital, L.P., or GSCMC, Citicorp North America, Inc., or Citicorp and SL Green in connection with a mortgage loan in the amount of
$250,000, or the Goldman Mortgage Loan, which is secured by certain properties owned or ground leased by the Goldman Loan Borrowers. The Goldman Mortgage Loan matures on March 9, 2010, with a
single one-year extension option. The terms of the Goldman Mortgage Loan were negotiated between the Goldman Loan Borrowers and GSCMC and Citicorp. The Goldman Mortgage Loan bore interest
at 4.35% over one-month LIBOR. The Goldman Mortgage Loan provides for customary events of default, the occurrence of which could result in an acceleration of all amounts payable under the
Goldman Mortgage Loan. The Goldman Mortgage Loan allows for prepayment under the terms of the agreement, subject to a 0.75% prepayment fee, during the first six months payable to the lender, as long
as simultaneously therewith a proportionate prepayment of the Goldman Mezzanine Loan (discussed below) shall also be made on such date. In August 2008, an amendment to the loan agreement was entered
into for the Goldman Mortgage Loan in conjunction with the bifurcation of the Goldman Mezzanine Loan into two separate mezzanine loans. Under this loan agreement amendment, the Goldman Mortgage Loan
bears interest at 1.99% over LIBOR.

The
Goldman Mortgage Loan requires an environmental escrow reserve for the remediation of environmental conditions in the combined amount of $700. In August 2008, $425 of this reserve
was released to the Goldman Loan Borrowers, leaving a balance of $275 reserved with the lender as of September 30, 2008. The lenders may upon the Company's request disburse funds from the
reserve on a monthly basis for the reimbursement of reasonable costs and expenses incurred to correct the environmental conditions.

The
Company has accrued interest of $757 and borrowings of $244,148 as of September 30, 2008.



On April 1, 2008, First States Group 3300 B, L.P., an indirect wholly-owned subsidiary of the Company ("PB Loan
Borrower"), entered into a loan agreement, or the PB Loan Agreement, with PB Capital Corporation, as agent for itself and other lenders, in connection with a secured term loan in the amount of
$240,000, or the PB Loan in part to refinance a portion of a portfolio of American

45

---



Gramercy Capital Corp.

Notes To Condensed Consolidated Financial Statements (Continued)

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

September 30, 2008

9. Debt Obligations (Continued)

Financial's
properties known as the WBBD Portfolio. The PB Loan matures on April 1, 2013 and bears interest at a 1.65% over one-month LIBOR. The PB Loan is secured by mortgages on
the 48 properties owned by the PB Loan Borrower and all other assets of the PB Loan Borrower. The PB Loan Agreement provides for customary events of default, the occurrence of which could result in an
acceleration of all amounts payable under the PB Loan Agreement. The PB Loan Borrower may prepay the PB Loan, in whole or in part (in amounts equal to at least $1,000), on any date.

The
PB Loan requires the company to enter into an interest rate protection agreement within five days of the tenth consecutive LIBOR banking day on which the strike rate exceeds 6.00%
per annum. The interest rate protection agreement must protect the PB Loan Borrower against upward fluctuations of interest rates in excess of 6.25% per annum.

The
Company had accrued interest of $800 as of September 30, 2008.

Certain
of our mortgage notes payable related to assets held for sale contain provisions that require us to compensate the lender for the early repayment of the loan. These charges will
be separately classified in the statement of operations as yield maintenance fees within discontinued operations during the period in which the charges are incurred.



On April 1, 2008, certain subsidiaries of the Company, collectively, the Mezzanine Borrowers, entered into a mezzanine loan
agreement with GSCMC, Citicorp and SL Green in connection with a mezzanine loan in the amount of $600,000, or the Goldman Mezzanine Loan, which is secured by pledges of certain equity interests owned
by the Mezzanine Borrowers and any amounts receivable by the Mezzanine Borrowers whether by way of distributions or other sources. The Goldman Mezzanine Loan matures on March 9, 2010, with a
single one-year extension option. The terms of the Goldman Mezzanine Loan were negotiated between The Mezzanine Borrowers and GSCMC and Citicorp. The Goldman Mezzanine Loan bore interest
at 4.35% over one-month LIBOR. The Goldman Mezzanine Loan provides for customary events of default, the occurrence of which could result in an acceleration of all amounts payable under the
Goldman Mezzanine Loan. The Goldman Mezzanine Loan allows for prepayment under the terms of the agreement, subject to a 1.00% prepayment fee during the first six months, payable to the lender, as long
as simultaneously therewith a proportionate prepayment of the Goldman Mortgage Loan shall also be made on such date. In addition, under certain circumstances the Goldman Mezzanine Loan is cross-
defaulted with events of default under the Goldman Mortgage Loan and with other mortgage loans pursuant to which, an indirect wholly-owned subsidiary of the Company, is the mortgagor. In August 2008,
the $600,000 mezzanine loan was bifurcated into two separate mezzanine loans by the lenders, the Junior Mezzanine Loan and the Senior Mezzanine Loan. Additional loan agreement amendments were entered
into for the Goldman Mezzanine Loan and Goldman Mortgage Loan. Under these loan agreement amendments, the Junior Mezzanine Loan bears interest at 6.00% over LIBOR, the Senior Mezzanine Loan bears
interest at 5.20% over LIBOR, and the Goldman Mortgage Loan bears interest at 1.99% over LIBOR. The weighted average of these interest rate spreads is equal to the combined weighted average of the
interest rates spreads on the initial loans.

46

---



Gramercy Capital Corp.

Notes To Condensed Consolidated Financial Statements (Continued)

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

September 30, 2008

9. Debt Obligations (Continued)

The
Goldman Mezzanine Loan required, and the Senior Mezzanine Loan requires, an environmental escrow reserve for the remediation of environmental conditions in the combined amount of
$850. In August 2008, $425 of this reserve was released to the Mezzanine Borrowers, leaving a balance of $425 reserved with the lender as of September 30, 2008. The lender may upon the
Company's request disburse funds from the reserve on a monthly basis for the reimbursement of reasonable costs and expenses incurred to correct the environmental conditions.

The
Company has accrued interest of $1,816 and borrowings of $598,063 as of September 30, 2008.

The
following is a summary of mortgage notes payable, mezzanine loans and acquisition loan facilities as of September 30, 2008.

Encumbered
Properties

Balance

Interest
Rates

Maturity DatesFixed-rate mortgages


479

$
1,440,954
(1)
4.5% to 8.3%

July 2009 to Sept. 2023Variable-rate mortgages


249


1,082,211

4.1% to 6.8%

March 2009 to April 2013Total mortgage notes payable


728


2,523,165Above/below market interest





22,608Mortgage notes payable related to assets held for sale





Balance, September 30, 2008


728

$
2,545,773


---

Combined
aggregate principal maturities of the Company's consolidated CDOs, Goldman repurchase facility, Wachovia credit facility and term loan, trust preferred securities, mortgage
loans (including the Goldman Mortgage Loan, Senior Mezzanine Loan and Junior Mezzanine Loan and the

47

---



Gramercy Capital Corp.

Notes To Condensed Consolidated Financial Statements (Continued)

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

September 30, 2008

9. Debt Obligations (Continued)

proportionately
consolidated mortgage note payable related to its TIC interest in 55 Corporate Drive) and the KeyBank unsecured credit facility as of September 30, 2008 are as follows:

CDOs

Repurchase
Facility
Credit
Facility
and Term
Loan

Trust
Preferred
Securities

Mortgage and
Mezzanine
Loans

KeyBank
Unsecured
Credit
Facility

Total2008

$


$


$


$
7,553

$


$
7,5532009





31,855





75,926





107,7812010





76,139





879,925


172,301


1,128,3652011











33,824





33,8242012











80,256





80,256Thereafter


2,662,955





150,000


1,445,681





4,258,636Above/Below Market Interest











22,608





22,608Total

$
2,662,955

$
107,994

$
150,000

$
2,545,773

$
172,301

$
5,639,023


10. Leasing Agreements

The Company's properties are leased and subleased to tenants under operating leases with expiration dates extending through the year 2031. These leases generally contain rent increases
and renewal options. Future minimum rental payments under non-cancelable leases, excluding reimbursements for operating expenses, as of September 30, 2008 are as follows:

Operating
Lease2008 (October 1December 31)

$
72,3392009


283,0812010


273,4912011


215,2762012


198,5762013 and thereafter


1,660,322Total minimum lease payments

$
2,703,085


11. Operating Partnership Agreement/Manager

At September 30, 2008, the Company owned all of the Class A limited partnership interests in the Operating Partnership. At September 30, 2008, the majority of the
Class B limited partnership interests were owned by the Manager and SL Green Operating Partnership, L.P. Interests were also held by certain officers and employees of SL Green, including
some of whom are the Company's executive officers or directors, certain of which interests are subject to performance thresholds that were satisfied in May 2008.

48

---



Gramercy Capital Corp.

Notes To Condensed Consolidated Financial Statements (Continued)

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

September 30, 2008

11. Operating Partnership Agreement/Manager (Continued)

At September 30, 2008, the majority of the interests in the Manager were held by SL Green Operating Partnership, L.P. Interests were also held by certain officers and
employees of SL Green, including some of whom are the Company's executive officers or directors, certain of which interests were subject to performance thresholds that were satisfied in May 2008.

12. Related Party Transactions

In connection with its initial public offering, the Company entered into a management agreement with the Manager, which was subsequently amended and restated in April 2006. The
management agreement was further amended in September 2007. The management agreement provides for a term through December 2009 with automatic one-year extension options and is subject to
certain termination rights. The Company pays the Manager an annual management fee equal to 1.75% of the Company's gross stockholders equity (as defined in the management agreement) inclusive of the
Company's trust preferred securities. The Company incurred expense to the Manager under this agreement of an aggregate of $5,978 and $15,934 for the three and nine months ended September 30,
2008 and $3,271 and $9,047 for the three and nine months ended September 30, 2007, respectively. In 2008, each of the Company and SL Green have formed special committees comprised solely of
independent directors to consider whether the internalization of the Manager and/or amendment to the management agreement would be in the best interest of each company and its respective stockholders.
In October 2008, the Company entered into the second amended and restated management agreement with the Manager which generally contains the same terms and conditions as the amended and restated
management agreement, as amended, except for the following material changes: (1) reduces the annual base management fee to 1.50% of the Company's gross stockholders equity; (2) reduces
the termination fee to an amount equal to the management fee earned by the Manager during the 12 months preceding the termination date; and (3) commencing July 2008, all fees in
connection with collateral management agreements are to be remitted by the Manager to the Company.

To
provide an incentive to enhance the value of the Company's common stock, the holders of the Class B limited partner interests of the Operating Partnership are entitled to an
incentive return equal
to 25% of the amount by which FFO plus certain accounting gains and losses (as defined in the partnership agreement of the Operating Partnership) exceed the product of the weighted average
stockholders equity (as defined in the partnership agreement of the Operating Partnership) multiplied by 9.5% (divided by four to adjust for quarterly calculations). The Company will record any
distributions on the Class B limited partner interests as an incentive distribution expense in the period when earned and when payments of such amounts have become probable and reasonably
estimable in accordance with the partnership agreement. In October 2008, the Company entered into a letter agreement with the Class B limited partners to waive the incentive distribution that
would have otherwise been earned for the period July 1, 2008 through December 31, 2008 and provide that starting January 1, 2009, the incentive distribution can be paid, at the
Company's option, in cash or shares of common stock of the Company. The Company incurred $0 and $5,100 and $22,868 and $29,469 with respect to such Class B limited partner interests for the
three and nine months ended September 30, 2008 and 2007, respectively.

The
Company is obligated to reimburse the Manager for its costs incurred under an asset servicing agreement between the Manager and an affiliate of SL Green Operating
Partnership, L.P. and a

49

---



Gramercy Capital Corp.

Notes To Condensed Consolidated Financial Statements (Continued)

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

September 30, 2008

12. Related Party Transactions (Continued)

separate
outsource agreement between the Manager and SL Green Operating Partnership, L.P. The asset servicing agreement, which was amended and restated in April 2006, provides for an annual fee
payable to SL Green Operating Partnership, L.P. by the Company of 0.05% of the book value of all credit tenant lease assets and non-investment grade bonds and 0.15% of the book
value of all other assets. The asset servicing fee may be reduced by SL Green Operating Partnership, L.P. for fees paid directly to outside servicers by the Company. At September 30,
2008, the outsource agreement provides for an annual fee payable by the Company, which fee became $2,814 per year subsequent to the closing of the American Financial merger to reflect higher costs
resulting from the increased size and number of assets of the combined company, increasing 3% annually over the prior year on the anniversary date of the outsource agreement in August of each year.
For the three and nine months ended September 30, 2008 and 2007, the Company realized expense of $697 and $1,721 and $338 and $1,001, respectively, to the Manager under the outsource agreement.
For the three and nine months ended September 30, 2008 and 2007, the Company realized expense of $1,350 and $4,022 and $1,041 and $2,700, respectively, to the Manager under the asset servicing
agreement. In October 2008, each of the asset servicing agreement and outsource agreement was terminated, effective as of September 30, 2008.

In
connection with the closing of the Company's first CDO in July 2005, the 2005 Issuer, entered into a collateral management agreement with the Manager. Pursuant to the collateral
management agreement, the Manager has agreed to provide certain advisory and administrative services in relation to the collateral debt securities and other eligible investments securing the CDO
notes. The collateral management agreement provides for a senior collateral management fee, payable quarterly in accordance with the priority of payments as set forth in the indenture, equal to 0.15%
per annum of the net outstanding portfolio balance, and a subordinate collateral management fee, payable quarterly in accordance with the priority of payments as set forth in the indenture, equal to
0.25% per annum of the net outstanding portfolio balance. Net outstanding portfolio balance is the sum of the (i) aggregate principal balance of the collateral debt securities, excluding
defaulted securities, (ii) aggregate principal balance of all principal proceeds held as cash and eligible investments in certain accounts, and (iii) with respect to the defaulted
securities, the calculation amount of such defaulted securities. As
compensation for the performance of its obligations as collateral manager under the first CDO, the Board of Directors has allocated to the Manager the subordinate collateral management fee paid on the
CDO notes not held by the Company. In October 2008, pursuant to the second amended and restated management agreement, the Manager has, commencing July 1, 2008, agreed to remit this amount to
the Company. At September 30, 2008 and December 31, 2007, the Company owned all of the non-investment grade bonds, preferred equity and equity in the 2005 CDO. The senior
collateral management fee and balance of the subordinate collateral management fee is allocated to the Company. For the three and nine months ended September 30, 2008 and 2007, the Company
realized expense of $0 and $1,024 and $518 and $1,537, respectively, to the Manager under such collateral management agreement.

Except
for the 2005 CDO, fees payable in connection with CDOs or other securitization vehicles are governed by the management agreement. Pursuant to that agreement, if a collateral
manager is retained as part of the formation of a CDO or other securitization vehicle, the Manager or an affiliate will be the collateral manager and will receive the following fees: (i) 0.25%
per annum of the principal amount outstanding of bonds issued by a managed transitional CDO that are owned by third-party

50

---



Gramercy Capital Corp.

Notes To Condensed Consolidated Financial Statements (Continued)

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

September 30, 2008

12. Related Party Transactions (Continued)

investors
unaffiliated with the Company or the Manager, which CDO is structured to own loans secured by transitional properties, (ii) 0.15% per annum of the book value of the principal amount
outstanding of bonds issued by a managed non-transitional CDO that are owned by third-party investors unaffiliated with the Company or the Manager, which CDOs structured to own loans
secured by non-transitional properties, (iii) 0.10% per annum of the principal amount outstanding of bonds issued by a static CDO that are owned by third party investors
unaffiliated with the Company or the Manager, which CDO is structured to own non-investment grade bonds, and (iv) 0.05% per annum of the principal amount outstanding of bonds issued
by a static CDO that are owned by third-party investors unaffiliated with the Company or the Manager, which CDO is structured to own investment grade bonds. For the purposes of the management
agreement, a "managed transitional" CDO means a CDO that is actively managed, has a reinvestment period and is structured to own debt collateral secured primarily by non-stabilized real
estate assets that are expected to experience substantial net operating income growth, and a "managed non-transitional" CDO means a CDO that is actively managed, has a reinvestment period
and is structured to own debt collateral secured primarily by non-stabilized real estate assets that are expected to experience substantial net operating income growth, and a "managed
non-transitional" CDO means a CDO that is actively managed, has a reinvestment period and is structured to own debt collateral secured primarily by stabilized real estate assets that are
not expected to experience substantial net operating income growth. Both "managed transitional" and "managed non-transitional" CDOs may at any given time during the reinvestment period of
the respective vehicles invest in and own non-debt collateral (in limited quantity) as defined by the respective indentures. If any fees were paid to the collateral manager in excess of
the fee structure provided for above, such fees are paid to the Company. In October 2008, pursuant to the second amended and restated management agreement, the Manager has, commencing July 1,
2008, agreed to remit this amount to the Company. For the three and nine months ended September 30, 2008 and 2007, the Company realized expense of $0 and $1,142 and $577 and $1,713,
respectively, to the Manager under this agreement. With respect to the CDO which closed in August 2007, the Company realized expense to the Manager of $0 and $432 and $178 and $178 for the three and
nine months ended September 30, 2008 and 2007, respectively.

In
April 2005, the Company closed on a $57,503 initial investment in a joint venture with SL Green to acquire, own and operate the South Building located at One Madison Avenue, New York,
New York. The joint venture, which was owned 45% by a wholly-owned subsidiary of the Company and 55% by a wholly-owned subsidiary of SL Green, was created to acquire, own and operate the South
Building. The joint venture interests were pari-passu. The joint venture completed the acquisition of the South Building from Metropolitan Life Insurance Company for the purchase price of
approximately $802,800 plus closing costs, financed in part through a $690,000 first mortgage loan on the South Building. The South Building comprises approximately 1.2 million square feet and
is almost entirely net leased to Credit Suisse Securities (USA) LLC ("CS") pursuant to a lease with a 15-year remaining term. In August 2007, the Company sold its entire investment
in the joint venture to SL Green for approximately $147,000 and realized a gain of $92,235. In August 2007, an affiliate of SL Green loaned approximately $147,000 to the Operating Partnership. This
loan was to be repaid with interest at an annual rate of 5.80% on the earlier of September 1, 2007 or the closing of the sale of the Company's 45% interest in One Madison Avenue to SL Green. As
a result of the sale of the Company's interest in August 2007, the loan was repaid with interest on such date.

51

---



Gramercy Capital Corp.

Notes To Condensed Consolidated Financial Statements (Continued)

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

September 30, 2008

12. Related Party Transactions (Continued)

Commencing
in May 2005, the Company is party to a lease agreement with SLG Graybar Sublease LLC, an affiliate of SL Green, for the Company's corporate offices at 420 Lexington
Avenue, New York, New York. The lease is for approximately 7,000 square feet and carries a term of 10 years with rents of approximately $249 per annum for year one rising to $315 per annum in
year ten. The Company leases an additional 3,215 square feet on a month-to-month basis for approximately $161. For the three and nine months ended September 30, 2008 and
2007, rent expense under this lease was $118 and $247 and $63 and $188 under this lease, respectively.

In
July 2005, the Company closed on the purchase from an SL Green affiliate of a $40,000 mezzanine loan which bears interest at 11.20%. As part of that sale, the seller retained an
interest-only participation. The Company has determined that the yield on its mezzanine loan after giving effect to the interest-only participation retained by the seller is at
market. The mezzanine loan is secured by the equity interests in an office property in New York, New York. As of September 30, 2008 and December 31, 2007, the loan has a book value of
$39,577 and $39,711, respectively.

In
February 2006, the Company closed on the purchase of a $90,000 whole loan, which bears interest at three-month LIBOR plus 2.15%, to a joint venture in which SL Green is an equity
holder. The loan is secured by 55 Corporate Drive in Bridgewater, New Jersey. The loan was repaid in full in June 2006 with the proceeds from new mortgage financing obtained in connection with the
sale of the property, 49.75% of which is now owned by the Company through a TIC structure, as discussed below.

In
March 2006, the Company closed on the purchase of a $25,000 mezzanine loan, which bears interest at one-month LIBOR plus 8.00%, to a joint venture in which SL Green is an
equity holder. The mezzanine loan was repaid in full on May 9, 2006, when the Company originated a $90,287 whole loan, which bears interest at one-month LIBOR plus 2.75%, to the
joint venture. The whole loan is secured by office and industrial properties in northern New Jersey and has a book value of $90,567 and $90,389 as of September 30, 2008 and December 31,
2007, respectively.

In
June 2006, the Company closed on the acquisition of a 49.75% TIC interest in 55 Corporate Drive, located in Bridgewater, New Jersey with a 0.25% interest to be acquired in the future.
The remaining 50% of the property is owned as a TIC interest by an affiliate of SL Green Operating Partnership, L.P. The property is comprised of three buildings totaling approximately six
hundred and seventy thousand square feet which is 100% net leased to an entity whose obligations are guaranteed by Sanofi-Aventis Group through April 2023. The transaction was valued at $236,000 and
was financed with a $190,000, 10-year, fixed-rate first mortgage loan.

In
August 2006, the Company 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 Green simultaneously acquired and owns the other 50% pari-passu interest. The investment bears interest at a blended fixed rate of 10.52%.

In
December 2006, the Company acquired from a financial institution a pari-passu interest of $125,000 in a $200,000 mezzanine loan, which bears interest at 6.384% and is
secured by a multi-family portfolio in New York, New York. An affiliate of SL Green simultaneously acquired the remaining $75,000 pari-passu interest in the mezzanine loan. As of
September 30, 2008 and December 31, 2007, the loan has a book value of $115,478 and $108,034, respectively.

52

---



Gramercy Capital Corp.

Notes To Condensed Consolidated Financial Statements (Continued)

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

September 30, 2008

12. Related Party Transactions (Continued)

In
January 2007, the Company originated two mezzanine loans totaling $200,000. The $150,000 loan was secured by a pledge of cash flow distributions and partial equity interests in a
portfolio of multi-family properties and bore interest at one-month LIBOR plus 6.00%. The $50,000 loan was initially secured by cash flow distributions and partial equity interests in an
office property. On March 8, 2007 the $50,000 loan was increased by $31,000 when the existing mortgage loan on the property was defeased, upon which event the Company's loan became secured by a
first mortgage lien on the property and was reclassified as a whole loan. The whole loan currently bears interest at one-month LIBOR plus 6.00% for the initial funding and
one-month LIBOR plus 1.00% for the subsequent funding. At closing, an affiliate of SL Green acquired from the Company and held a 15.15% pari-passu interest in the mezzanine
loan and the whole loan. As of September 30, 2008 and December 31, 2007, the Company's interest in the whole loan had a carrying value of $66,158 and $65,033, respectively. The
investment in the mezzanine loan was repaid in full in September 2007.

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

In
April 2007, the Company purchased for $103,200 a 45% TIC interest to acquire the fee interest in a parcel of land located at 2 Herald Square, located along
34th Street in New York, New York. The acquisition was financed with a $86,063 10-year fixed rate mortgage loan. The property is subject to a long-term
ground lease with an unaffiliated third party for a term of 70 years. The remaining TIC interest is owned by a wholly-owned subsidiary of SL Green. The TIC interests are pari-passu.
As of September 30, 2008 and December 31, 2007, the investment had a carrying value of $24,881and $20,390, respectively. The Company recorded its pro rata share of net income of $1,237
and $3,991 and $772 and $1,871 for the three and nine months ended September 30, 2008 and 2007, respectively.

In
July 2007, the Company purchased for $144,240 an investment in a 45% TIC interest to acquire a 79% fee interest and 21% leasehold interest in the fee position in a parcel of land
located at 885 Third Avenue, on which is situated The Lipstick Building. The transaction was financed with a $120,443 10-year fixed rate mortgage loan. The property is subject to a
70-year leasehold ground lease with an unaffiliated third party. The remaining TIC interest is owned by a wholly-owned subsidiary of SL Green. The TIC interests are pari passu. As of
September 30, 2008 and December 31, 2007, the investment had a carrying value of $34,866 and $28,332, respectively. The Company recorded its pro rata share of net income of $1,476 and
$4,815 and $946 and $946 for the three and nine months ended September 30, 2008 and 2007, respectively.

In
July 2007, the Company acquired for $71,871 a 100% fee interest in the property located at 292 Madison Avenue, New York, New York, purchased from SL Green. The Company
entered into a 70-year ground lease with an unaffiliated third party which simultaneously purchased from SL Green the Class B office building situated on the property. The Company's
acquisition of the fee interest was financed with a $59,099 10-year fixed rate mortgage loan.

53

---



Gramercy Capital Corp.

Notes To Condensed Consolidated Financial Statements (Continued)

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

September 30, 2008

12. Related Party Transactions (Continued)

In
August 2007, the Company closed on the purchase from a financial institution of a $12,500 mezzanine loan on a substantially complete residential condominium project in the upper east
side of Manhattan. The investment bears interest at the current pay rate of 11% over LIBOR, and a 19% look-back internal rate of return at maturity. At closing, an affiliate of SL Green
simultaneously acquired a $12,500 pari-passu interest in the same tranche of the capital structure. The loan was retired in August 2008.

In
September 2007, the Company acquired a 50% interest in a $25,000 senior mezzanine loan from SL Green. Immediately thereafter the Company, along with SL Green, sold all of its
interests in the loan to an unaffiliated third party. Additionally, the Company acquired from SL Green a 100% interest in a $25,000 junior mezzanine loan associated with the same properties as the
preceding senior mezzanine loan. Immediately thereafter the Company participated 50% of its interest in the loan back to SL Green. As of September 30, 2008 and December 31, 2007, the
loan has a book value of $12,792 and $11,917, respectively. In October 2007, the Company acquired a 50% pari-passu interest in $57,795 of two additional tranches in the senior mezzanine
loan from an unaffiliated third party. At closing, an affiliate of SL Green simultaneously acquired the other 50% pari-passu interest in the two tranches. As of September 30, 2008
and December 31, 2007, the loan has a book value of $26,882 and $26,776, respectively.

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

In
November 2007, the Company acquired from a syndicate comprised of financial institutions a $25,000 interest in a $100,000 junior mezzanine investment secured by a hotel portfolio and
franchise headquarters. An affiliate of SL Green simultaneously acquired and owns another $25,000 interest in the investment. The investment was purchased at a discount and bears interest at an
effective spread to one-month LIBOR of 9.50%. As of September 30, 2008 and December 31, 2007, the loan has a book value of $22,279 and $22,238, respectively.

In
December 2007, the Company acquired a $52,000 interest in a senior mezzanine loan from a financial institution. Immediately thereafter the Company participated 50% of its interest in
the loan to an affiliate of SL Green. The investment, which is secured by a retail property in New York, New York, was purchased at a discount and bears interest at an effective spread to
one-month LIBOR of 5.00%. As of September 30, 2008 and December 31, 2007, the loan has a book value of $24,234 and $23,141, respectively.

In
December 2007, the Company acquired a 50% interest in a $200,000 senior mezzanine loan from a financial institution. Immediately thereafter the Company participated 50% of the
Company's interest in the loan to an affiliate of SL Green. The investment was purchased at a discount and bears interest at an effective spread to one-month LIBOR of 6.50%. As of
September 30, 2008 and December 31, 2007, the loan has a book value of $45,626 and $44,739, respectively.

In
connection with the closing of the acquisition of American Financial, the Company as part of a larger financing received financing of $50,000 from SL Green, which is described more
fully in Note 9.

54

---



Gramercy Capital Corp.

Notes To Condensed Consolidated Financial Statements (Continued)

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

September 30, 2008

12. Related Party Transactions (Continued)

An
affiliate of SL Green was granted 644,787 shares of common stock for services rendered, subject to a one-year vesting period. These shares had a value of approximately $11,213 on the
date of issuance.

In
August 2008, the Company closed on the purchase from an SL Green affiliate of a $9,375 pari-passu participation interest in a $18,750 first mortgage. The loan is secured
by a retail shopping center located in Staten Island, New York. The investment bears interest at a fixed rate of 6.50%. As of September 30, 2008, the loan has a book value of $9,362.

In
September 2008, the Company closed on the purchase from an SL Green affiliate of a $30,000 interest in a $135,000 mezzanine loan. The loan is secured by the borrower's interests in a
retail condominium located New York, New York. The investment bears interest at an effective spread to one-month LIBOR of 10.00%. As of September 30, 2008, the loan has a book value
of $29,910.

Bright
Star Couriers LLC, or Bright Star, provides messenger services to the Company. Bright Star is owned by Gary Green, a son of Stephen L. Green, the Company's Chairman. The
aggregate amount of fees paid by the Company for such services for each of the three and nine months ended September 30, 2008 and 2007, was less than $1.

13. Deferred Costs

Deferred costs at September 30, 2008 and December 31, 2007 consisted of the following:

2008

2007Deferred financing

$
89,375

$
59,294Deferred acquisition


5,237


4,320Deferred leasing


10,596


9,457105,208


73,071Less accumulated amortization


(30,818
)

(16,962
)74,390


56,109Less held for sale


(134
)

$
74,256

$
56,109


Deferred
financing costs relate to the Company's existing Goldman repurchase facility, the term loan and credit facility with Wachovia, the credit facility with Keybank, the Goldman
Mortgage Loan, the Goldman Senior and Junior Mezzanine Loans, the PB Loan Agreement, the Company's CDOs, mortgage loans, including, the proportionately consolidated mortgage note payable related to
the Company's TIC interest in 55 Corporate Drive, and the trust preferred securities. These costs are
amortized on a straight-line basis to interest expense based on the remaining term of the related financing.

Deferred
acquisition costs consist of fees and direct costs incurred to originate the Company's investments and are amortized using the effective yield method over the related term of
the investment.

Deferred
leasing costs include direct costs incurred to initiate and renew operating leases and are amortized on a straight-line basis over the related lease term.

55

---



Gramercy Capital Corp.

Notes To Condensed Consolidated Financial Statements (Continued)

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

September 30, 2008

14. Fair Value of Financial Instruments

Effective January 1, 2008, the Company adopted SFAS 157, which among other things, requires additional disclosures about financial instruments, carried at fair value.
SFAS 157 establishes a hierarchal disclosure framework associated with the level of pricing observability utilized in measuring financial instruments at fair value. The following discussion of
fair value was determined by the Manager, using available market information and appropriate valuation methodologies. Considerable judgment is necessary to interpret market data and develop estimated
fair value. Accordingly, fair values are not necessarily indicative of the amounts the Company could realize on disposition of the financial instruments. Financial instruments with readily available
active quoted prices or for which fair value can be measured from actively quoted prices generally will have a higher degree of pricing observability and a lesser degree of judgment utilized in
measuring fair value. Conversely, financial instruments rarely traded or not quoted will generally have less, or no, pricing observability and a higher degree of judgment utilized in measuring fair
value. The use of different market assumptions and/or estimation methodologies may have a material effect on estimated fair value amounts.

Fair Value on a Recurring Basis

Assets and liabilities measured at fair value on a recurring basis are categorized in the table below based upon the lowest level of
significant input to the valuations.

At September 30, 2008

Total

Level I

Level II

Level IIIFinancial Assets:Derivative instruments

$
437

$


$
437

$
Financial Liabilities:Derivative instruments

$
83,718

$


$
83,718

$



Fair Value on a Non-Recurring Basis

The Company uses fair value measurements on a nonrecurring basis in its assessment of assets classified as loans and other lending
investments, which are reported at cost and have been written down to fair value as a result of valuation allowances established for possible loan losses. The following table shows the fair value
hierarchy for those assets measured at fair value on a non-recurring basis based upon the lowest level of significant input to the valuations for which a non-recurring change
in fair value has been recorded during the nine months ended September 30, 2008:

At September 30, 2008

Total

Level I

Level II

Level IIIFinancial Assets:Lending investments

$
229,281

$


$


$
229,281


The
total change in fair value of financial instruments for which a fair value adjustment has been included in the consolidated statements of income for the three and nine months ended
September 30, 2008 was $18,875 and $50,089, respectively.

The
valuations derived from pricing models overall valuation process may include adjustments to the financial instruments. These adjustments may be made when, in management's judgment,
either the size of the position in the financial instrument or other features of the financial instrument such as its

56

---



Gramercy Capital Corp.

Notes To Condensed Consolidated Financial Statements (Continued)

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

September 30, 2008

14. Fair Value of Financial Instruments (Continued)

complexity,
or the market in which the financial instrument is traded (such as counterparty, credit, concentration or liquidity) require that an adjustment be made to the value derived from the
pricing models. Additionally, an adjustment from the price derived from a model typically reflects management's judgment that other participants in the market for the financial instrument being
measured at fair value would also consider such an adjustment in pricing that same financial instrument.

Financial
assets and liabilities presented at fair value and categorized as Level III are generally those that are marked to model using relevant empirical data to extrapolate an
estimated fair value. The models' inputs reflect assumptions that market participants would use in pricing the instrument in a current period transaction and outcomes from the models represent an exit
price and expected future cash flows. The parameters and inputs are adjusted for assumptions about risk and current market conditions. Changes to inputs in valuation models are not changes to
valuation methodologies, rather, the inputs are modified to reflect direct or indirect impacts on asset classes from changes in market conditions. Accordingly, results from valuation models in one
period may not be indicative of future period measurements.

15. Stockholders' Equity

The Company's authorized capital stock consists of 125,000,000 shares, $0.001 par value, of which the Company has authorized the issuance of up to 100,000,000 shares of common stock,
$0.001 par value per share, and 25,000,000 shares of preferred stock, par value $0.001 per share. As of September 30, 2008, 51,316,586 shares of common stock and 4,600,000 shares of preferred
stock were issued and outstanding.

Preferred Stock

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

Common Stock

As of the date of the Company's formation, April 12, 2004, the Company had 500,000 shares of common stock outstanding valued at
approximately $200. On August 2, 2004 the Company completed its initial public offering of 12,500,000 shares of common stock resulting in net proceeds of approximately $172,900, which was used
to fund investments and commence operations. As of September 30, 2008 and December 31, 2007, 705,004 and 594,333, respectively, restricted shares had
also been issued under the Company's 2004 Equity Incentive Plan, or the Equity Incentive Plan. These shares have a vesting period of two to four years.

57

---



Gramercy Capital Corp.

Notes To Condensed Consolidated Financial Statements (Continued)

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

September 30, 2008

15. Stockholders' Equity (Continued)

In December 2004, the Company sold 5,500,000 shares of its common stock, at a price of $17.27 per share, resulting in net proceeds of approximately $93,740 under a private placement
exemption from the registration requirements of Section 5 of the Securities Act of 1933, as amended, or the Securities Act. The Company subsequently registered these shares for resale under the
Securities Act in August 2005. A total of 4,225,000 shares were sold to various institutional investors and an additional 1,275,000 shares were sold to SL Green Operating Partnership, L.P.
pursuant to its contractual right to choose to maintain up to a 25% ownership interest in the Company's outstanding shares of common stock. Of the 5,500,000 shares sold, 2,000,000 shares were settled
in December 2004 and the remaining 3,500,000 shares were settled in January 2005.

In
September 2005, the Company sold 3,833,333 shares of common stock, at a price of $25.80 per share, resulting in net proceeds of approximately $97,830. A total of 2,875,000 shares were
sold through a public offering and an additional 958,333 shares were sold to SL Green Operating Partnership, L.P. pursuant to its contractual right to choose to maintain up to a 25% ownership
interest in the Company's outstanding shares of common stock. Net proceeds were used for loan acquisitions and originations, repayment of outstanding principal under one of the Company's repurchase
facilities and general corporate purposes.

In
May 2006, the Company sold 3,000,000 shares of common stock, at a price of $26.75 per share, resulting in net proceeds of approximately $79,787. A total of 2,250,000 shares were sold
through a public offering and an additional 750,000 shares were sold to SL Green Operating Partnership, L.P. pursuant to its contractual right to choose to maintain up to a 25% ownership
interest in the Company's outstanding shares of common stock. Net proceeds were used for loan acquisitions and originations, repayment of outstanding principal under the Company's repurchase
facilities and general corporate purposes.

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

In
September 2007, the Company sold 4,825,000 shares of common stock, at a public offering price of $26.25 per share, resulting in net proceeds of approximately $124,451. A total of
3,618,750 shares were sold through a public offering and an additional 1,206,250 shares were sold directly to SL Green Operating Partnership, L.P. pursuant to its contractual right to choose to
maintain up to a 25% ownership interest in the Company's outstanding shares of common stock. After this offering, SL Green Operating Partnership, L.P. owned 7,624,583 shares of the Company's
common stock. Net proceeds were used to retire borrowings under the Company's unsecured facility and to create additional funding capacity for opportunistic investments.

In
November 2007, the Company sold, through a private placement, 3,809,524 shares of common stock at a price of $26.25 per share to an affiliate of Morgan Stanley Real Estate Special
Situations Fund III, a global diversified fund managed by Morgan Stanley Real Estate, raising gross proceeds of approximately $100,000. The shares were not registered under the Securities Act of 1933
or any state securities laws, and were sold in a private transaction under Regulation D of the Securities Act. Subsequent to this offering, SL Green's ownership percentage was approximately 22%
of the outstanding shares of the Company's common stock at March 31, 2008.

58

---



Gramercy Capital Corp.

Notes To Condensed Consolidated Financial Statements (Continued)

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

September 30, 2008

15. Stockholders' Equity (Continued)

In
April 2008, the Company issued approximately 15,634,854 shares of common stock in connection with the American Financial acquisition. These shares had a value of approximately
$378,672 on the date the merger agreement was executed. Also, as a result of the American Financial acquisition, an affiliate of SL Green was granted 644,787 shares of common stock for services
rendered, subject to an one-year vesting period. These shares had a value of approximately $11,213 on the date of issuance SL Green Operating Partnership, L.P. owned shares of the
Company's common stock representing approximately 15.8% of the outstanding shares of the Company's common stock as of September 30, 2008.

Equity Incentive Plan

As part of the Company's initial public offering, the Company instituted its Equity Incentive Plan. The Equity Incentive Plan, as
amended, authorizes (i) the grant of stock options that qualify as incentive stock options under Section 422 of the Internal Revenue Code of 1986, as amended, or ISOs, (ii) the
grant of stock options that do not qualify, or NQSOs, (iii) the grant of stock options in lieu of cash directors' fees and (iv) grants of shares of restricted and unrestricted common
stock. The exercise price of stock options will be determined by the compensation committee, but may not be less than 100% of the fair market value of the shares of common stock on the date of grant.
At September 30, 2008, 2,581,423 shares of common stock were available for issuance under the Equity Incentive Plan.

As
of September 30, 2008, management fees and outsource fees (the fees are no longer payable effective October 1, 2008) paid to the Company's Manager and SL Green Operating
Partnership, L.P. are sufficient to reimburse the Manager and SL Green Operating Partnership, L.P. for the applicable compensation, including payroll taxes, of the employees who provide
services to Gramercy pursuant to the confirmatory addendum to the management agreement among the Company, the Manager and the Operating Partnership. Those employees who provided services under the
confirmatory addendum were considered co-leased employees. The confirmatory addendum was terminated as part of
the second amended and restated management agreement. Options granted under the Equity Incentive Plan to recipients who were co-leased employees of Gramercy are exercisable at the fair
market value on the date of grant and, subject to termination of employment, expire ten years from the date of grant, are not transferable other than on death, and are exercisable in three to four
annual installments commencing one year from the date of grant. In some instances, options may be granted under the Equity Incentive Plan to persons who provide significant services to the Company or
its affiliates, but are not considered co-leased employees because compensation for their services were not covered by the management agreement or outsource agreement. Options granted to
recipients that are not co-leased employees have the same terms as those issued to co-leased employees except as it relates to any performance-based provisions within the
grant. To the extent there are performance provisions associated with a grant to a recipient who is not a co-leased employee, an estimated expense related to these options is recognized
over the vesting period and the final expense is reconciled at the point performance has been met, or the measurement date. If no performance based provision exists, the fair value of the options is
calculated on a quarterly basis and the related expense is recognized over the vesting period.

59

---



Gramercy Capital Corp.

Notes To Condensed Consolidated Financial Statements (Continued)

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

September 30, 2008

15. Stockholders' Equity (Continued)

A
summary of the status of the Company's stock options as of September 30, 2008 and December 31, 2007 are presented below:

September 30, 2008

December 31, 2007Options
Outstanding

Weighted
Average
Exercise
Price

Options
Outstanding

Weighted
Average
Exercise
PriceBalance at beginning of period


1,428,169

$
22.82


830,001

$
18.02Modification


110,716








Granted


85,000

$
21.17


770,500

$
27.76Exercised


(85,547
)
$
14.83


(103,330
)
$
19.44Lapsed or cancelled


(95,349
)
$
26.96


(69,002
)
$
25.29Balance at end of period


1,442,989

$
21.31


1,428,169

$
22.82


For
the three and nine months ended September 30, 2008, all options were granted within a price range of $18.98 to $25.90. The remaining weighted average contractual life of the
options was 7.5 years. Compensation expense of $1,339 will be recorded over the next nine months, representing the remaining weighted average vesting period of the option awards as of
September 30, 2008. In connection with the payment of a special dividend to common shareholders, the equity incentive plan was amended to provide for the modification of stock options to adjust
for the impact of the special dividend paid. There was no incremental cost to the modification. Compensation expense of $245 and $771 and $155 and $481 was recorded for the three and nine months ended
September 30, 2008 and 2007, respectively, related to the issuance of stock options.

Through
September 30, 2008, 705,004 restricted shares had been issued under the Equity Incentive Plan, of which 64% have vested. The vested and unvested shares are currently
entitled to receive distributions on common stock if declared by the Company. Holders of restricted shares are prohibited from selling such shares until they vest but are provided the ability to vote
such shares beginning on the date of grant. Compensation expense of $1,690 will be recorded over the next eight months, representing the remaining weighted average vesting period of the restricted
stock awards as of September 30, 2008. Compensation expense of $672 and $2,202 and $443 and $2,318 was recorded for the three and nine months ended September 30, 2008 and 2007,
respectively, related to the issuance of restricted shares.

Employee Stock Purchase Plan

In November 2007, the Company's board of directors adopted, and the stockholders subsequently approved in June 2008, the 2008 Employee
Stock Purchase Plan, or ESPP, to encourage its employees to increase their efforts to make the Company's business more successful by providing equity-based incentives to eligible employees. The ESPP
is intended to qualify as an "employee stock purchase plan" under Section 423 of the Internal Revenue Code of 1986, as amended, and has been adopted by the board to enable the Company's
eligible employees to purchase its shares of common stock through payroll deductions. The ESPP became effective on January 1, 2008 with a maximum of 250,000 shares of the common stock available
for issuance, subject to adjustment upon a merger, reorganization, stock split or other similar corporate change. The Company filed a registration statement on Form S-8 with

60

---



Gramercy Capital Corp.

Notes To Condensed Consolidated Financial Statements (Continued)

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

September 30, 2008

15. Stockholders' Equity (Continued)

the
Securities and Exchange Commission with respect to the ESPP. The common stock will be offered for purchase through a series of successive offering periods. Each offering period will be three
months in duration and will begin on the first day of each calendar quarter, with the first offering period having commenced on January 1, 2008. The ESPP provides for eligible employees to
purchase the common stock at a purchase price equal to 85% of the lesser of (1) the market value of the common stock on the first day of the offering period or (2) the market value of
the common stock on the last day of the offering period.

Outperformance Plan

In June 2005, the compensation committee of the board of directors approved a long-term incentive compensation program, the
2005 Outperformance Plan. Participants in the 2005 Outperformance Plan, all of whom are co-leased employees, were to share in a "performance pool" if the Company's total return to
stockholders for the period
from June 1, 2005 through May 31, 2008 exceeded a cumulative total return to stockholders of 30% during the measurement period over a base share price of $20.21 per share. The Company
recorded the expense of the plan award in accordance with FASB Statement No. 123(R). Compensation expense of $308 and $926 and $383 and $1,150 was recorded for the three and nine months ended
September 30, 2008 and 2007, respectively, related to the 2005 Outperformance Plan. Based on the Company's total return to stockholders as of the May 31, 2008 measurement period
conclusion date, the Company did not meet the minimum 30% return.

Deferred Stock Compensation Plan for Directors

Under the Company's Independent Director's Deferral Program, which commenced April 2005, the Company's independent directors may elect
to defer up to 100% of their annual retainer fee, chairman fees and meeting fees. Unless otherwise elected by a participant, fees deferred under the program shall be credited in the form of phantom
stock units. The phantom stock units are convertible into an equal number of shares of common stock upon such directors' termination of service from the Board of Directors or a change in control by
the Company, as defined by the program. Phantom stock units are credited to each independent director quarterly using the closing price of the Company's common stock on the applicable dividend record
date for the respective quarter. Each participating independent director who elects to receive fees in the form of phantom stock units has the option to have their account credited for an equivalent
amount of phantom stock units based on the dividend rate for each quarter or have dividends paid in cash.

As
of September 30, 2008, there were approximately 49,276 phantom stock units outstanding, of which 37,276 units were vested.

61

---



Gramercy Capital Corp.

Notes To Condensed Consolidated Financial Statements (Continued)

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

September 30, 2008

15. Stockholders' Equity (Continued)

Earnings per Share

Earnings per share for the three and nine months ended September 30, 2008 and 2007 is computed as follows:

For The Three
Months Ended
September 30,

For The Nine
Months Ended
September 30,2008

2007

2008

2007Numerator (Income (loss))Net income from continuing operations

$
10,313

$
97,150

$
48,765

$
136,059Net loss from discontinued operations


(654
)




(1,239
)

Net income


9,659


97,150


47,526


136,059Preferred stock dividends


(2,336
)

(2,336
)

(7,008
)

(4,231
)Numerator for basic income per sharenet income available to common stockholders


7,323


94,814


40,518


131,828Effect of dilutive securities











Diluted earnings:Numerator for diluted income per sharenet income applicable to common stockholders

$
7,323

$
94,814

$
40,518

$
131,828Denominator (Weighted Average Shares)Denominator for basic income per shareweighted average shares


51,307


26,339


45,736


26,390Effect of dilutive securities:Stock-based compensation plans





1,272


29


1,272Phantom stock units


49


27


49


27Diluted Shares


51,356


27,638


45,814


27,527


16. Benefit Plans

At September 30, 2008, the Company did not maintain a defined benefit pension plan, post-retirement health and welfare plan, 401(k) plan or other benefits plans. As an
affiliate of SL Green, the Company's employees are covered by a 401(K) Savings/Retirement Plan implemented by SL Green. The 401(K) Plan permits eligible employees to defer up to
15% of their annual compensation, subject to certain limitations imposed by the Code. The employees' elective deferrals are immediately vested and non-forfeitable upon contribution to the
401(K) Plan. The plan provides for discretionary matching contributions only.

17. Commitments and Contingencies

The Company and the Operating Partnership are not presently involved in any material litigation nor, to the Company's knowledge, is any material litigation threatened against the Company
or its investments, other than routine litigation arising in the ordinary course of business. Management believes the costs, if any, incurred by the Operating Partnership and the Company related to
litigation will not materially affect its financial position, operating results or liquidity.

62

---



Gramercy Capital Corp.

Notes To Condensed Consolidated Financial Statements (Continued)

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

September 30, 2008

17. Commitments and Contingencies (Continued)

The
Company's corporate offices at 420 Lexington Avenue, New York, New York 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 7,000 square feet and carries a term of 10 years with rents of approximately $249 per annum for year one rising to $315 per annum in
year ten. The Company leases an additional 3,215 square feet on a month to month basis for approximately $161 per annum.

As
of September 30, 2008, the Company leased certain of its commercial properties from third parties with expiration dates extending to the year 2085 and has various ground leases
with expiration dates extending through 2087. These lease obligations generally contain rent increases and renewal options.

Future
minimum lease payments under non-cancelable operating leases as of September 30, 2008 are as follows:

2008 (October 1  December 31)

$
4,6002009


18,8392010


18,5482011


18,4572012


18,1562013 and thereafter


170,980Total

$
249,580


The
Company, through certain of its subsidiaries, may be required in its role in connection with its CDOs, to repurchase loans that it contributed to its CDOs in the event of breaches of
certain representations or warranties provided at the time the CDOs were formed or the loans contributed. These obligations do not relate to the credit performance of the loans or other collateral
contributed to the CDOs, but only to breaches of specific representations and warranties. Since inception, the Company has not been required to make any repurchases.

Certain
real estate assets are pledged as collateral for mortgage loans held by two of its CDOs. Additionally, borrowings secured by these pledges are guaranteed by the Company. The
loans are eliminated in the consolidation of the Company's CDOs.

18. Financial Instruments: Derivatives and Hedging

FASB No. 133, or SFAS 133, "Accounting for Derivative Instruments and Hedging Activities," which became effective January 1, 2001, requires the Company to recognize
all derivatives on the balance sheet at fair value. Derivatives that are not hedges must 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 the change in fair value of the hedged asset, liability, or firm commitment through earnings, or recognized in other comprehensive income until the hedged item is
recognized in earnings. The ineffective portion of a derivative's change in fair value will be immediately recognized in earnings. SFAS 133 may increase or decrease reported net income and
stockholders' equity prospectively, depending on future levels of LIBOR interest rates and other variables affecting the fair values of derivative instruments and hedged items, but will have no effect
on cash flows, provided the contract is carried through to full term.

63

---



Gramercy Capital Corp.

Notes To Condensed Consolidated Financial Statements (Continued)

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

September 30, 2008

18. Financial Instruments: Derivatives and Hedging (Continued)

The
following table summarizes the notional and fair value of the Company's derivative financial instruments at September 30, 2008. The notional value is an indication of the
extent of the Company's involvement in this instrument at that time, but does not represent exposure to credit, interest rate or market risks:

Benchmark Rate

Notional Value

Strike
Rate

Effective
Date

Expiration
Date

Fair
ValueInterest Rate Swap

1 month LIBOR

$
3,465


4.280
%

7/2005


12/2009

$
(44
)Interest Rate Swap

3 month LIBOR


3,465


5.178
%

4/2006


3/2010


(90
)Interest Rate Swap

3 month LIBOR


14,650


4.425
%

11/2007


7/2015


(392
)Interest Rate Swap

3 month LIBOR


12,000


3.063
%

1/2008


7/2010


43Interest Rate Swap

3 month LIBOR


12,000


9.850
%

8/2006


8/2011


(517
)Interest Rate Swap

3 month LIBOR


2,000


3.073
%

1/2008


7/2010


7Interest Rate Swap

3 month LIBOR


347,908


5.408
%

8/2007


5/2017


(22,278
)Interest Rate Swap

3 month LIBOR


699,441


5.331
%

8/2007


1/2018


(54,579
)Interest Rate Swap

1 month LIBOR


42,718


4.990
%

1/2007


1/2017


(3,114
)Interest Rate Swap

3 month LIBOR


24,143


5.114
%

2/2008


1/2017


(1,501
)Interest Rate Swap

3 month LIBOR


16,412


5.203
%

2/2008


5/2017


(1,103
)Interest Rate Swap

3 month LIBOR


4,700


3.170
%

4/2008


4/2012


57Interest Rate Cap

1 month LIBOR


250,000


5.250
%

4/2008


3/2010


128Interest Rate Cap

1 month LIBOR


600,000


5.250
%

8/2008


3/2010


308Interest Rate Cap

1 month LIBOR


9,375


4.260
%

8/2008


1/2015


(206
)Total



$
2,042,277










$
(83,281
)


At
September 30, 2008, derivative instruments were reported at their fair value as a net liability of $83,281. Offsetting adjustments are represented as deferred losses in
Accumulated Other Comprehensive Income of $17,775. For the three and nine months ended September 30, 2008, the Company recognized a decrease to interest expense of $132 attributable to any
ineffective component of its derivative instruments designated as cash flow hedges. For the same period, the Company recognized an increase to earnings of $0 attributable to the change in value of
undesignated derivatives. Currently, all derivative instruments are designated as cash flow hedging instruments. Over time, the realized and unrealized gains and losses held in Accumulated Other
Comprehensive Income will be reclassified into earnings in the same periods in which the hedged interest payments affect earnings.

The
Company is hedging exposure to variability in future interest payments on our debt facilities and cash flows for future transactions. Additionally, the Company has in the past and
may in the future enter into total rate of return swaps, or TROR swaps, which are tied to a CMBS index and are intended to hedge the Company's exposure to variability in the rate of return in excess
of anticipated future interest payments on that portion of the Company's debt facilities used to fund fixed rate mortgage loan assets held as available for sale.

19. Income Taxes

The Company has elected to be taxed as a REIT, under Sections 856 through 860 of the Internal Revenue Code beginning with it's taxable year ended December 31, 2004. To
qualify as a REIT, the Company must meet certain organizational and operational requirements, including a requirement to

64

---



Gramercy Capital Corp.

Notes To Condensed Consolidated Financial Statements (Continued)

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

September 30, 2008

19. Income Taxes (Continued)

distribute
at least 90% of its ordinary taxable income to stockholders. As a REIT, the Company generally will not be subject to federal income tax on taxable income that it distributes to its
stockholders. If the Company fails to qualify as a REIT in any taxable year, it will then be subject to federal income taxes on taxable income at regular corporate rates and will not be permitted to
qualify for treatment as a REIT for federal income tax purposes for four years following the year during which qualification is lost unless the Internal Revenue Service grants the Company relief under
certain statutory provisions. Such an event could materially adversely affect the Company's net income and net cash available for distributions to stockholders. However, the Company believes that it
is organized and will operate in such a manner as to qualify for treatment as a REIT and the Company intends to operate in the foreseeable future in such a manner so that it will qualify as a REIT for
federal income tax purposes. The Company may, however, be subject to certain state and local taxes.

The
Company's Board of Directors elected to not pay for the third quarter of 2008 any dividend on its common stock, which for the second quarter of 2008 was $0.63 per share, and will
revisit the
Company's dividend policy at year-end. Based on current estimates of taxable income, the Company believes its cumulative distributions made to date in 2008 will satisfy the Company's tax
requirements for the 2008 calendar year.

For
the three and nine months ended September 30, 2008 and 2007, the Company recorded $36 and $47 and $338 and $1,301 of income tax expense, respectively, in net income from
continuing operations for income attributable to the Company's wholly-owned TRSs. The Company has assumed an effective tax rate for the three and nine months ended September 30, 2008 of 43%
taking into consideration the anticipated applicable U.S. federal statutory tax rate at September 30, 2008 of 34% and state and local taxes.

20. Environmental Matters

The Company's management believes the Company is in compliance in all material respects with applicable Federal, state and local ordinances and regulations regarding environmental
issues. It's management is not aware of any environmental liability that it believes would have a materially adverse impact on the Company's financial position, results of operations or cash flows.

21. Segment Reporting

Prior to the acquisition of American Financial, the Company was a REIT focused primarily on originating and acquiring loans and securities related to real estate and under the provisions
of SFAS 131 operated in only one segment. As a result of the acquisition of American Financial, as of September 30, 2008, the Company has determined that it has two reportable operating
segments: Structured Finance and Real Estate. The reportable segments were determined based on the management approach, which looks to the Company's internal organizational structure. These two lines
of business require different support infrastructures.

The
Structured Finance segment includes all of the Company's activities related to senior and mezzanine real estate debt and senior and mezzanine capital investment activities and the
financing thereof, including the Company's CMBS investments. These include a dedicated management team within Gramercy Finance for real estate lending origination, acquisition and servicing.

65

---



Gramercy Capital Corp.

Notes To Condensed Consolidated Financial Statements (Continued)

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

September 30, 2008

21. Segment Reporting (Continued)

The
Real Estate segment includes all of the Company's activities related to the ownership and leasing of commercial real estate and credit net lease properties. In connection with the
Company's significant increase in the size and scope of its real estate portfolio resulting from the American Financial acquisition, the Company initiated the build-out of an integrated
asset management platform within Gramercy Realty to consolidate responsibility for, and control over, leasing, lease administration, property management, and tenant relationship management.

The
Company evaluates performance based on the following financial measures for each segment:

Structured
Finance

Real Estate

Corporate/
Other(1)

Total CompanyThree months ended September 30, 2008Total revenues(2)

$
80,083

$
111,630

$


$
191,713Earnings (loss) from unconsolidated joint
ventures


2,090


(674
)




1,416Total operating and interest expense(3)


(58,572
)

(111,107
)

(13,125
)

(182,804
)Net income from continuing operations(4)

$
23,601

$
(151
)
$
(13,125
)
$
10,325Nine months ended September 30, 2008Total revenues(2)

$
254,310

$
219,844

$


$
474,154Earnings (loss) from unconsolidated joint
ventures


7,519


(1,402
)




6,117Total operating and interest expense(3)


(171,941
)

(217,937
)

(41,364
)

(431,242
)Net income from continuing operations(4)

$
89,888

$
505

$
(41,364
)
$
49,029Total Assets

$
4,487,919

$
4,089,253

$
(783,988
)
$
7,793,184


---

66

---



Gramercy Capital Corp.

Notes To Condensed Consolidated Financial Statements (Continued)

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

September 30, 2008

22. Supplemental Disclosure of Non-Cash Investing and Financing Activities

The following table represents non-cash activities recognized in other comprehensive income for the nine months ended September 30, 2008 and 2007:

2008

2007Deferred losses and other non-cash activity related to derivatives

$
(17,775
)
$
(22,164
)


23. Subsequent Events

On October 27, 2008, the Company, the Operating Partnership, SL Green and SL Green Operating Partnership, L.P., entered into a services agreement (the "Services Agreement")
pursuant to which SL Green will provide consulting and other services to the Company. SL Green will make Marc Holliday, Andrew Mathias and David Schonbraun available to provide services until the
earliest of (i) September 30, 2009, (ii) the termination of the management agreement or (iii) with respect to a particular executive, the termination of any such
executive's employment with SL Green. In consideration for the consulting services, the Company will pay a fee to SL Green of $200,000 per month payable, at the Company's option, in cash or, if
permissible under applicable law or the requirements of the exchange on which the shares of the Company's common stock trade, shares of the Company's common stock. SL Green will also provide
the Company with certain other services described in the Services Agreement for a fee of $100,000 per month in cash and for a period terminating at the earlier of (i) three months after the
date of the Services Agreement, subject to a one-time 30-day extension, or (ii) the termination of the management agreement.

On
October 27, 2008, the Board of Directors (the "Board") of the Company appointed Roger M. Cozzi as Chief Executive Officer of the Company. The Board also appointed
Mr. Cozzi as President of the Company and agreed to nominate Mr. Cozzi for election to the Board at the next annual meeting of the stockholders of the Company at which a class of
directors with a vacancy is up for election. In connection with Mr. Cozzi's appointment, the Company and Mr. Cozzi also entered into a severance agreement on October 27, 2008 (the
"Severance Agreement") pursuant to which Mr. Cozzi will be entitled to receive certain benefits upon the termination of his employment with the Manager. Pursuant to the Severance Agreement, if
Mr. Cozzi's employment with the Manager is terminated by the Manager without "Cause" or by Mr. Cozzi with "Good Reason" (as such terms are defined in Mr. Cozzi's employment
agreement with the Manager as in effect from time to time), Mr. Cozzi will be credited with 12 months of additional vesting under all equity awards granted to him by the Company. In
addition, if Mr. Cozzi's employment with the Manager is terminated due to his death or disability, he will be credited with 12 months of additional vesting under all equity awards
granted to him by the Company.

The
following officers of the Company resigned effective as of October 27, 2008: Marc Holliday, Chief Executive Officer; Andrew Mathias, Chief Investment Officer; and Gregory F.
Hughes, Chief Credit
Officer. Mr. Holliday also resigned as President of the Company effective as of October 28, 2008. Mr. Holliday and Mr. Mathias will remain as consultants to the Company
through the earliest of (i) September 30, 2009, (ii) the termination of the Second Amended Management Agreement or (iii) the termination of their respective employment with
SL Green.

67

---





ITEM 2:    Management's Discussion and Analysis of Financial Condition and Results of Operations  (Amounts in thousands, except for share and per share data)

Overview

Gramercy Capital Corp. is an integrated commercial real estate finance and property investment company. We were formed in April 2004
and commenced operations upon the completion of our initial public offering in August 2004. On April 1, 2008, we completed the acquisition of American Financial Realty Trust (NYSE: AFR), or
American Financial, in a transaction with a total value of approximately $3.3 billion, including the assumption of approximately $1.3 billion of American Financial's secured debt. The
acquisition transformed our company from a pure specialty finance company into a diversified enterprise with complementary business lines consisting of commercial real estate finance and property
investments.

Our
commercial real estate finance business, which operates under the name Gramercy Finance, focuses on the direct origination and acquisition of whole loans, subordinate interests in
whole loans, mezzanine loans, preferred equity, commercial mortgage-backed securities, or CMBS, and other real estate related securities. Our property investment business, which operates under the
name Gramercy Realty, focuses on the acquisition and management of commercial properties net leased primarily to
regulated financial institutions and affiliated users throughout the United States. These institutions are for the most part deposit taking commercial banks, thrifts and credit unions, which we
generally refer to as "banks." Our portfolio of wholly-owned and jointly-owned bank branches and office buildings is leased to large banks such as Bank of America, N.A., Wachovia Bank, National
Association, Regions Financial Corporation and Citizens Financial Group, Inc. and to mid-sized and community banks. Neither Gramercy Finance nor Gramercy Realty is a separate legal
entity but are divisions of us through which our commercial real estate finance and property investment businesses are conducted.

We
conduct substantially all of our operations through our operating partnership, GKK Capital LP, or our Operating Partnership. We are externally managed and advised by GKK
Manager LLC, or our Manager, a majority-owned subsidiary of SL Green Realty Corp. (NYSE: SLG), or SL Green. We have elected to be taxed as a real estate investment trust, or REIT, under the
Internal Revenue Code and generally will not be subject to federal income taxes to the extent we distribute our income to our stockholders. We have in the past established, and may in the future
establish taxable REIT subsidiaries, or TRSs, to effect various taxable transactions. Those TRSs would incur federal, state and local taxes on the taxable income from their activities. Unless the
context requires otherwise, all references to "we," "our" and "us" mean Gramercy Capital Corp.

In
each financing transaction we undertake, we seek to control as much of the capital structure as possible in order to be able to identify and retain that portion that provides the best
risk-adjusted returns. This is generally achieved through the direct origination of whole loans, the ownership of which permits a wide variety of financing, syndication, and securitization
executions to achieve excess returns for the risks being taken. By providing a single source of financing for developers and sponsors, we streamline the lending process, provide greater certainty for
borrowers, and retain the high yield debt instruments that we manufacture. By originating, rather than buying, whole loans, subordinate interests in whole loans, mezzanine debt and preferred equity,
we strive to deliver superior returns to our stockholders.

Since
our inception, we have completed transactions in a variety of markets and secured by a variety of property types. Until the second half of 2007, the market for commercial real
estate debt exhibited high relative returns and significant inflows of capital. However, due to growing illiquidity in the credit markets and an overall slowing in macroeconomic conditions, the
default levels for commercial real estate have begun to rise. The market for debt instruments had for several years, until the second half of 2007, evidenced declining yields and more flexible credit
standards and loan structures. In particular, "conduit" originators who packaged whole loans for resale to investors drove

68

---



debt
yields lower while maintaining substantial liquidity because of the then-strong demand for the resulting securities. Because of reduced profits in the most liquid sectors of the
mortgage finance business then existing, several large institutions began originating large bridge loans for the purpose of generating interest income, rather than the typical focus on trading
profits. In response to those developments, we focused on areas where we had comparative advantages rather than competing for product merely on the basis of yield or structure. This had particularly
included whole loan origination in markets and transactions where we had 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 in secondary market transactions in tranched debt, we often avoided first loss risk in larger transactions due to the then high valuations of the underlying real
estate relative to historic valuation levels. Because of the then significant increase in the value of institutional quality assets relative to historic norms, we focused on positions in which a
property sale or conventional refinancing at loan maturity would provide for a complete return of our investment. We generally matched our assets and liabilities in terms of base interest rate
(generally one-month LIBOR) and, to the extent possible, expected duration. We raised debt and equity in several different capital markets to improve the diversity of our funding sources,
maintain liquidity, and achieve our match-funding objectives.

However,
beginning in the second quarter of 2007, the sub-prime residential lending and single family housing markets in the U.S. began to experience significant default
rates, declining real estate values and increasing backlog of housing supply, and other lending markets experienced higher volatility and decreased liquidity resulting from the poor credit performance
in the residential lending markets. Concerns in the residential sector of the capital markets quickly spread more broadly into the asset-backed commercial real estate, corporate and other credit and
equity markets. The factors described above have resulted in substantially reduced mortgage loan originations and securitizations, and caused more generalized credit market dislocations and a
significant contraction in available credit. As a result, most financial industry participants, including commercial real estate lenders and investors, including us, continue to find it difficult to
obtain cost-effective debt capital to finance new investment activity or to refinance maturing debt.

Credit
spreads on commercial mortgages (i.e., the interest rate spread over given benchmarks such as LIBOR or U.S. Treasury securities) are significantly influenced by:
(a) supply and demand for such mortgage loans; (b) perceived risk of the underlying real estate collateral cash flow; and (c) capital markets execution for the sale or financing
of such commercial mortgage assets. In the case of (a), the number of potential lenders in the market place and the amount of funds they are willing to devote to commercial mortgage assets will impact
credit spreads. As liquidity increases, spreads on equivalent commercial mortgage loans will decrease. Conversely, a lack of liquidity results in credit spreads increasing. During periods of
volatility, such as the markets are currently experiencing, the number of lenders participating in the market may change at an accelerated pace. Further, many lenders depend on the capital markets to
finance their portfolio of commercial loans. Lenders are forced to increase the credit spread at which they are willing to lend as liquidity in the capital market decreases. As the market tightens,
many warehouse lenders have requested additional collateral or repayments with respect to their loans in order to maintain margins that are acceptable to them.

For
existing loans, when credit spreads widen, the fair value of these existing loans decreases. If a lender were to originate a similar loan today, such loan would carry a greater
credit spread than the existing loan. Even though a loan may be performing in accordance with its loan agreement and the underlying collateral has not changed, the fair value of the loan may be
negatively impacted by the incremental interest foregone from the widened credit spread. Accordingly, when a lender wishes to sell or finance the loan, the reduced value of the loan may reduce the
total proceeds that the lender will receive.

69

---



In
the short-term, we believe the current environment of rapidly changing and evolving markets will provide increasing challenges to both our industry and our company. While
we continue to believe the commercial lending business has strong long-term fundamentals and is being adversely affected by volatility in the credit and capital markets, due to these
uncertainties, we are experiencing the following: (i) lower loan originations, (ii) limited access to capital, and increased cost of financing, (iii) reduced cash available for
distribution to stockholders, particularly as our portfolio is reduced by scheduled maturities and prepayments and (iv) increased instances of defaults by borrowers.

During
the first nine months of 2008, the global capital markets continued to experience tremendous volatility and a wide-ranging lack of liquidity. The impact of the global
credit crisis on our sector has been acute. Transaction volume has declined significantly, credit spreads for all forms of mortgage debt have reach all-time highs, issuance levels of CMBS
have ground to a halt, and other forms of financing from the debt markets have been dramatically curtailed. Financial institutions still hold significant inventories of unsold loans and CMBS, creating
a further overhang on the markets. We believe that the continuing dislocation in the debt capital markets, coupled with a slowdown in the U.S. economy, has already reduced property valuations and will
ultimately impact commercial real estate fundamentals. These developments have impacted and may further impact, the performance of our existing portfolio of assets. Furthermore, the volatility in the
capital markets has caused stress to all financial institutions and our business is dependent upon these counterparties for, among other things, financing and interest rate derivatives. We expect
credit to continue to be challenging throughout 2008 and 2009.

We
responded to these difficult conditions by decreasing investment activity when we observed deteriorating market conditions, increasing our liquidity and extending debt maturities. In
addition, our Board of Directors elected to not pay for the third quarter of 2008 a dividend on shares of our common stock, which for the second quarter of 2008 was $0.63 per share. Our Board of
Directors will revisit the Company's dividend policy at year-end.

In
response to these market disruptions, legislators and financial regulators implemented a number of mechanisms designed to add stability to the financial markets, including the
provision of direct and indirect assistance to distressed financial institutions, assistance by the banking authorities in arranging acquisitions of weakened banks and broker-dealers, implementation
of programs by the Federal Reserve to provide liquidity to the commercial paper markets and temporary prohibitions on short sales of certain financial institution securities. On October 3,
2008, the President of the United States signed into law the Emergency Economic Stabilization Act of 2008, or the EESA. The EESA provides the U.S. Secretary of Treasury with the authority to establish
a Troubled Asset Relief Program, or TARP, to purchase from financial institutions up to $700 billion of residential or commercial mortgages and any securities, obligations, or other instruments
that are based on, or related to, such mortgages, that in each case was originated or issued on or before March 14, 2008, as well as any other financial instrument that the U.S. Secretary of
Treasury, after consultation with the Chairman of the Board of
Governors of the Federal Reserve System, determines the purchase of which is necessary to promote financial market stability, upon transmittal of such determination, in writing, to the appropriate
committees of the U.S. Congress. In addition, the U.S. Secretary of Treasury has the authority to establish a program to guarantee, upon request from a financial institution, the timely payment of
principal and interest on these financial assets. The overall effects of these and other legislative and regulatory efforts on the financial markets is uncertain, and they may not have the intended
stabilization effects. Should these or other legislative or regulatory initiatives fail to stabilize and add liquidity to the financial markets, our business, financial condition, results of
operations and prospects could be materially and adversely affected.

Even
if legislative or regulatory initiatives or other efforts successfully stabilize and add liquidity to the financial markets, we may need to modify our strategies, businesses or
operations, and we may incur increased capital requirements and constraints or additional costs in order to satisfy new

70

---



regulatory
requirements or to compete in a changed business environment. It is uncertain what effects recently enacted or future legislation or regulatory initiatives will have on us. Given the
volatile nature of the current market disruption and the uncertainties underlying efforts to mitigate or reverse the disruption, we may not timely anticipate or manage existing, new or additional
risks, contingencies or developments, including regulatory developments and trends in new products and services, in the current or future environment. Our failure to do so could materially and
adversely affect our business, financial condition, results of operations and prospects.

All
of our term CDO liabilities are in their reinvestment periods which means when the underlying assets repay we are able to reinvest the proceeds in new assets without having to repay
the liabilities. Because credit spreads are currently much wider than when we issued these liabilities, we currently expect to earn a higher return on equity on capital redeployed in this market.
Approximately $1.4 billion of our loans have their initial maturity date in 2008 or 2009. However, many of these loans contain extension options of at least six months (many subject to
performance criteria) so it is difficult to estimate how much capital from initial maturities or early pre-payments may be recycled into higher earning investments. Approximately
$1.4 billion of our loans have their initial, or next, maturity date in the last quarter of 2008 or in 2009. Many of these loans contain extension options of at least six months, although many
extension options are subject to performance criteria. The ongoing liquidity and credit crisis, and a slowing economy, make it increasingly difficult for management to estimate whether loans will be
repaid at or prior to maturity, qualify for extension options, or default at maturity due to the borrower's inability to refinance its loan or sell the property and retire its loan. The variability of
possible outcomes will influence the amount of capital available to us for reinvestment into higher earning investments, and the ability to maintain compliance with the financial and operating
covenants of our CDOs.

We
believe that in the longer term, liquidity and attractive liquidity pricing could return to the commercial real estate finance markets but that in the near term, new financing sources
must be developed in order to attractively fund incremental new investment activity. We believe these sources could include term loans from financial institutions and life companies, more restrictive
commercial
real estate finance structures which may not permit reinvestment from asset repayments, and financing provided by motivated sellers of assets.

The
recent credit crisis has put many borrowers and financial institutions, including many of our borrowers and tenants, under increasing amounts of financial and capital distress. This
has led to an increased incidence of defaults under loans and leases and could lead to increased vacancy rates in office properties occupied by these institutions. For the three and nine months ended
September 30, 2008, we recorded a gross provision for loan losses of $18.9 and $50.1 million, respectively, related to five separate loans.

As
of September 30, 2008, Gramercy Finance held loans and other lending investments and CMBS of $3.1 billion net of fees, discounts, and unfunded commitments with an
average spread to 30-day LIBOR of 455 basis points for its floating rate investments, and an average yield of 7.09% for its fixed rate investments. As of September 30, 2008,
Gramercy Finance also held interests in three credit tenant net lease investments, or CTL investments, two interests in joint ventures holding fee positions on properties subject to
long-term ground leases and a 100% fee interest in a property subject to a long-term ground lease.

71

---



The
aggregate carrying values, allocated by product type and weighted average coupons of our loans, and other lending investments and CMBS investments as of September 30, 2008 and
December 31, 2007, including loans held for sale, were as follows (dollars in thousands):

Carrying Value(1)

Allocation by
Investment Type

Fixed Rate:
Average Yield

Floating Rate:
Average Spread over
LIBOR(2)2008

2007

2008

2007

2008

2007

2008

2007Whole loans, floating rate

$
1,245,982

$
1,594,338


55.9
%

60.5
%







372 bps


332 bpsWhole loans, fixed rate


164,618


204,192


7.4
%

7.7
%

7.10
%

7.79
%




Subordinate interests in whole loans, floating rate


101,179


146,901


4.5
%

5.6
%







401 bps


447 bpsSubordinate interests in whole loans, fixed rate


62,832


61,890


2.8
%

2.3
%

9.26
%

8.78
%




Mezzanine loans, floating rate


432,117


413,813


19.4
%

15.7
%







670 bps


607 bpsMezzanine loans, fixed rate


212,052


203,753


9.5
%

7.7
%

9.49
%

8.91
%




Preferred equity, fixed rate


11,990


11,858


0.5
%

0.5
%

10.22
%

10.09
%




Subtotal/ Weighted average


2,230,770


2,636,745


100.0
%

100.0
%

8.61
%

8.45
%

446 bps


395 bpsCMBS, floating rate


69,460


23,817


8.1
%

3.0
%







687 bps


593 bpsCMBS, fixed rate


787,942


768,166


91.9
%

97.0
%

6.22
%

6.13
%




Subtotal/ Weighted average


857,402


791,983


100.0
%

100.0
%

6.22
%

6.13
%

687 bps


593 bpsTotal

$
3,088,172

$
3,428,728


100.0
%

100.0
%

7.09
%

7.02
%

455 bps


397 bps


---

As
of September 30, 2008, Gramercy Realty owned a portfolio comprised of 744 bank branches, 344 office buildings and 11 land parcels, of which 84 bank braches and one office
building were partially owned through joint ventures. Our wholly-owned properties aggregated approximately 27.5 million rentable square feet and its partially-owned properties aggregated
approximately 0.8 million rentable square feet, including 0.4 million rentable square feet in an unconsolidated joint venture. As of September 30, 2008, the occupancy of our
wholly-owned properties was 87.5% and the occupancy for our partially-owned properties was 99.9%. Our two largest tenants are Bank of America, N.A. and Wachovia Bank, National Association and, as of
September 30, 2008, they represented approximately 39.0% and 14.2%, respectively, of the rental income of our portfolio and occupied approximately 45.1% and 19.2%, respectively, of our total
rentable square feet.

72

---



Summarized in the table below are our key property portfolio statistics as of September 30, 2008:

Number of Properties

Square Feet

OccupancyPortfolio

At
Acquisition

At
September 30,
2008

At
Acquisition

At
September 30,
2008

At
Acquisition

At
September 30,
2008Core


653


647


20,935,260


20,830,900


96.4
%

96.1
%ValueAdd


303


225


5,265,870


4,749,349


65.8
%

69.5
%Subtotal


956


872


26,201,130


25,580,249


90.3
%

90.2
%Held for Sale


96


143


2,382,666


2,244,038


57.1
%

47.8
%Total


1,052


1,015


28,583,796


27,824,287


87.5
%

87.6
%


Due
to the nature of the business of our tenant base, which places a high premium on serving its customers from a well established distribution network, we typically enter into
long-term leases with our tenants. As of September 30, 2008, the weighted average remaining term of our leases was 10.6 years and approximately 80.4% of our base revenue was
derived from triple net and bond net leases. With in-house capabilities in acquisitions, asset management, property management and leasing, we are focused on maximizing the value of our
portfolio through acquisitions and strategic sales and through effective and efficient property management and leasing operations.

We
rely on the credit and equity markets to finance and grow our business. During the second half of 2007 and the first three quarters of 2008, severe credit and liquidity issues in the
sub-prime residential lending and single family housing sectors negatively impacted the asset-backed and corporate fixed income markets, as well as the equity securities of financial
institutions and real estate companies. As the severity of residential sector issues increased, nearly all securities markets experienced decreased liquidity and greater risk premiums as concerns
about the outlook for the U.S. and world economic growth increased. These concerns continue and risk premiums in many capital markets remain at or near all-time highs with liquidity
extremely low compared to historical standards or virtually non-existent. As a result, most commercial real estate finance and financial services industry participants, including ours,
have reduced new investment activity until the capital markets become more stable, the macroeconomic outlook becomes clearer and market liquidity increases. In this environment, we are focused on
actively managing portfolio credit, generating and recycling liquidity from existing assets, leasing vacant space, and extending debt maturities.

Liquidity
is a measurement of the ability to meet cash requirements, including ongoing commitments to repay borrowings, fund and maintain loans and other investments, pay dividends and
other general business needs. Due to continued market turbulence, we do not anticipate having the ability in the near term to access new equity capital or debt capital through new warehouse lines, CDO
issuances, term or credit facilities or trust preferred issuances, although we continue to explore capital raising options. In the event we are not able to successfully secure financing, we will rely
on cash flows from operations, principal and lease payments on our investments and proceeds from asset and loan sales to satisfy our liquidity requirements. If we (i) are unable to renew,
replace or expand our sources of financing, (ii) are unable to execute asset and loan sales in a timely manner or to receive anticipated proceeds from them or (iii) fully utilize
available cash, it may have an adverse effect on our business, results of operations, ability to make distributions to our stockholders and ability to service our debt.

Our
current and future borrowings may require us, among other restrictive covenants, to keep uninvested cash on hand to maintain a certain portion of our assets free from liens and to
secure such borrowings without assets. These conditions could limit our ability to incur further borrowings. Additionally, we have several restrictive covenants in our KeyBank unsecured credit
facility, Goldman repurchase facility and Wachovia term loan and credit facility. The Company was in compliance with all such covenants as of September 30, 2008. However, compared to prior
quarters, we were much closer to the minimum requirements set forth in such covenants. Further, to the extent that in future periods

73

---



we
realize higher amounts of losses related to its loans and other lending investments, it would put additional pressure on our ability to continue to meet these covenants. If we are unable to make
required payments under such borrowings, breach any representation or warranty in the loan documents or violate any covenant contained in a loan document (including those described above), our lenders
may accelerate the maturity of our debt or require us to pledge more collateral. If we are unable to retire our borrowings in such a situation, (i) we may need to prematurely sell the assets
securing such debt, (ii) the lenders could accelerate the debt and foreclose on the assets that are pledged as collateral to such lenders, (iii) such lenders could force us into
bankruptcy, (iv) such lenders could force us to take other actions to protect the value of their collateral and (v) our other debt financings could become immediately due and payable.
Any such event would have a material adverse effect on our liquidity, the value of our common stock, our ability to make distributions to our stockholders and our ability to continue as a going
concern.

The
majority of our loan and other investments are pledged as collateral for our CDO bonds and the income generated from these investments is used to fund interest obligations of our CDO
bonds and the remaining income, if any, is retained by us. Our CDO bonds contain interest coverage and asset over collateralization covenants that must be met in order for us to receive such payments.
If we fail these covenants in any of our CDOs, all cash flows from the applicable CDO would be diverted to repay principal and interest on the outstanding CDO bonds and we would not receive any
residual payments until that CDO regained compliance with such tests. The Company was in compliance with all such covenants as of September 30, 2008. In the event of a breach of our CDO
covenants that we could not cure in the near term, we would be required to fund our non-CDO expenses, including management fees, distributions on Class B units, debt coverage,
interest on our trust preferred securities and other expenses with (i) cash on hand, (ii) income from any CDO not in default, (iii) income from our real property and unencumbered
loan assets, (iv) sale of assets, (v) or accessing the equity or debt capital markets, if available. We have the ability to cure defaults which would resume normal residual payments to
us by purchasing non-performing loans out of our CDOs. However, we may not have sufficient liquidity available to do so at such time.

The
following discussion related to our consolidated financial statements should be read in conjunction with the financial statements appearing in Item 1 of this Quarterly Report
on Form 10-Q.

Critical Accounting Policies

Our discussion and analysis of financial condition and results of operations is based on our financial statements, which have been
prepared in accordance with accounting principles generally accepted in the United States, known as GAAP. These accounting principles require us to make some complex and subjective decisions and
assessments. Our most critical accounting policies involve decisions and assessments, which could significantly affect our reported assets, liabilities and contingencies, as well as our reported
revenues and expenses. We believe that all of the decisions and assessments upon which our financial statements are based were reasonable at the time made based upon information available to us at
that time. We evaluate these decisions and assessments on an ongoing basis. Actual results may differ from these estimates under different assumptions or conditions. We have identified our most
critical accounting policies to be the following:

Variable Interest Entities

Our ownership of the subordinated classes of CMBS from a single issuer may provide us with the right to control the foreclosure/workout
process on the underlying loans. There are certain exceptions to the scope of FIN 46R, one of which provides that an investor that holds a variable interest in a qualifying special-purpose
entity, or QSPE, does not consolidate that entity unless the investor has the unilateral ability to cause the entity to liquidate. FASB No. 140, or SFAS No. 140, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of Liabilities," provides the requirements for an entity to qualify as a QSPE. To maintain the QSPE exception, the special-purpose

74

---



entity
must initially meet the QSPE criteria and must continue to satisfy such criteria in subsequent periods. A special-purpose entity's QSPE status can be affected in future periods by activities by
its transferors or other involved parties, including the manner in which certain servicing activities are performed. To the extent that our CMBS investments were issued by a special-purpose entity
that meets the QSPE requirements, we record those investments at the purchase price paid. To the extent the underlying special-purpose entities do not satisfy the QSPE requirements, we follow the
guidance set forth in FIN 46R as the special-purpose entities would be determined to be VIEs.

We
have analyzed the pooling and servicing agreements governing each of our controlling class CMBS investments and we believe that the terms of those agreements conform to industry
standards and are consistent with the QSPE criteria. In April 2008, the FASB voted to eliminate the scope exception for QSPEs from the guidance in SFAS No. 140 and to remove the scope exception
for QSPEs from FIN 46R. This will require that VIEs previously accounted for as QSPEs be analyzed for consolidation
according to FIN 46R. While the revised standards have not been finalized, and deferred for potential application until 2010, this change may affect our financial statements.

At
September 30, 2008, we owned securities of three controlling class CMBS trusts with a carrying value of $39,225. The total par amounts of CMBS issued by the three CMBS trusts
was $921,654. Using the fair value approach to calculate expected losses or residual returns, we have concluded that we would not be the primary beneficiary of any of the underlying special-purpose
entities. At September 30, 2008, our maximum exposure to loss as a result of its investment in these QSPEs totaled $39,225, which equals the book value of these investments as of
September 30, 2008.

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

Real Estate and CTL Investments

We record acquired real estate and CTL investments at cost less accumulated depreciation. Costs directly related to the acquisition of
such investments are capitalized. Certain improvements are capitalized when they are determined to increase the useful life of the building. Depreciation is computed using the
straight-line method over the shorter of the estimated useful life of the capitalized item or 40 years for buildings, five to ten years for building equipment and fixtures, and the
lesser of the useful life or the remaining lease term for tenant improvements and leasehold interests. Maintenance and repair expenditures are charged to expense as incurred.

In
leasing office space, we may provide funding to the lessee through a tenant allowance. In accounting for tenant allowances, we determine whether the allowance represents funding for
the construction of leasehold improvements and evaluates the ownership, for accounting purposes, of such improvements. If we are considered the owner of the leasehold improvements for accounting
purposes, we capitalize the amount of the tenant allowance and depreciates it over the shorter of the useful life of the leasehold improvements or the lease term. If the tenant allowance represents a
payment for a purpose other than funding leasehold improvements, or in the event we are not considered the owner of the improvements for accounting purposes, the allowance is considered to be a lease
incentive and is recognized over the lease term as a reduction of rental revenue. Factors considered during this evaluation usually include (i) who holds legal title to the improvements,
(ii) evidentiary requirements concerning the spending of the tenant allowance, and (iii) other controlling rights provided by the lease agreement (e.g. unilateral control of the
tenant space during the build-out process.) Determination of the accounting for a tenant allowance is made on a case-by-case basis, considering the facts and
circumstances of the individual tenant lease.

Results
of operations of properties acquired are included in the Consolidated Statements of Income from the date of acquisition.

75

---



In
accordance with FASB No. 144, or SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," a property to be disposed of is reported at
the lower of its carrying amount or its estimated fair value, less its cost to sell. Once an asset is classified as held for sale, depreciation expense and straight-line rent adjustments
are no longer recorded and historic results are reclassified as Discontinued Operations.

We
also review the recoverability of the property's carrying value when circumstances indicate a possible impairment of the value of a property. The review of recoverability is based on
an estimate of the future undiscounted cash flows, excluding interest charges, expected to result from the property's use and eventual disposition. These estimates consider factors such as expected
future operating income, market and other applicable trends and residual value, as well as the effects of leasing demand, competition and other factors. If management determines impairment exists due
to the inability to recover the carrying value of a property, an impairment loss is recorded to the extent that the carrying value exceeds the estimated fair value of the property for properties to be
held and used and for assets held for sale, an impairment loss is recorded to the extent that the carrying value exceeds the fair value less estimated cost to dispose of assets held for sale. These
assessments are recorded as an impairment loss in the Consolidated Statements of Income, resulting in an immediate negative adjustment to net income.

In
accordance with FASB No. 141, or SFAS No. 141, "Business Combinations," we allocate the purchase price of real estate to land, building and improvements, and
intangibles, such as the value of above-, below- and at-market, leases and origination costs associated with the in-place leases. We depreciate the amount allocated to building
and other intangible assets over their estimated useful lives, which generally range from three to 40 years. The values of the above- and below-market leases are amortized and recorded as
either an increase (in the case of below-market leases) or a decrease (in the case of above-market leases) to rental income over the remaining term of the associated lease. The value associated with
in-place leases and tenant relationships are amortized over the expected term of the relationship, which includes an estimated probability of the lease renewal, and its estimated term. If
a tenant vacates its space prior to the contractual termination of the lease and no rental payments are being made on the lease, any unamortized balance of the related intangible will be written off.
The tenant improvements and origination costs are amortized as an expense over the remaining life of the lease (or charged against earnings if the lease is terminated prior to its contractual
expiration date). We assess fair value of the leases based on estimated cash flow projections that utilize appropriate discount and capitalization rates and available market information. Estimates of
future cash flows are based on a number of factors including the historical operating results, known trends, and market/economic conditions that may affect the property.

We
have not yet obtained all the information necessary to finalize our estimates to complete the purchase price allocations in accordance with SFAS No. 141 related to the American
Financial acquisition. The purchase price allocations will be finalized once the information indentified has been received, which should not be longer than one year from the date of acquisition.

Leasehold Interests

Leasehold interest assets and liabilities are recorded based on the difference between the fair value of our estimate of the net
present value of cash flows expected to be paid and earned from the subleases over the non-cancelable lease terms and any payments received in consideration for assuming the leasehold
interests. Factors used in determining the net present value of cash flows include contractual rental amounts, costs of tenant improvements, costs of capital expenditures and amounts due under the
corresponding operating lease assumed. Amounts allocated to leasehold interests, based on their respective fair values, are amortized on a straight-line basis over the remaining lease
term.

76

---



Investments in Unconsolidated Joint Ventures

We account for our investments in unconsolidated joint ventures under the equity method of accounting since we exercise significant
influence, but do not unilaterally control the entities, and is not considered to be the primary beneficiary under FIN 46R. In the joint ventures, the rights of the other investors are
protective and participating. Unless we are determined to be the primary beneficiary, these rights preclude us from consolidating the investments. The investments are recorded initially at cost as an
investment in unconsolidated joint ventures, and subsequently are adjusted for equity in net income (loss) and cash contributions and distributions. Any difference between the carrying amount of the
investments on our balance sheet and the underlying equity in net assets is amortized as an adjustment to equity in net income (loss) of unconsolidated joint ventures over the lesser of the joint
venture term or 40 years. None of the joint venture debt is recourse to us. As of September 30, 2008 and December 31, 2007, we had investments of $93,087 and $49,440 in
unconsolidated joint ventures, respectively.

Assets Held for Sale



Loans held for investment are intended to be held to maturity and, accordingly, are carried at cost, net of unamortized loan
origination fees, discounts, repayments, sales of partial interests in loans, and unfunded commitments unless such loan or investment is deemed to be impaired. Loans held for sale are carried at the
lower of cost or market value using available market information obtained through consultation with dealers or other originators of such investments. During the three months ended September 30,
2008, the Company redesignated loans with a carrying value of $154,409 from assets held for sale to loans and other lending investments. We may originate or acquire preferred equity interests that
allow us to participate in a percentage of the underlying property's cash flows from operations and proceeds from a sale or refinancing. Should we make such a preferred equity investment, we must
determine whether that investment should be accounted for as a loan, joint venture or as an interest in real estate.



The results of operations from real estate investments or CTL Investments sold or held for sale in the current and prior periods are
classified as "Loss from discontinued operations" on our consolidated statement of operations even though such losses were actually recognized by us prior to the asset sale.

Commercial Mortgage-Backed Securities

We designate our CMBS investments pursuant to FASB No. 115, or SFAS No. 115, on the date of acquisition of the
investment. Held to maturity investments are stated at cost plus any premiums or discounts which are amortized through the consolidated statements of income using the level yield method. CMBS
securities that we do not hold for the purpose of selling in the near-term but may dispose of prior to maturity, are designated as available-for-sale and are
carried at estimated fair value with the net
unrealized gains or losses recorded as a component of accumulated other comprehensive income (loss) in stockholder's equity. Unrealized losses on securities that in the judgment of management are
other than temporary are charged against earnings as a loss on the consolidated statement of income. In November 2007, subsequent to financing our CMBS investments in our CDOs, we redesignated all of
our available-for-sale CMBS investments with a book value of approximately $43.6 million to held to maturity. As of September 30, 2008 and December 31,
2007, the unrealized loss on the redesignated CMBS investments included in other comprehensive income was $5,134 and $5,575, respectively.

We
account for CMBS (other than those of high credit quality or sufficiently collateralized to ensure that the possibility of credit loss is remote) under Emerging Issues Task Force
99-20, "Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in

77

---



Securitized
Financial Assets," or EITF 99-20. Accordingly, on a quarterly basis, when significant changes in estimated cash flows from the cash flows previously estimated occur due
to actual prepayment and credit loss experience, and the present value of the revised cash flow is less then the present value previously estimated, an other than temporary impairment is deemed to
have occurred. The security is written down to fair value with the resulting charge against earnings and a new cost basis is established. We calculate a revised yield based on the current amortized
cost of the investment (including any other-than-temporary impairments recognized to date) and the revised yield is then applied prospectively to recognize interest income.

We
determine the fair value of CMBS based on the types of securities in which we have invested. For liquid, investment-grade securities, we consult with dealers of such securities to
periodically obtain updated market pricing for the same or similar instruments. For non-investment grade securities, we actively monitor the performance of the underlying properties and
loans and update our pricing model to reflect changes in projected cash flows. The value of the securities is derived by applying discount rates to such cash flows based on current market yields. The
yields employed are obtained from our own experience in the market, advice from dealers and/or information obtained in consultation with other investors in similar instruments. Because fair value
estimates may vary to some degree, we must make certain judgments and assumptions about the appropriate price to use to calculate the fair values for financial reporting purposes. Different judgments
and assumptions could result in materially different presentations of value.

In
accordance with SFAS No. 115, when the estimated fair value of the security classified as available-for-sale has been below amortized cost for a
significant period of time and we conclude that we no longer have the ability or intent to hold the security for the period of time over which we expect the values to recover to amortized cost, the
investment is written down to its fair value, and this loss is realized and charged against earnings. The determination of other-than-temporary impairment is a subjective
process, and different judgments and assumptions could affect the timing of loss realization. In addition, it is possible that we in the future may need to recognized our
other-than-temporary impairment notwithstanding our continued determination that no credit loss has occurred and
estimated cash flows remain stable, due to the duration that the estimated fair value remains below book value.

Pledged Government Securities

We maintain a portfolio of treasury securities that are pledged to provide principal and interest payments for mortgage debt previously
collateralized by properties in our real estate portfolio. These securities are carried at amortized cost because we have positive intent and the ability to hold the securities to maturity. These
securities had a carrying value of $102,607, a fair value of $100,889 and unrealized losses of $1,718 at September 30, 2008, and have maturities that extend through November 2013. We did not
maintain a portfolio of pledged treasury securities at December 31, 2007.

Tenant and Other Receivables

Tenant and other receivables are primarily derived from the rental income that each tenant pays in accordance with the terms of its
lease, which is recorded on a straight-line basis over the initial term of the lease. Since many leases provide for rental increases at specified intervals, straight-line basis
accounting requires us to record a receivable, and include in revenues, unbilled rent receivables that will only be received if the tenant makes all rent payments required through the expiration of
the initial term of the lease. Tenant and other receivables also include receivables related to tenant reimbursements for common area maintenance expenses and certain other recoverable expenses that
are recognized as revenue in the period in which the related expenses are incurred.

Tenant
and other receivables are recorded net of the allowances for doubtful accounts, which as of September 30, 2008 and December 31, 2007 were $5,457 and $0,
respectively. We continually review receivables related to rent, tenant reimbursements and unbilled rent receivables and determines

78

---



collectability
by taking into consideration the tenant's payment history, the financial condition of the tenant, business conditions in the industry in which the tenant operates and economic
conditions in the area in which the property is located. In the event that the collectability of a receivable is in doubt, we increase the allowance for uncollectible accounts or record a direct
write-off of the receivable in the consolidated statements of income.

Intangible Assets

Pursuant to SFAS No. 141, we follow the purchase method of accounting for all business combinations. To ensure that intangible
assets acquired and liabilities assumed in a purchase method business combination are recognized and reported apart from goodwill, we apply criteria specified in SFAS No. 141.

We
allocate the purchase price of acquired properties to tangible and identifiable intangible assets acquired based on their respective fair values. Tangible assets include land,
buildings and improvements on an as-if-vacant basis. We utilize various estimates, processes and information to determine the as-if-vacant property
value. Estimates of value are made using customary methods, including data from appraisals, comparable sales, discounted cash flow analysis and other methods. Identifiable intangible assets include
amounts allocated to acquired leases for above- and below-market lease rates and the value of in-place leases.

Above-market
and below-market in-place lease values for properties acquired are recorded based on the present value (using an interest rate which reflects the risks
associated with the leases acquired) of the difference between the contractual amount to be paid pursuant to each in-place lease and management's estimate of the fair market lease rate for
each such in-place lease, measured over a period equal to the remaining non-cancelable term of the lease. The capitalized above-market lease values are amortized as a reduction
of rental income over the remaining non-cancelable terms of the respective leases. The capitalized below-market lease values are amortized as an increase to rental income over the initial
term and any fixed-rate renewal periods in the respective leases.

The
aggregate value of intangible assets related to in-place leases is primarily the difference between the property valued with existing in-place leases adjusted
to market rental rates and the property valued as-if-vacant. Factors considered by management in its analysis of the in-place lease intangibles include an estimate
of carrying costs during the expected lease-up period for each property taking into account current market conditions and costs to execute similar leases. In estimating carrying costs, we
include real estate taxes, insurance and other operating expenses and estimates of lost rentals at market rates during the anticipated lease-up period, which is expected to average six
months. We also estimate costs to execute similar leases including leasing commissions, legal and other related expenses.

The
value of in-place leases is amortized to expense over the initial term of the respective leases, which range primarily from two to 20 years. In no event does the
amortization period for intangible assets exceed the remaining depreciable life of the building. If a tenant terminates its lease, the unamortized portion of the in-place lease value and
customer relationship intangibles is charged to expense.

In
making estimates of fair values for purposes of allocating purchase price, we utilize a number of sources, including independent appraisals that may be obtained in connection with the
acquisition or financing of the respective property and other market data. We also consider information obtained about each property as a result of its pre-acquisition due diligence, as
well as subsequent marketing and leasing activities, in estimating the fair value of the tangible and intangible assets acquired and intangible liabilities assumed. The allocations presented in the
accompanying consolidated balance sheets as of September 30, 2008 is substantially complete; however, there are certain items that we will finalize once additional information is received.
Accordingly, this allocation is subject to revision when final information is available, although future revisions are not expected to have a significant impact on our financial position or results of
operations.

79

---



Deferred Costs

Deferred costs include deferred financing costs which represent commitment fees, legal and other third party costs associated with
obtaining commitments for financing which result in a closing of such financing. These costs are amortized over the terms of the respective agreements and the amortization is reflected in interest
expense. Unamortized deferred financing costs are expensed when the associated debt is refinanced or repaid before maturity. Costs incurred in seeking financing transactions, that do not close are
expensed in the period in which it is determined that the financing will not close.

Deferred
costs also consist of fees and direct costs incurred to originate new investments and are amortized using the effective yield method over the related term of the investment.
Deferred costs also consist of fees and direct costs incurred to initiate and renew operating leases and are amortized on a straight-line basis over the related lease term.

Other Assets

We make payments for certain expenses such as insurance and property taxes in advance of the period in which it receives the benefit.
These payments are classified as prepaid expenses and amortized over the respective period of benefit relating to the contractual arrangement. We also escrow deposits related to pending acquisitions
and financing arrangements, as required by a
seller or lender, respectively. Prepaid acquisition costs represent a portion of the total purchase price of a property and are reclassified into real estate investments and related intangible assets,
as appropriate, at the time the acquisition is completed. If such costs are related to an acquisition that will not be consummated and the deposit is not recoverable, the respective amounts are
recorded as broken deal costs in the accompanying consolidated statements of income. Costs prepaid in connection with securing financing for a property are reclassified into deferred costs at the time
the transaction is completed.

Revenue Recognition



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

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

We
designate loans as non-performing at such time as: (1) the loan becomes 90 days delinquent or (2) the loan has a maturity default other than if
subject to a forbearance agreement. All non-performing loans are placed on non-accrual status and income is recognized only upon actual cash receipt. At September 30,
2008, we had three first mortgage loans with an aggregate carrying value of $169,809, one second lien loan with a carrying value of $18,900 and one third lien loan with a carrying value of $0, which
were classified as non-performing loans. In April 2008, the first lien lenders commenced a foreclosure action with respect to the collateral supporting the second lien and third lien loans
referenced above and such loans changed from being classified as sub-performing loans as of March 31, 2008 to non-performing loans as of each of June 30, 2008 and
September 30, 2008. The first and second lien loans are secured by land in California, which is intended primarily for residential development. Given the significant deterioration in the United
States residential real estate markets, we

80

---



believe
that the successful restructuring of these loans is speculative, additional reserves are possible, and any such restructuring will take longer than a more customary restructuring. Therefore,
there is uncertainty surrounding the possible outcome of these loans. In September 2008, the borrower and its subsidiaries were put into an involuntary bankruptcy which resulted in an automatic stay
of the foreclosure action instituted by the senior lender. In April 2008, the borrower under a first mortgage loan classified as non-performing as of September 30, 2008 with a
carrying value of $100,054 filed legal action in connection with the Company's alleged wrongful administration of the loan. We believe the borrower's claim is without merit. We have filed a
counterclaim in the form a foreclosure action to enforce its rights under the loan documents as a result of the borrower's default. Our action has been stayed by the borrower's bankruptcy
filing. In May 2008, the borrowers (controlled by the same sponsor) under two of the non-performing first mortgage loans with an aggregate value of $69,755 filed a petition in bankruptcy
under Chapter 11. We are currently evaluating our options to protect our interest, including the pursuit of a guaranty provided by the sponsor for all principal due. At December 31,
2007, we had one non-performing loan with foreclosure and carrying value of $29,058, which was subsequently repaid in full on March 14, 2008, along with accrued interest and
substantially all other fees and charges due to us.

We
classify loans as sub-performing if they are not performing in material accordance with their terms, but they do not qualify as non-performing loans. The
specific facts and circumstances of these loans may cause them to develop into non-performing loans should certain events occur. We evaluate the specific facts and circumstances of each
subperforming loan, and consider factors including, but not limited to: the performance of the underlying collateral; the adequacy of reserves (e.g. for operating deficits, interest, tenant
improvements, leasing commissions), the remaining term to maturity; the likelihood that the borrower will or will not satisfy conditions to extend the loan; and the financial condition of borrower and
sponsor. At September 30, 2008, three first mortgage loans with a total carrying value of $73,625 and three mezzanine loan with a carrying value of $100,873 were classified as
sub-performing. At December 31, 2007, one first mortgage loan with a carrying value of $10,403, and one 40% participation interest in a first mortgage loan with a carrying value of
$22,000, were classified as sub-performing.

In
some instances we may sell all or a portion of our investments to a third party. To the extent the fair value received for an investment exceeds the amortized cost of that investment
and SFAS No.140 criteria are met, under which 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 has a discount or fees, which were deferred at the time the investment was made and were
being recognized over the term of the investment, the unamortized portion of the discount or fees are recognized at the time of sale and recorded as a gain on the sale of the investment through other
income. For the three and nine months ended September 30, 2008 and 2007, we recognized $(186) and $294 and $0 and $4,354, respectively, in net gains from the sale of debt investments or
commitments.



Rental income from leases is recognized on a straight-line basis regardless of when payments are contractually due. Certain
lease agreements also contain provisions that require tenants to reimburse us for real estate taxes, common area maintenance costs and the amortized cost of capital expenditures with interest. Such
amounts are included in both revenues and operating expenses when we are the primary obligor for these expenses and assume the risks and rewards of a principal under these arrangements. Under leases
where the tenant pays these expenses directly, such amounts are not included in revenues or expenses.

Deferred
revenue represents rental revenue and management fees received prior to the date earned. Deferred revenue also includes rental payments received in excess of rental revenues
recognized as a result of straight-line basis accounting.

81

---



Other
income includes fees paid by tenants to terminate their leases, which are recognized when fees due are determinable, no further actions or services are required to be performed by
us, and collectability is reasonably assured. In the event of early termination, the unrecoverable net book values of the assets or liabilities related to the terminated lease are recognized as
depreciation and amortization expense in the period of termination.

We
recognize sales of real estate properties only upon closing, in accordance with SFAS No. 66, "Accounting for Sales of Real Estate." Payments received from purchasers prior to
closing are recorded as deposits. Profit on real estate sold is recognized using the full accrual method upon closing when the collectability of the sale price is reasonable assured and we are not
obligated to perform significant activities after the sale. Profit may be deferred in whole or part until the sale meets the requirements of profit recognition on sale of real estate under SFAS
No. 66.

Rent Expense

Rent expense is recognized on a straight-line basis regardless of when payments are due. Accrued expenses and other
liabilities in the accompanying consolidated balance sheets as of September 30, 2008 include an accrual for rental expense recognized in excess of amounts due at that time. Rent expense related
to leasehold interests is included in property operating expenses, and rent expense related to office rentals is included in marketing, general and administrative expense.

Reserve for Possible Loan Losses

Specific valuation allowances are established for possible loan losses on loans in instances where it is deemed possible that we may be
unable to collect all amounts of principal and interest due according to the contractual terms of the loan. We consider the estimated value of the collateral securing the loan, and compare it to the
carrying value of the loan. The estimated value of the collateral is determined by selecting the most appropriate valuation methodology, or methodologies, among several generally available and
accepted in the commercial real estate industry. The determination of the most appropriate valuation methodology is based on the key characteristics of the collateral type, collateral location,
quality and prospects of the sponsor, the amount and status of any senior debt, and other factors. These methodologies include the evaluation of operating cash flow from the property during the
projected holding period, and the estimated sales value of the collateral computed by applying an expected capitalization rate to the stabilized net operating income of the specific property, less
selling costs, all of which are discounted at market discount rates. Because the determination of estimated value is based upon projections of future economic events, which are inherently subjective,
amounts ultimately realized from loans and investments may differ materially from the net carrying value at the balance sheet date.

If,
upon completion of the valuation, the estimated fair value of the underlying collateral securing the loan is less than the net carrying value of the loan, an allowance is created
with a corresponding charge to the provision for possible loan losses. The allowance for each loan is maintained at a level we believe is adequate to absorb possible losses. Impairment losses are
recognized as a direct write-down of the loan investment with a corresponding charge-off to the allowance. We maintained a reserve of $48,092 and $8,658 at September 30,
2008 and December 31, 2007, respectively, relating to ten and eleven separate loans, respectively, with carrying values of $367,083 and $264,612, respectively. A substantial majority of the
loan loss reserve recognized in 2008 is attributable to a broadly syndicated second and third lien financing secured by residential land in Southern California. We reserved against the entire $15,000
third lien and $26,100 of the $45,000 second lien. We continue to work with our co-lenders, the senior lending group and the borrower for a favorable resolution, but the successful
restructuring of these loans is speculative, additional reserves are possible and any such restructuring will take longer than a more customary restructuring. During the nine months ended
September 30, 2008, charge-offs totaled $10,655 relating to two loans we foreclosed upon and two additional loans, one of which was sold at a loss and the other was retired. During
the year ended December 31, 2007,

82

---



charge-offs
totaled $3,200 relating to one defaulted loan we foreclosed upon, which had a carrying value of $19,911 and $19,155 at September 30, 2008 and December 31, 2007,
respectively, and is recorded in other assets.

Stock Based Compensation Plans

We have a stock-based compensation plan, described more fully in Note 15. We account for this plan using the fair value
recognition provisions of FASB Statement No. 123(R), "Share-Based Payment, a revision of FASB Statement No. 123, Accounting for Stock-Based Compensation."

The
Black-Scholes option-pricing model was developed for use in estimating the fair value of traded options, which have no vesting restrictions and are fully transferable. In addition,
option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because our plan has characteristics significantly different from those of
traded options and because changes in the subjective input assumptions can materially affect the fair value estimate, in our opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of our stock options.

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

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

2008

2007Dividend yield


8.8%


7.9%Expected life of option


5.8 years


5.9 yearsRisk-free interest rate


3.21%


4.32%Expected stock price volatility


35.0%


28.0%


Incentive Distribution (Class B Limited Partner Interest)

The Class B limited partner interests are entitled to receive an incentive return equal to 25% of the amount by which funds from
operations, or FFO, plus certain accounting gains (as defined in the partnership agreement of our Operating Partnership) exceed the product of our weighted average stockholders equity (as defined in
the partnership agreement of our Operating Partnership) multiplied by 9.5% (divided by four to adjust for quarterly calculations). We will record any distributions on the Class B limited
partner interests as an incentive distribution expense in the period when earned and when payment of such amounts has become probable and reasonably estimable in accordance with the partnership
agreement. These cash distributions will reduce the amount of cash available for distribution to our common unit holders in our Operating Partnership and to our common stockholders. In October 2008,
the Company entered into a letter agreement with the Class B limited partners to waive the incentive distribution that would have otherwise been earned for the period July 1,2008 through
December 31,2008 and provide that starting January 1, 2009, the incentive distribution can be paid, at our option, in cash or shares of our common stock. . We incurred approximately $0
and $5,100 and $22,868 and $29,469 with respect to such Class B limited partner interests for the three and nine months ended September 30, 2008 and 2007, respectively.

83

---



Derivative Instruments

In the normal course of business, we use a variety of derivative instruments to manage, or hedge, interest rate risk. We require that
hedging derivative instruments be effective in reducing the interest rate risk exposure that they are designated to hedge. This effectiveness is essential for qualifying for hedge accounting. Some
derivative instruments are associated with an anticipated transaction. In those cases, hedge effectiveness criteria also require that it be probable that the underlying transaction occurs. Instruments
that meet these hedging criteria are formally designated as hedges at the inception of the derivative contract.

We
use a variety of commonly used derivative products that are considered "plain vanilla" derivatives. These derivatives typically include interest rate swaps, caps, collars and floors.
We also use total rate of return swaps, or TROR swaps, which are tied to a CMBS index. We expressly prohibit the use of unconventional derivative instruments and using derivative instruments for
trading or speculative purposes. Further, we have a policy of only entering into contracts with major financial institutions based upon their credit ratings and other factors.

To
determine the fair value of derivative instruments, we use a variety of methods and assumptions that are based on market conditions and risks existing at each balance sheet date. For
the majority of financial instruments including most derivatives, long-term investments and long-term debt, standard market conventions and techniques such as discounted cash
flow analysis, option-pricing models, replacement cost, and termination cost are used to determine fair value. All methods of assessing fair value result in a general approximation of value, and such
value may never actually be realized.

In
the normal course of business, we are exposed to the effect of interest rate changes and limit these risks by following established risk management policies and procedures including
the use of derivatives. To address exposure to interest rates, we use derivatives primarily to hedge cash flow variability caused by interest rate fluctuations of our liabilities. We may also use
derivatives to hedge variability in sales proceeds to be received upon the sale of loans held for sale.

FASB
No. 133, or SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," as amended by FASB No. 149, requires us to recognize all derivatives
on the balance sheet at fair value. Derivatives that are not hedges must 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 the change in fair value of the hedged asset, liability, or firm commitment through earnings, or recognized in other comprehensive income until
the hedged item is recognized in earnings. The ineffective portion of a derivative's change in fair value will be immediately recognized in earnings. SFAS No. 133 may increase or decrease
reported net income and stockholders' equity prospectively, depending on future levels of LIBOR, swap spreads and other variables affecting the fair values of derivative instruments and hedged items,
but will have no effect on cash flows, provided the contract is carried through to full term.

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

All
hedges held by us are deemed effective based upon the hedging objectives established by our corporate policy governing interest rate risk management. The effect of our derivative
instruments on our financial statements is discussed more fully in Note 18 to our Consolidated Financial Statements.

Income Taxes

We elected to be taxed 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 certain

84

---



organizational
and operational requirements, including a requirement to distribute at least 90% of our ordinary taxable income to stockholders. As a REIT, we generally will not be subject to federal
income tax on taxable income that we distribute to our stockholders. If we fail to qualify as a REIT in any taxable year, we will then be subject to federal income taxes on our taxable income at
regular corporate rates and we will not be permitted to qualify for treatment as a REIT for federal income tax purposes
for four years following the year during which qualification is lost unless the Internal Revenue Service grants us relief under certain statutory provisions. Such an event could materially adversely
affect our net income and net cash available for distributions to stockholders. However, we believe that we will be organized and operate in such a manner as to qualify for treatment as a REIT and we
intend to operate in the foreseeable future in such a manner so that we will qualify as a REIT for federal income tax purposes. We may, however, be subject to certain state and local taxes.

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

Our
Board of Directors elected to not pay for the third quarter of 2008 a dividend on shares of our common stock, which for the second quarter of 2008 was $0.63 per share, and will
revisit the Company's dividend policy at year-end. Based on current estimates of taxable income, the Company believes its cumulative distributions made to date in 2008 will satisfy the
Company's tax requirements.

For
the three and nine months ended September 30, 2008 and 2007, we recorded $36 and $47 and $338 and $1,301 of income tax expense, respectively, in income from continuing
operations for income attributable to our wholly-owned TRSs. We have assumed an effective tax rate for the three and nine months ended September 30, 2008 of 44% taking into consideration the
anticipated applicable U.S. federal statutory tax rate at September 30, 2008 of 34% and state and local taxes.

Results of Operations (Amounts in thousands, except share and per share data)

Comparison of the three months ended September 30, 2008 to the three months ended September 30, 2007



2008

2007

$ ChangeInvestment income

$
60,552

$
85,796

$
(25,244
)Rental revenue


80,597


2,523


78,074Operating expense reimbursement


33,442





33,442Gain on sales and other income


5,441


1,895


3,546Total revenues


180,032

$
90,214

$
89,818Equity in net income of joint ventures

$
1,416

$
1,264

$
152Gain on extinguishment of debt

$
11,681

$


$
11,681


Investment
income is generated on our whole loans, subordinate interests in whole loans, mezzanine loans, preferred equity interests and CMBS. The decrease of $25,244 over the prior
period is primarily due to a decrease in the size of our investment portfolio of loans and other lending instruments by approximately $378.4 million, a decline in LIBOR interest rates in 2008
and non-performing loans with a carrying value of $188,709 in 2008. There were no non-performing loans in the three months ended September 30, 2007.

Rental
revenue for the three months ended September 30, 2008 includes revenue earned on 292 Madison Avenue, revenue earned on our TIC interest in 55 Corporate Drive, which has
been held as a proportionately consolidated property since its acquisition in June 2006, and revenue earned on properties acquired as a result of the American Financial acquisition. Rental revenue for
the three months ended September 30, 2008 includes the effect of adjustments for straight-line rent for 55 Corporate Drive and 292 Madison Avenue. For the three months ended
September 30, 2008, $3,591

85

---



was
earned on 292 Madison Avenue and 55 Corporate Drive and $77,006 was earned on American Financial's rental property portfolio. The increase in rental revenue of $78,074 over the prior period is due
primarily to our acquisition of American Financial.

Operating
expense reimbursement of $33,442 for the three months ended September 30, 2008 is attributed entirely to the closing of the American Financial rental property portfolio.

Gains
on extinguishment of debt for the three months ended September 30, 2008 is primarily attributable to net gains from the repurchase of CRE CDO bonds previously issued by us.
The remaining balance is primarily composed of interest on restricted cash balances in our three CDOs (only two of which were in place during the same period in 2007) and other cash balances held by
us.

The
income on investments in unconsolidated joint ventures of $1,416 for the three months ended September 30, 2008 represents our proportionate share of the income generated by
our joint venture interests including $104 of real estate-related depreciation and amortization, which when added back, results in a contribution to Funds from Operations, or FFO, of $1,520. Our use
of FFO as an important non-GAAP financial measure is discussed in more detail below. The income on investments in unconsolidated joint venture of $1,264 for the three months ended
September 30, 2007 represents our proportionate share of income generated by our unconsolidated joint venture interests including $753 of real estate-related depreciation and amortization,
which when added back, resulted in a contribution to FFO of $2,017.



2008

2007

$ ChangeProperty operating expenses

$
49,883




$
49,883Interest expense


78,586

$
50,601


27,985Management fees


8,025


5,923


2,102Incentive fee





22,868


(22,868
)Depreciation and amortization


22,335


1,188


21,147Marketing, general and administrative


5,100


3,145


1,955Provision for loan loss


18,875


2,500


16,375Provision for taxes


36


338


(302
)Total expenses

$
182,840

$
86,563

$
96,277


Property
operating expenses for the three months ended September 30, 2008 were $49,833, entirely attributed to the American Financial acquisition rental property portfolio. This
amount included ground
rent and leasehold obligations, real estate and taxes, utilities, property and leasehold improvements, other property operating expenses and direct billable expenses.

Interest
expense was $78,586 for the three months ended September 30, 2008 compared to $50,601 for the three months ended September 30, 2007. The increase of $27,985 is
primarily attributed to $2.5 billion in additional debt incurred as a result of the American Financial acquisition. Interest expense associated with this additional debt was $39,788 for the
three months ended September 30, 2008.

Management
fees increased $2,102 for the three months ended September 30, 2008 to $8,025 versus $5,923 for the same period in 2007, due primarily to an increase in our
stockholder's equity as a result of additional issuances of common equity during the second half of 2007 and in April 2008 in connection with the American Financial acquisition. The remaining
increase is attributable to the amount paid or payable to our Manager on investments in our three CDOs (only two of which was in place during the same period in 2007) in accordance with the
CDO collateral management agreements, higher fees paid or payable to SL Green Operating Partnership, L.P. under our servicing and

86

---



outsourcing
agreements due to the increase in our investment balances, and an increase in fees paid to SL Green Operating Partnership, L.P. under our outsourcing agreement, which fees
were increased in April 2008 to compensate for additional services provided as a result of the American Financial acquisition.

In
October 2008, we entered into a letter agreement with the Class B limited partners to waive the incentive distribution that would have otherwise been earned for the period
July 1, 2008 through December 31, 2008, and provide that starting January 1, 2009, the incentive distribution can be paid, at our option, in cash or shares of our common stock.
Accordingly, no incentive fees were recorded for the three months ended September 30, 2008. We recorded incentive fee expense of $22,868 for the three months ended September 30, 2007,
which reflects sharply higher FFO recognized during that period (largely related to the sale of One Madison Avenue) compared to the comparable period in 2008.

We
recorded depreciation and amortization expenses of $22,335 for the three months ended September 30, 2008, versus $1,188 for the three months ended September 30, 2007.
The increase of $21,147 is attributed primarily to the increase in size of our real estate investments as a result of the American Financial acquisition.

Marketing,
general and administrative expenses were $5,100 for the three months ended September 30, 2008, versus $3,145 for the same period in 2007.

Provision
for loan losses was $18,875 for the three months ended September 30, 2008, versus $2,500 for the three months ended September 30, 2007. The provision was based
upon an increase in non-performing loans and the review of our loan portfolio, and reflects the challenging economic conditions, severe illiquidity in the capital markets, and a difficult
operating environment.

Provision
for taxes was $36 for the three months ended September 30, 2008, versus $338 for the three months ended September 30, 2007.

Comparison of the nine months ended September 30, 2008 to the nine months ended September 30, 2007



2008

2007

$ ChangeInvestment income

$
197,882

$
218,593

$
(20,711
)Rental revenue


163,350


6,109


157,241Operating expense reimbursement


64,993





64,993Gain on sales and other income


14,551


11,949


2,602Total revenues

$
440,776

$
236,651

$
204,125Equity in net income of joint ventures

$
6,117

$
1,053

$
5,064Gain on extinguishment of debt

$
33,378

$


$
33,378


Investment
income is generated on our whole loans, subordinate interests in whole loans, mezzanine loans, preferred equity interests and CMBS. The decrease of $20,711
over the prior period is primarily due to a decrease in the size of our investment portfolio of loans and other lending instruments by approximately $378.4 million, a decline in LIBOR interest
rates in 2008 and non-performing loans with a carrying value of $188,709 in 2008. There were no non-performing loans in the nine months ended September 30, 2007.

The
increase in rental revenue of $157,241 over the prior period is due primarily to the acquisition of American Financial.

87

---



Operating
expense reimbursement of $64,993 for the nine months ended September 30, 2008 is attributed to the closing of the American Financial acquisition on April 1, 2008.

Gain
on extinguishment of debt for the nine months ended September 30, 2008 is primarily attributable to $33,378 in net gains from the repurchase of CRE CDO bonds previously
issued by us. The remaining balance is primarily composed of interest on restricted cash balances in our three CDOs (only two of which were in place during the same period in 2007) and other cash
balances held by us.

The
income on investments in unconsolidated joint ventures of $6,117 for the nine months ended September 30, 2008 represents our proportionate share of the income generated by our
joint venture interests including $469 of real estate-related depreciation and amortization, which when added back, results in a contribution to FFO of $6,586. Our use of FFO as an important
non-GAAP financial measure is discussed in more detail below. The income on investments in unconsolidated joint venture of $1,053 for the nine months ended September 30, 2007
represents our proportionate share of the losses generated by our joint venture interests including $4,647 of real estate-related depreciation and amortization, which when added back, resulted in a
contribution to FFO of $5,700.



2008

2007

$ ChangeProperty operating expenses

$
95,379




$
95,379Interest expense


197,785

$
126,271


71,514Management fees


24,275


16,176


8,099Incentive fee


5,100


29,469


(24,369
)Depreciation and amortization


46,625


2,947


43,678Marketing, general and administrative


11,989


11,068


921Provision for loan loss


50,089


6,648


43,441Provision for taxes


47


1,301


(1,254
)Total expenses

$
431,289

$
193,880

$
237,409


Property
operating expenses for the nine months ended September 30, 2008 were $95,379, entirely attributed to the American Financial acquisition rental property
portfolio. This amount included ground rent and leasehold obligations, real estate and taxes, utilities, property and leasehold improvements, other property operating expenses and direct billable
expenses

Interest
expense was $197,785 for the nine months ended September 30, 2008 compared to $126,271 for the nine months ended September 30, 2007. The increase of $71,514 is
primarily attributed to $2.5 billion in additional debt incurred as a result of the American Financial acquisition. Interest expense associated with this additional debt was $80,208 for the
nine months ended September 30, 2008.

Management
fees increased $8,099 for the nine months ended September 30, 2008 to $24,275 versus $16,176 for the same period in 2007 due primarily to an increase in our
stockholder's equity as a result of additional issuances of common equity during the second half of 2007 and in April 2008 in connection with the American Financial acquisition. The remaining
increase is attributable to the amount paid or payable to our Manager on investments in our three CDOs (only two of which was in place during the same period in 2007) in accordance with the CDO
collateral management agreements, higher fees paid or payable to SL Green Operating Partnership, L.P. under our servicing and outsourcing agreements due to the increase in our investment
balances, and an increase in fees paid to SL Green Operating Partnership, L.P. under our outsourcing agreement, which fees were increased in April 2008 to compensate for
additional services provided as a result of the American Financial acquisition.

88

---



We
recorded an incentive fee expense of $5,100 during the nine months ended September 30, 2008 in accordance with requirements of the partnership agreement of our Operating
Partnership which entitles owners of Class B limited partner interests in our Operating Partnership to an incentive return equal to 25% of the amount by which FFO plus certain accounting gains
(as defined in the partnership agreement of our Operating Partnership) exceed the product of our weighted average stockholders equity (as defined in the amended and restated partnership agreement of
our Operating Partnership) multiplied by 9.5% (divided by 4 to adjust for quarterly calculations). In October 2008, we entered into a letter agreement with the Class B limited partners to waive
the incentive distribution that would have otherwise been earned for the period July 1, 2008 through December 31, 2008, and provide that starting January 1, 2009, the incentive
distribution can be paid, at our option, in cash or shares of our common stock. We recorded incentive fee expense of $29,469 for the nine months ended September 30, 2007, which reflects sharply
higher FFO recognized during that period (largely related to the sale of One Madison Avenue) compared to comparable period in 2008.

We
recorded depreciation and amortization expenses of $46,625 for the nine months ended September 30, 2008, versus $2,947 for the nine months ended September 30, 2007. The
increase of $43,678 is attributed primarily to the increase in size of our real estate investments as a result of the American Financial acquisition.

Marketing,
general and administrative expenses were $11,989 for the nine months ended September 30, 2008, versus $11,068 for the same period in 2007.

Provision
for loan losses was $50,089 for the nine months ended September 30, 2008, versus $6,648 for the nine months ended September 30, 2007. The provision was based upon
an increase in non-performing loans and our review of our loan portfolio, and reflects the challenging economic conditions, severe illiquidity in the capital markets, and a difficult
operating environment. See Note 2 to our Consolidated Financial Statements-Revenue Recognition-Finance Investments.

Provision
for taxes was $47 for the nine months ended September 30, 2008, versus $1,301 for the nine months ended September 30, 2007.

Liquidity and Capital Resources

Liquidity is a measurement of the ability to meet cash requirements, including ongoing commitments to repay borrowings, fund and
maintain loans and other investments, pay dividends and other general business needs. Our principal sources of working capital and funds for additional investments primarily include: 1) cash
flow from operations; 2) borrowings under our repurchase facility and credit facilities; 3) our CDOs; 4) other forms of financing or additional securitizations including CMBS or
subsequent CDO offerings; 5) proceeds from common or preferred equity offerings; 6) issuances of trust preferred securities; 7) the proceeds from principal payments on our
investment; and 8) the sale or syndication of certain of our debt investments or real estate investments. We believe these sources of financing will be sufficient to meet our
short-term liquidity needs. Due to recent conditions in the capital and credit markets, we do not anticipate having the ability in the near-term to access equity or debt
capital through the public markets or debt capital through new CDO issuances. Therefore, we will rely primarily on cash flows from operations, principal and interest payments on our investments, sales
or syndications of loans, asset sales and, if available, other forms of secured or unsecured debt, or private equity, that may become available to us.

Our
ability to fund our short-term liquidity needs, including distributions to stockholders, debt service and general operations, through cash flow from operations can be
evaluated through the consolidated statement of cash flows provided in our financial statements. However, the net cash from operations or net cash used in operations disclosed on the statement of cash
flows should be adjusted to exclude the effect of loans originated for sale and the proceeds of loans sold during any respective reporting period. These activities are included in cash flow from
operations in accordance with GAAP,

89

---



but
constitute an integral part of our investment activity. Consequently, net cash flow from operations is not necessarily reflective of our true recurring operating activities and our ability to fund
our required distributions to stockholders and other liquidity requirements through our operating activities.

In
July 2008, a special committee of our Board of Directors was formed to consider whether the internalization of our Manager is in the best interests of our stockholders. The
actions of the special committee resulted in the execution of the second amended and restated management agreement and other related agreements in October 2008. However, the special committee
continues to explore the internalization of our Manager. If such internalization occurs, it potentially could require additional
liquidity to the extent any of the consideration for the internalization consists of cash. We currently anticipate that any consideration would consist primarily, if not 100%, of equity consideration.

Further,
our short-term liquidity requirements could be affected by a potential change in our dividend policy. Our Board of Directors elected to not pay for the third quarter
of 2008 the dividend to common stock, which for the second quarter of 2008 was $0.63 per share, and will revisit the Company's dividend policy at year-end. Based on current estimates of
taxable income, the Company believes its cumulative distributions made to date in 2008 will satisfy the Company's tax requirements for the 2008 calendar year.

Our
ability to meet our long-term liquidity and capital resource requirements will be subject to obtaining additional debt financing and equity capital. Our inability to
renew, replace or expand our sources of financing on substantially similar terms, may have an adverse effect on our business and results of operations. In addition, an event of default can be
triggered under our repurchase facility and our credit facilities if, among other things, the management agreement with our Manager is terminated. Depending on market conditions, our debt financing
will generally be in the range of 70% to 80% of the carrying value of our total assets. Any indebtedness we incur will likely be subject to continuing covenants which may or may not be more
restrictive and we will likely be required to make continuing representations and warranties 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 which could serve to limit our borrowing ability. Moreover, our debt may be secured by our assets. If we default in the payment of
interest or principal on any such debt, breach any representation or warranty in connection with any borrowing or violate any covenant in any loan document, our lender may accelerate the maturity of
such debt requiring us to immediately repay all outstanding principal. If we are unable to make such payment, our lender could foreclose on our assets that are pledged as collateral to such lender.
The lender could also sue us or force us into bankruptcy. Any such event would have a material adverse effect on our liquidity and the value of our common stock. In addition, posting additional
collateral to support our credit and repurchase facilities will reduce our liquidity and limit our ability to leverage our assets.

To
maintain our status as a REIT under the Internal Revenue Code, we must distribute annually at least 90% of our taxable income. This distribution requirement limits our ability to
retain earnings and thereby replenish or increase capital for operations. However, we believe that our capital resources and access to financing, as noted above, should continue to provide us with
financial flexibility at levels sufficient to meet current and anticipated capital requirements, including funding new lending and investment opportunities.

90

---



We rely on the credit and equity markets to finance and grow our business. During the second half of 2007 and the first three quarters of 2008, severe credit and liquidity issues in the
sub-prime residential lending and single family housing sectors negatively impacted the asset-backed and corporate fixed income markets, as well as the equity securities of financial
institutions and real estate companies. As the severity of residential sector issues increased, nearly all securities markets experienced decreased liquidity and greater risk premiums as concerns
about the outlook for the U.S. and world economic growth increased. These concerns continue and risk premiums in many capital markets remain at or near all-time highs with liquidity
extremely low compared to historical standards or virtually non-existent. As a result, most commercial real estate finance and financial services industry participants, including ours,
have reduced new investment activity until the capital markets become more stable, the macroeconomic outlook becomes clearer and market liquidity increases. In this environment, we are focused on
actively managing portfolio credit, generating and recycling liquidity from existing assets, leasing up vacant space, and extending debt maturities.

During
the first nine months of 2008, the global capital markets continued to experience tremendous volatility and a wide-ranging lack of liquidity. The impact of the global
credit crisis on our sector has been acute. Transaction volume has declined significantly, credit spreads for all forms of mortgage debt have reach all-time highs, issuance levels of CMBS
have ground to a halt, and other forms of financing from the debt markets have been dramatically curtailed. Financial institutions still hold significant inventories of unsold loans and CMBS, creating
a further overhang on the markets. We believe that the continuing dislocation in the debt capital markets, coupled with a slowdown in the U.S. economy, has already reduced property valuations and will
ultimately impact real estate fundamentals. These developments have impacted and may further impact the performance of our existing portfolio of assets. Furthermore, the volatility in the capital
markets has caused stress to all financial institutions and, our business is dependent upon these counterparties for, among other things, financing and interest rate derivatives.

Cash Flows (Amounts in thousands, except share and per share data)

Net cash provided by operating activities increased $38,995 to $121,290 for the nine months ended September 30, 2008 compared to
cash provided of $82,295 for same period in 2007. Operating cash flow is generated primarily by net interest income from our Structured Finance segment and net rental income from our Real Estate
segment. The increase in operating cash flow for the nine months ended September 30, 2008 compared to the same period in 2007 was primarily due to a decrease in restricted cash of $31,146, an
increase in depreciation of $33,327, an increase in provision for loan losses of $43,441 and a decrease in other assets of $19,816 net of a gain on the extinguishment of debt of $33,378 and a decrease
in management and incentive fee payable of $22,670.

Net
cash used in investing activities for the nine months ended September 30, 2008 was $558,645 compared to net cash used in investing activities of $1,271,486 during the same
period in 2007. The decrease in cash used in investing activities is primarily due to a significant decline in new investment originations (net of repayments and acquisitions of real estate
investments) for the nine months ended September 30, 2008 as compared to the same period in 2007.

Net
cash provided by financing activities for the nine months ended September 30, 2008 was $239,424 as compared to $1,476,637 during the same period in 2007. In connection with
the acquisition of American Financial on April 1, 2008, we received proceeds from acquisition financing of $1,114,743, offset by repayments on mortgage notes and credit facilities of 742,034.
The decrease for the nine months ended 2008 as compared to the prior year is primarily attributable to a decrease of $111,205 in proceeds from the sale of preferred stock, a net decrease in
proceeds/payments of repurchase facilities of $128,149, a decrease of $169,551 in restricted cash in our CDOs, an increase of dividends paid in 2008 of $117,498 (which was primarily due to the
declaration of a $2.00 per common share special

91

---



dividend
in December 2007 paid in January 2008). In addition, we issued $1,043,572 in CDO bonds in 2007. There were no CDO bond issuances during the nine months ended September 30, 2008.

Capitalization (Amounts in thousands, except share and per share data)

Our authorized capital stock consists of 125,000,000 shares, $0.001 par value, of which we have authorized the issuance of up to
100,000,000 shares of common stock, $0.001 par value per share, and 25,000,000 shares of preferred stock, par value $0.001 per share. As of September 30, 2008, 51,316,586 shares of common stock
and 4,600,000 shares of preferred stock were issued and outstanding.

Preferred Stock (Amounts in thousands, except share and per share data)

In April 2007, we issued 4,600,000 shares of our 8.125% Series A cumulative redeemable preferred stock (including the
underwriters' over-allotment option of 600,000 shares) with a mandatory liquidation preference of $25.00 per share. Holders of the Series A cumulative redeemable preferred shares
receive annual dividends of $2.03125 per share paid on a quarterly basis and dividends are cumulative, subject to certain provisions. On or after April 18, 2012, we may at our option redeem the
Series A cumulative redeemable preferred stock at par for cash. Net proceeds (after deducting underwriting fees and expenses) from the offering were approximately $111,205.

Common Stock (Amounts in thousands, except share and per share data)

As of the date of our formation, April 12, 2004, we had 500,000 shares of common stock outstanding valued at approximately $200.
On August 2, 2004 we completed our initial public offering of 12,500,000 shares of common stock resulting in net proceeds of approximately $172,900, which was used to fund investments and
commence our operations. As of September 30, 2008, and December 31, 2007, 705,004 and 594,333 restricted shares had also been issued under our 2004 Equity Incentive Plan, or our Equity
Incentive Plan. These shares have a vesting period of two to four years.

In
December 2004, we sold 5,500,000 shares of our common stock, at a price of $17.27 per share, resulting in net proceeds of approximately $93,740 under a private placement exemption
from the registration requirements of Section 5 of the Securities Act of 1933, as amended. We subsequently registered these shares for resale under the Securities Act in August 2005. A total of
4,225,000 shares were sold to various institutional investors and an additional 1,275,000 shares were sold to SL Green Operating Partnership, L.P. pursuant to its contractual right to choose to
maintain up to a 25% ownership interest in the outstanding shares of our common stock. Of the 5,500,000 shares sold, 2,000,000 shares were settled on December 31, 2004 and the remaining
3,500,000 shares were settled on January 3, 2005.

In
September 2005, we sold 3,833,333 shares of our common stock, at a price of $25.80 per share, resulting in net proceeds of approximately $97,830. A total of 2,875,000 shares were sold
through a public offering and an additional 958,333 shares were sold to SL Green Operating Partnership, L.P. pursuant to its contractual right to choose to maintain up to a 25% ownership
interest in our outstanding shares of common stock. Net proceeds were used for loan acquisitions and originations,
repayment of outstanding principal under one of our repurchase facilities and general corporate purposes.

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

92

---



In
May 2007 our new $500,000 shelf registration statement was declared effective by the Securities and Exchange Commission, or SEC. This registration statement provides us with the
ability to issue common and preferred stock, depository shares and warrants. We currently have $373,344 available under the shelf.

In
September 2007, we sold 4,825,000 shares of common stock, at a public offering price of $26.25 per share, resulting in net proceeds of approximately $124,500. A total of 3,618,750
shares were sold through a public offering and an additional 1,206,250 shares were sold directly to SL Green Operating Partnership, L.P. pursuant to its contractual right to choose to maintain
up to a 25% ownership interest in our outstanding shares of common stock. After this offering, SL Green Operating Partnership, L.P. owned 7,624,583 shares of our common stock. Net proceeds were
used to retire borrowings under the our unsecured facility and to create additional funding capacity for opportunistic investments.

In
November 2007, we sold, through a private placement pursuant to Section 4(2) of the Securities Act, 3,809,524 shares of common stock at a price of $26.25 per share to an
affiliate of Morgan Stanley Real Estate Special Situations Fund III, a global diversified fund managed by Morgan Stanley Real Estate, raising gross proceeds of approximately $100,000.

In
April 2008, we issued approximately 15,634,854 shares of common stock in connection with the American Financial acquisition. These shares had a value of approximately $378,672 on the
date the merger agreement was executed.

Also
as a result of the American Financial acquisition, an affiliate of SL Green was granted 644,787 shares of common stock for services rendered, subject to a one-year
vesting period. These shares had a value of approximately $11,213 on the date of issuance. As of September 30, 2008,
SL Green Operating Partnership, L.P. owned approximately 15.8% of the outstanding shares of our common stock.

Outperformance Plan (Amounts in thousands, except share and per share data)

In June 2005, the Compensation Committee of the Board of Directors approved a long-term incentive compensation program, the
2005 Outperformance Plan. Participants in the 2005 Outperformance Plan, all of whom are co-leased employees, were to share in a "performance pool" if our total return to stockholders for
the period from June 1, 2005 through May 31, 2008 exceeded a cumulative total return to stockholders of 30% during the measurement period over a base share price of $20.21 per share. We
recorded the expense of the LTIP Units award in accordance with FASB Statement No. 123(R). Compensation expense of $308 and $926 and $383 and $1,150 was recorded for the three and nine months
ended September 30, 2008 and 2007, respectively, related to the 2005 Outperformance Plan. Based on our total return to stockholders as of the May 31, 2008 measurement period conclusion
date, we did not meet the minimum 30% return threshold.

Deferred Stock Compensation Plan for Directors (Amounts in thousands, except share and per share data)

Under our Independent Director's Deferral Program, which commenced April 2005, our independent directors may elect to defer up to 100%
of their annual retainer fee, chairman fees and meeting fees. Unless otherwise elected by a participant, fees deferred under the program shall be credited in the form of phantom stock units. The
phantom stock units are convertible into an equal number of shares of common stock upon such directors' termination of service from the Board of Directors or a change in control by us, as defined by
the program. Phantom stock units are credited to each independent director quarterly using the closing price of our common stock on the applicable dividend record date for the respective quarter. Each
participating independent director who elects to receive fees in the form of phantom stock units has the option to have their account credited for an

93

---



equivalent
amount of phantom stock units based on the dividend rate for each quarter or have dividends paid in cash.

As
of September 30, 2008, there were approximately 49,276 phantom stock units outstanding, of which 37,276 units were vested.

Market Capitalization (Amounts in thousands, except share and per share data)

At September 30, 2008, our CDOs and borrowings under our Goldman repurchase facility, Wachovia credit facility and term loan,
trust preferred securities, mortgage loans (including the Goldman Mortgage Loan, Senior Mezzanine Loan and Junior Mezzanine Loan and the proportionally consolidated mortgage note payable related to
our TIC interest in 55 Corporate Drive) and the KeyBank unsecured credit facility (excluding our share of joint venture debt), represented 93% of our consolidated market capitalization of
$3.3 billion (based on a common stock price of $2.59 per share, the closing price of our common stock on the New York Stock Exchange on September 30, 2008). Market capitalization
includes our consolidated debt and common and preferred stock.

Indebtedness (Amounts in thousands, except share and per share data)

The table below summarizes borrowings at September 30, 2008 and December 31, 2007, which currently include our Wachovia
credit facility and term loan, Goldman repurchase facility, KeyBank unsecured credit facility, mortgage loans (including the Goldman Mortgage Loan, Senior Mezzanine Loan and Junior Mezzanine Loan and
and the proportionately consolidated mortgage note payable related to our TIC interest in 55 Corporate Drive), our CDOs and our junior subordinated debentures:

September 30,
2008

December 31,
2007Term loan, credit facility and repurchasing facility

$
107,994

$
200,197Unsecured credit facility


172,301


Mortgage Loan and Mezzanine Loans


2,545,773


153,624Collateralized debt obligations


2,662,955


2,735,145Junior subordinated debentures


150,000


150,000Total

$
5,639,023

$
3,238,966Cost of debt


LIBOR+1.91
%

LIBOR+0.81
%


Term Loan, Credit Facility and Repurchase Facility (Amounts in thousands, except share and per share data)

The repurchase facility with Wachovia Capital Markets, LLC or one or more of its affiliates, or Wachovia, was initially
established as a $250,000 facility, was increased to $350,000 from $250,000 effective January 2005, and was subsequently increased to $500,000 effective April 2005. In June 2007, the facility was
modified further by reducing the credit spreads. In July 2008, the original facility was terminated and a new facility was executed by subsidiaries of ours, with Wachovia to provide for a total credit
availability of $215,680, comprised of a term loan equal to $115,680 and a revolving loan equal to $100,000 with a credit spread of 242.5 basis points (which will be increased to 267.5 basis points
upon an extension of the maturity of the credit facility). The term of the credit facility is two years and the borrowers may extend the term for an additional twelve-month period if certain
conditions are met. Advance rates for assets acquired pursuant to the credit facility vary from 50% to 80% of purchase price, depending on the type and structure of the asset. The lender has a consent
right with respect to the inclusion of investments in this facility, determines periodically the market value of the investments, and has the right to require a pay down to the corresponding loan with
respect to a reduction in an investment's market value. Wachovia's ability to mark an asset, however, is limited to situations where

94

---



an
asset's value has been affected by credit issues with respect to the related underlying property. Wachovia cannot mark an asset based on credit spreads or other criteria outside of property-level
credit issues. We had no accrued interest and borrowings of $76,139 at a weighted average spread to LIBOR of 2.27% as of September 30, 2008, and no accrued interest and borrowings of $165,286
on the repurchase facility at a weighted average spread to LIBOR of 1.33% as of December 31, 2007. We have guaranteed a portion of our consolidated subsidiaries' obligations under this
facility.

We
also have a repurchase facility with Goldman Sachs Mortgage Company, or Goldman. In October 2006 this facility was increased from $200,000 to $400,000 and its maturity date was
extended until September 2009. In June 2007, the facility was modified further by reducing the credit spreads. In August 2008, the facility was amended to reduce the borrowing capacity to $200,000 and
to provide for an extension of the maturity to December 2010, for a fee, provided that no event of default has occurred. The facility bears interest at spreads of 2.00% to 2.30% over
one-month LIBOR and, based on its expected investment activities, provides for advance rates that vary from 65% to 75% based upon the collateral provided under a borrowing base
calculation. The lender has a consent right to the inclusion of investments in this facility, determines periodically the market value of the investments, and has the right to require additional
collateral, a partial repayment of the facility (margin call), or a reduction in unused availability under the facility, sufficient to rebalance the facility if the estimated market value of the
included investments declines. We had accrued interest of $120 and borrowings of $31,855 at a weighted average spread to LIBOR of 2.50% as of September 30, 2008, and accrued interest of $189
and borrowings of $34,911 at a weighted average spread to LIBOR of 1.07% under this facility at December 31, 2007. We have guaranteed a portion of this facility

Restrictive Covenants (Amounts in thousands, except share and per share data)

The terms of each of our Wachovia credit facility and our Goldman repurchase facility (together with the related guarantees) includes
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 $15,000, (c) require our
fixed charge coverage ratio to be at no time less than 1.25 to 1.00, (d) require our minimum interest coverage ratio to be at no time less than 1.35 to 1.00, and (e) require us to
maintain minimum tangible net worth of not less than (i) $650,000 for the Wachovia credit facility and $400,000 for the Goldman repurchase facility, plus (ii) 75% of the net proceeds of
our equity offerings completed subsequent to the date of the June 2007 amendments. The covenants also restrict us from making annual distributions to stockholders in excess of a maximum of 100% of our
FFO (as defined therein) for the previous four quarters under the Wachovia facility, except that we may in any case pay distributions necessary to maintain our REIT status. An event of default can be
triggered on our repurchase facility if, among other things, GKK Manager LLC is terminated as our Manager. As of September 30, 2008 and December 31, 2007, we were in compliance
with all such covenants.

The
Goldman repurchase facility and Wachovia credit facility require that borrowings under these facilities be paid down as principal payments on the loans and investments pledged to
these facilities are received. Assets pledged as collateral under these facilities may include stabilized and transitional whole loans, subordinate interests in whole loans, mezzanine loans, and rated
CMBS or commercial real estate CDO securities originated or acquired by us.

Unsecured Credit Facility (Amounts in thousands, except share and per share data)

In May 2006, we closed on a $100,000 senior unsecured revolving credit facility with KeyBank National Association, or Keybank, with an
initial term of three years and a one-year extension option. The initial facility was supported by a negative pledge of an identified asset base (involving substitution rights) with
advance rates that vary from 30% to 90% of the asset value provided under a borrowing base calculation. The facility bore interest at 1.90% over one-month LIBOR to the extent our leverage
ratio, defined as total liabilities to total assets, including our proportionate share of the liabilities and

95

---



assets
of our unconsolidated subsidiaries, is less than 80% and 2.10% over one-month LIBOR to the extent our leverage ratio is equal to or greater than 80%. In June 2007 the facility was
increased to $175,000 and interest spreads on the facility were reduced. The facility is supported by a negative pledge 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 the inclusion of assets in the borrowing base calculation. Following the modifications in June 2007, the
facility bears interest at 1.65% over one-month LIBOR. We had accrued interest of $333 and borrowings of $172,301 as of September 30, 2008, and no accrued interest and borrowings
under this facility at December 31, 2007.

The
terms of the unsecured revolving credit facility include covenants that (a) limit our maximum total consolidated indebtedness to no more than 85% of total assets,
(b) require our fixed charge coverage ratio to be at no time less than 1.30, and (c) require us to maintain minimum tangible net worth of not less than $450,000 plus 75% of the net
proceeds from equity offerings completed following the date of the June 2007 amendment. The covenants also restrict us from making annual distributions in excess of a maximum of 100% of our FFO (as
defined by the National Association of Real Estate Investment Trusts, or NAREIT) for the previous four quarters, except that we may in any case pay distributions necessary to maintain our REIT status.
An event of default can be triggered on our unsecured revolving credit facility if, among other things, GKK Manager LLC is terminated as our Manager. As of September 30, 2008 and
December 31, 2007, we were in compliance with all such covenants.

In
connection with the acquisition of American Financial on April 1, 2008, our indirect wholly-owned subsidiaries, First States Investors DB I L.P. (formerly known as First
States Investors DB I LLC) and American Financial TRS, Inc., and certain of their direct or indirect subsidiaries, collectively, the DB Loan Borrowers entered into an amendment and
restatement of an assumed American Financial credit facility, or the DB Loan Agreement with Deutsche Bank AG, Cayman Islands Branch, or Deutsche Bank, as agent for certain lenders. As part of the
amendment and restatement of the DB Loan Agreement, the available amount under the DB Loan Agreement was reduced from $400,000 to $100,000, or the DB Loan. In addition, amounts were paid to reduce the
outstanding borrowings under the former facility to $95,000. The DB Loan Agreement provided the DB Loan Borrowers with a one-year facility that matures on March 31, 2009, and
permits, subject to certain conditions, a six month extension at the DB Loan Borrowers' option, subject to certain conditions. Advances made under the DB Loan Agreement bear interest at 3.00% plus the
greater of (i) 3.50% or (ii) LIBOR. The DB Loan allows for prepayment in whole or in part on any payment date; provided, however, that, any such prepayment shall be accompanied by all
accrued interest on the portion of the DB Loan being prepaid. In September 2008, two of our CDOs purchased the DB Loan from the lender and simultaneously amended the maturity date to be March 2011.
The loan is eliminated in the consolidation of our CDOs. At the repurchase date, the DB Loan had an outstanding balance of approximately $88.5 million. We recorded costs related to the purchase
of $0.8 million, which is recorded against other income.

The
obligations under the DB Loan now owned by two of our CDOs, are secured by equity pledges of the shares in certain DB Loan Borrowers and mortgages over the various properties owned
by certain DB Loan Borrowers. The DB Loan is guaranteed by us. The DB Loan Agreement contains customary events of default, the occurrence of which could result in the acceleration of all amounts
payable thereunder.

The
DB Loan requires us to establish and fund certain reserve accounts to be used for the payment of taxes and insurance, rollover and replacement expenses, payment of tenant
improvements and leasing commissions and the funding of debt service shortfalls.

96

---



Mortgage Loans (Amounts in thousands, except share and per share data)

Certain real estate assets are subject to mortgage liens. As of September 30, 2008, 728 of our real estate assets were
encumbered with mortgages and Mezzanine Loans with a cumulative outstanding balance of $2,545,773. Our mortgage notes payable typically require that specified loan-to-value and
debt service coverage ratios be maintained with respect to the financed properties before we can exercise certain rights under the loan agreements relating to such properties. If the specified
criteria are not satisfied, in addition to other conditions that we may have to observe, our ability to release properties from the financing may be restricted and the lender may be able to "trap"
portfolio cash flow until the required ratios are met on an ongoing basis. As of September 30, 2008, one of our mortgage loans was operating under a cash flow trap, which is not an event of
default under the applicable loan agreement. The cash flow trap has been in effect since a date prior to the assumption of the loan by us as part of the American Financial acquisition.

Goldman Mortgage Loan (Amounts in thousands, except share and per share data)

On April 1, 2008, certain of our subsidiaries, collectively, the Goldman Loan Borrowers entered into a mortgage loan agreement,
the Goldman Mortgage Loan, with Goldman Sachs Commercial Mortgage Capital, L.P., or GSCMC, Citicorp North America, Inc., or Citicorp, and SL Green in connection with a mortgage loan in
the amount of $250,000, or the Goldman Mortgage Loan, which is secured by certain properties owned or ground leased by the Goldman Loan Borrowers. The Goldman Mortgage Loan matures on March 9,
2010, with a single one-year extension option. The terms of the Goldman Mortgage Loan were negotiated between the Goldman Loan Borrowers and GSCMC and Citicorp. The Goldman Mortgage Loan
bore interest at 4.35% over one-month LIBOR. The Goldman Mortgage Loan provides for customary events of default, the occurrence of which could result in an acceleration of all amounts
payable under the Goldman Mortgage Loan. The Goldman Mortgage Loan allows for prepayment under the terms of the agreement, subject to a 0.75% prepayment fee during the first six months, payable to the
lender, as long as simultaneously therewith a proportionate prepayment of the Goldman Mezzanine Loan (discussed below) shall also be made on such date. In August 2008, an amendment to the loan
agreement was entered into for the Goldman Mortgage Loan in conjunction with the bifurcation of the
Goldman Mezzanine Loan into two separate mezzanine loans. Under this loan agreement amendment, the Goldman Mortgage Loan bears interest at 1.99% over LIBOR.

The
Goldman Mortgage Loan requires an environmental escrow reserve for the remediation of environmental conditions in the combined amount of $700. In August 2008, $425 of this reserve
was released to the Goldman Loan Borrowers, leaving a balance of $425 reserved with the lender as of September 30, 2008. The lenders may upon our request disburse funds from the reserve on a
monthly basis for the reimbursement of reasonable costs and expenses incurred to correct the environmental conditions.

We
have accrued interest of $757 and borrowings of $244,148 as of September 30, 2008.

Secured Term Loan (Amounts in thousands, except share and per share data)

On April 1, 2008 First States Group 3300 B, L.P., an indirect wholly-owned subsidiary of ours, or the PB Loan Borrower,
entered into a loan agreement, the PB Loan Agreement, with PB Capital Corporation, as agent for itself and other lenders, in connection with a secured term loan in the amount of $240,000 or the PB
Loan in part to refinance a portion of a portfolio of American Financial's properties known as the WBBD Portfolio. The PB Loan matures on April 1, 2013 and bears interest at a 1.65% over
one-month LIBOR. The PB Loan is secured by mortgages on the 48 properties owned by the PB Loan Borrower and all other assets of the PB Loan Borrower. The PB Loan Agreement provides for
customary events of default, the occurrence of which could result in an

97

---



acceleration
of all amounts payable under the PB Loan Agreement. The PB Loan Borrower may prepay the PB Loan, in whole or in part (in amounts equal to at least $1,000), on any date.

The
PB Loan requires us to enter into an interest rate protection agreement within five days of the tenth consecutive LIBOR banking day on which the strike rate exceeds 6.00% per annum.
The interest rate protection agreement must protect the PB Loan Borrower against upward fluctuations of interest rates in excess of 6.25% per annum.

We
have accrued interest of $800 as of September 30, 2008.

Certain
of our mortgage notes payable related to assets held for sale contain provisions that require us to compensate the lender for the early repayment of the loan. These charges will
be separately classified in the statement of operations as yield maintenance fees within discontinued operations during the period in which the charges are incurred.

Goldman Senior and Junior Mezzanine Loans (Amounts in thousands, except share and per share data)

On April 1, 2008, certain of our subsidiaries, collectively, the Mezzanine Borrowers, entered into a mezzanine loan agreement
with GSCMC, Citicorp and SL Green in connection with a mezzanine loan in the amount of $600,000, or the Goldman Mezzanine Loan, which is secured by pledges of certain equity interests owned by the
Mezzanine Borrowers and any amounts receivable by the Mezzanine Borrowers whether by way of distributions or other sources. The Goldman Mezzanine Loan matures on March 9, 2010, with a single
one-year extension option. The terms of the Goldman Mezzanine Loan were negotiated between the Mezzanine Borrowers and GSCMC and Citicorp. The Goldman Mezzanine Loan bore interest at 4.35%
over one-month LIBOR. The Goldman Mezzanine Loan provides for customary events of default, the occurrence of which could result in an acceleration of all amounts payable under the Goldman
Mezzanine Loan. The Goldman Mezzanine Loan allows for prepayment under the terms of the agreement, subject to a 1.00% prepayment fee during the first six months, payable to the lender, as long as
simultaneously therewith a proportionate prepayment of the Goldman Mortgage Loan shall also be made on such date. In addition, under certain circumstances the Goldman Mezzanine Loan is cross-
defaulted with events of default under the Goldman Mortgage Loan and with other mortgage loans pursuant to which an indirect wholly-owned subsidiary of ours is the mortgagor. In August 2008, the
$600,000 mezzanine loan was bifurcated into two separate mezzanine loans by the lenders, the Junior Mezzanine Loan and the Senior Mezzanine Loan. Additional loan agreement amendments were entered into
for the Goldman Mezzanine Loan and Goldman Mortgage Loan. Under these loan agreement amendments, the Junior Mezzanine Loan bears interest at 6.00% over LIBOR and the Senior Mezzanine Loan bears
interest at 5.20% over LIBOR, and the Goldman Mortgage Loan bears interest at 1.99% over LIBOR. The weighted average of these interest rate spreads is equal to the combined weighted average of the
interest rates spreads on the initial loans.

The
Goldman Mezzanine Loan required, and the Senior Mezzanine Loan requires, an environmental escrow reserve for the remediation of environmental conditions in the combined amount of
$850. In August 2008, $425 of this reserve was released to the Mezzanine Borrowers, leaving a balance of $425 reserved with the lender as of September 30, 2008. The lender may upon our request
disburse funds from the reserve on a monthly basis for the reimbursement of reasonable costs and expenses incurred to correct the environmental conditions.

We
have accrued interest of $1,816 and borrowings of $598,063 as of September 30, 2008.

98

---



Collateralized Debt Obligations (Amounts in thousands, except share and per share data)

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

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

In
August 2007, we issued $1,100,000 of CDOs through two newly-formed indirect subsidiaries, Gramercy Real Estate CDO 2007-1 Ltd., or the 2007 Issuer, and together
with the 2005 Issuer and the 2006 Issuer, the Issuers, and Gramercy Real Estate CDO 2007-1 LLC, or the 2007 Co-Issuer, and together with the 2005 Co-Issuer
and the 2006 Co-Issuer, the Co-Issuers. The CDO consists of $1,045,550 of investment
grade notes, $22,000 of non-investment grade notes, which were co-issued by the 2007 Issuer and the 2007 Co-Issuer, and $32,450 of preferred shares, which were
issued by the 2007 Issuer. The investment grade notes were issued with floating rate coupons with a combined weighted average rate of three-month LIBOR plus 0.46%. We incurred approximately $16,816 of
costs related to Gramercy Real Estate CDO 2007-1, which are amortized on a level-yield basis over the average life of the CDO.

We
retained all non-investment grade securities, the preferred shares and the common shares in the Issuer of each CDO. The Issuers and Co-Issuers in each CDO
holds assets, consisting primarily of whole loans, subordinate interests in whole loans, mezzanine loans and preferred equity investments and CMBS, which serve as collateral for the CDO. Each CDO may
be replenished, pursuant to certain rating agency guidelines relating to credit quality and diversification, with substitute collateral for loans that are repaid during the first five years of the
CDO. Thereafter, the CDO securities will be retired in sequential order from senior-most to junior-most as loans are repaid. The financial statements of the Issuer of each CDO
are consolidated in our financial statements. The investment grade notes are treated as a secured financing, and are non-recourse to us. Proceeds from the sale of the investment grade
notes issued in each CDO were used to repay substantially all outstanding debt under our repurchase agreements and to fund additional investments.

During
the three months ended September 30, 2008, we repurchased, at a discount, $9,000 of investment grade notes of the 2005 issuer and $12,000 of investment grade notes of the
2006 Issuer. During the nine months ended September 30, 2008, we repurchased, at a discount, $25,900 of investment grade notes of the 2005 Issuer, $24,000 of investment grade notes of the 2006
issuer, and $22,400 of investment grade notes of the 2007 Issuer. We recorded a net gain of $11,681 and $33,378 for the three and nine months ended September 30, 2008, respectively, in
connection with the repurchase of notes of such Issuers.

99

---



Junior Subordinated Debentures (Amounts in thousands, except share and per share data)

In May 2005, August 2005 and January 2006, we completed issuances of $50,000 each in unsecured trust preferred securities through three
Delaware Statutory Trusts, or DSTs, Gramercy Capital Trust I, or GCTI, Gramercy Capital Trust II, or GCTII, and Gramercy Capital Trust III, or GCT III, that are also wholly-owned subsidiaries of our
Operating Partnership. The securities issued in May 2005 bear interest at a fixed rate of 7.57% for the first ten years ending June 2015 and the securities issued in August 2005 bear interest at a
fixed rate of 7.75% for the first ten years ending
October 2015. Thereafter the rates will float based on the three-month LIBOR plus 300 basis points. The securities issued in January 2006 bear interest at a fixed rate of 7.65% for the first ten years
ending January 2016, with an effective rate of 7.43% when giving effect to the swap arrangement previously entered into in contemplation of this financing. Thereafter the rate will float based on the
three-month LIBOR plus 270 basis points.

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

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

Our
interests in GCTI, GCTII and GCTIII are accounted for using the equity method and the assets and liabilities of those entities are not consolidated into our financial statements.
Interest on the junior subordinated notes is included in interest expense on our consolidated statements of income while the value of the junior subordinated notes, net of our investment in the trusts
that issued the securities, are presented as a separate item in our consolidated balance sheet.

Contractual Obligations (Amounts in thousands, except share and per share data)

Combined aggregate principal maturities of our CDOs, Wachovia credit facility and term loan and Goldman repurchase facility, trust
preferred securities, mortgage loans (including the Goldman Mortgage and Senior and Junior Mezzanine Loans), unsecured credit facility, unfunded loan

100

---



commitments
and our obligations under our management agreement and operating lease as of September 30, 2008 are as follows:

CDOs

Term Loan and Credit Facility and
Repurchase
Facility

Trust
Preferred
Securities

Mortgage
and
Mezzanine
Loans(1)

Unsecured
Credit
Facility

Unfunded
Loan(2)
Commitments

Management
Agreements(3)

Operating
Lease

Total2008

$


$


$


$
7,553

$


$


$
5,125

$
4,600

$
17,2782009





31,855





75,926





44,599


20,331


18,839


191,5502010





76,139





879,925


172,301


37,525





18,548


1,184,4382011











33,824











18,457


52,2812012











80,256











18,156


98,412Thereafter


2,662,955





150,000


1,445,681











170,980


4,429,616Above/Below Market Interest











22,608














22,608Total

$
2,662,955

$
107,994

$
150,000

$
2,545,773

$
172,301

$
82,124

$
25,456

$
249,580

$
5,996,183


---

Leasing Agreements (Amounts in thousands, except share and per share data)

Our properties are leased and subleased to tenants under operating leases with expiration dates extending through the year 2031. These
leases generally contain rent increases and renewal options. As of September 30, 2008, we also leased bank branches and office buildings from third parties with expiration dates extending to
the year 2085 and have various ground leases with expiration dates extending through 2087. These lease obligations generally contain rent increases and renewal options.

Future
minimum rental payments under non-cancelable leases, excluding reimbursements for operating expenses, as of September 30, 2008 are as follows:

2008 (October 1December 31)

$
4,6002009


18,8392010


18,5482011


18,4572012


18,1562013 and thereafter


170,980Total

$
249,580


Off-Balance-Sheet Arrangements

We have several off-balance-sheet investments, including joint ventures and structured finance investments. These
investments all have varying ownership structures. Substantially all of our joint venture arrangements are accounted for under the equity method of accounting as we have the ability to exercise
significant influence, but not control over the operating and financial decisions of these joint venture arrangements. Our off-balance-sheet arrangements are discussed in Note 6,
"Investments in Unconsolidated Joint Ventures" in the accompanying financial statements.

101

---



Dividends

To maintain our qualification as a REIT, we must pay annual dividends to our stockholders of at least 90% of our REIT taxable income,
determined before taking into consideration the dividends paid deduction and net capital gains. Before we pay any dividend, whether for Federal income tax purposes or otherwise, which would only be
paid out of available cash to the extent permitted under our unsecured and secured credit and repurchase facilities, and our term loans, we must first meet both our operating requirements and
scheduled debt service on our mortgages and loans payable.

Our
Board of Directors elected to not pay for the third quarter of 2008 a dividend on shares of our common stock, which for the second quarter of 2008 was $0.63 per share, and will
revisit the Company's dividend policy at year-end. Based on current estimates of taxable income, the Company believes its cumulative distributions made to date in 2008 will satisfy the
Company's tax requirements for the 2008 calendar year.

Inflation

A majority of our assets and liabilities are interest rate sensitive in nature. As a result, interest rates and other factors influence
our performance more so than inflation. Changes in interest rates do not necessarily correlate with inflation rates or changes in inflation rates. Further, our financial statements are prepared in
accordance with GAAP and our distributions are determined by our board of directors based primarily on our net income as calculated for tax purposes, in each case, our activities and balance sheet are
measured with reference to historical costs or fair market value without considering inflation.

Related Party Transactions (Amounts in thousands, except share and per share data)

In
connection with our initial public offering, we entered into a management agreement with our Manager, which was subsequently amended and restated in April 2006. The management
agreement was further amended in September 2007. The management agreement provides for a term through December 2009 with automatic one-year extension options and is subject to certain
termination rights. We pay our Manager an annual management fee equal to 1.75% of our gross stockholders equity (as defined in the management agreement) inclusive of our trust preferred securities. We
incurred expense to our Manager under this agreement of an aggregate of $5,978 and $15,934 and $3,271 and $9,047 for the three and nine months ended September 30, 2008 and 2007, respectively.
In 2008, we and SL Green formed special committees comprised solely of independent directors to consider whether the internalization of the Manager and/or amendment to the management agreement would
be in the best interest of each company and its respective stockholders. In October 2008, we entered into the second amended and restated management agreement with our manager which generally contains
the same terms and conditions as the amended and restated management agreement, except for the following material changes: (1) reduces the annual base management fee to 1.50% of our gross
stockholders equity; (2) reduces the termination fee to an amount equal to the management fee earned by our manager during the 12 months preceding the termination date; and
(3) commencing July 2008, all fees in connection with collateral management agreements are to be remitted by our Manager to us.

To
provide an incentive to enhance the value of our common stock, the holders of the Class B limited partner interests of our Operating Partnership are entitled to an incentive
return equal to 25% of the amount by which FFO plus certain accounting gains and losses (as defined in the partnership agreement of our Operating Partnership) exceed the product of the weighted
average stockholders equity (as defined in the partnership agreement of our Operating Partnership) multiplied by 9.5% (divided by four to adjust for quarterly calculations). We will record any
distributions on the Class B limited partner interests as an incentive distribution expense in the period when earned and when payments of such amounts have become probable and reasonably
estimable in accordance with the

102

---



partnership
agreement. In October 2008, we entered into a letter agreement with the Class B limited partners to waive the incentive distribution that would have otherwise been earned for the
period July 1, 2008 through December 31, 2008 and provide that starting January 1, 2009, the incentive distribution can be paid, at our option, in cash or shares of our common
stock. We incurred $0 and $5,100 and $22,868 and $29,469 with respect to such Class B limited partner interests for the three and nine months ended September 30, 2008 and 2007.

We
are obligated to reimburse our Manager for its costs incurred under an asset servicing agreement between our Manager and an affiliate of SL Green Operating Partnership, L.P.
and a separate outsource agreement between our Manager and SL Green Operating Partnership, L.P. The asset servicing agreement, which was amended and restated in April 2006, provides for an
annual fee payable to SL Green Operating Partnership, L.P. by us of 0.05% of the book value of all credit tenant lease assets and non-investment grade bonds and 0.15% of the book
value of all other assets. The asset servicing fee may be reduced by SL Green Operating Partnership, L.P. for fees paid directly to outside servicers by us. The outsource agreement provides for
an annual fee payable by us, which fee became $2,814 per year subsequent to the closing of the American Financial merger to reflect higher costs resulting from the increased size and number of assets
of the combined company, increasing 3% annually over the prior year on the anniversary date of the outsource agreement in August of each year. For the three and nine months ended September 30,
2008 and 2007, we realized expense of $697 and $1,721 and $338 and $1,001, respectively, to our Manager under the outsource agreement. For the three and nine months ended September 30, 2008 and
2007, we realized expense of $1,350 and $4,022 and $1,041 and $2,700, respectively, to our Manager under the asset servicing agreement. In October 2008, each of the asset servicing agreement and
outsource agreement was terminated, effective as of September 30, 2008.

In
connection with the closing of our first CDO in July 2005, the 2005 Issuer, entered into a collateral management agreement with our Manager. Pursuant to the collateral management
agreement, our Manager has agreed to provide certain advisory and administrative services in relation to the collateral debt securities and other eligible investments securing the CDO notes. The
collateral management agreement provides for a senior collateral management fee, payable quarterly in accordance with the priority of payments as set forth in the indenture, equal to 0.15% per annum
of the net outstanding portfolio balance, and a subordinate collateral management fee, payable quarterly in accordance with the priority of payments as set forth in the indenture, equal to 0.25% per
annum of the net outstanding portfolio balance. Net outstanding portfolio balance is the sum of the (i) aggregate principal balance of the collateral debt securities, excluding defaulted
securities, (ii) aggregate principal balance of all principal proceeds held as cash and eligible investments in certain accounts, and (iii) with respect to the defaulted securities, the
calculation amount of such defaulted securities. As compensation for the
performance of its obligations as collateral manager under the first CDO, the Board of Directors has allocated to our Manager the subordinate collateral management fee paid on the CDO securities not
held by us. In October 2008, pursuant to the second amended and restated management agreement, our manager has, commencing July 1, 2008, agreed to remit this amount to us. At
September 30, 2008 and December 31, 2007 we owned all of the non-investment grade bonds, preferred equity and equity in both CDOs. The senior collateral management fee and
balance of the subordinate collateral management fee is allocated to us. For the three and nine months ended September 30, 2008 and 2007, we realized expense of $0 and $1,024 and $518 and
$1,760, respectively, to our Manager under such collateral management agreement.

Except
for the 2005 CDO, fees payable in connection with CDOs or other securitization vehicles are governed by the management agreement. Pursuant to that agreement, if a collateral
manager is retained as part of the formation of a CDO or other securitization vehicle, our Manager or an affiliate will be the collateral manager and will receive the following fees: (i) 0.25%
per annum of the principal amount outstanding of bonds issued by a managed transitional CDO that are owned by third-party

103

---



investors
unaffiliated with us or our Manager, which CDO is structured to own loans secured by transitional properties, (ii) 0.15% per annum of the book value of the principal amount
outstanding of bonds issued by a managed non-transitional CDO that are owned by third-party investors unaffiliated with us or our Manager, which CDOs structured to own loans secured by
non-transitional properties, (iii) 0.10% per annum of the principal amount outstanding of bonds issued by a static CDO that are owned by third party investors unaffiliated with us
or our manager, which CDO is structured to own non-investment grade bonds, and (iv) 0.05% per annum of the principal amount outstanding of bonds issued by a static CDO that are
owned by third-party investors unaffiliated with us or our manager, which CDO is structured to own investment grade bonds. For the purposes of the management agreement, a "managed transitional" CDO
means a CDO that is actively managed, has a reinvestment period and is structured to own debt collateral secured primarily by non-stabilized real estate assets that are expected to
experience substantial net operating income growth, and a "managed non-transitional" CDO means a CDO that is actively managed, has a reinvestment period and is structured to own debt
collateral secured primarily by stabilized real estate assets that are not expected to experience substantial net operating income growth. Both "managed transitional" and "managed
non-transitional" CDOs may at any given time during the reinvestment period of the respective vehicles invest in and own non-debt collateral (in limited quantity) as defined by
the respective indentures. If any fees were paid to the collateral manager in excess of the fee structure provided for above, such fees are paid to us. In October 2008, pursuant to the second amended
and restated management agreement, our Manager has, commencing July 1, 2008, agreed to remit this amount to us. For the three and nine months ended September 30, 2008 and 2007, we
realized expense of $0 and $1,142 and $577 and $1,713, respectively, to our Manager under this agreement. With respect to the CDO which closed in August, 2007, we realized expense to our Manager of $0
and $432 and $178 and $178 for the three and nine months ended September 30, 2008 and 2007, respectively.

In
April 2005, we closed on a $57,503 initial investment in a joint venture with SL Green to acquire, own and operate the South Building located at One Madison Avenue, New York, New
York. The joint venture, which was owned 45% by a wholly-owned subsidiary of us and 55% by a wholly-owned subsidiary of SL Green was created to acquire, own and operate the South Building, The joint
venture
interests are pari-passu. The joint venture completed the acquisition of the South Building from Metropolitan Life Insurance Company for the purchase price of approximately $802,800 plus
closing costs, financed in part through a $690,000 first mortgage loan on the South Building. The South Building comprises approximately 1.2 million square feet and is almost entirely net
leased to Credit Suisse Securities (USA) LLC ("CS") pursuant to a lease with a 15-year remaining term. In August 2007 we sold our entire investment in the joint venture to SL Green
Realty Corp. for approximately $147,000 and realized a gain of $92,235. In August 2007, an affiliate of SL Green loaned approximately $147,000 to our Operating Partnership. This loan was to be repaid
with interest at an annual rate of 5.80% on the earlier of September 1, 2007 or the closing of the sale of our 45% interest in One Madison Avenue to SL Green. As a result of the sale of our
interest in August 2007, the loan was repaid with interest on such date.

Commencing
in May 2005 we are party to 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 7,000 square feet and carries a term of 10 years with rents of approximately $249 per annum for year one rising to $315 per annum in year 10. The Company
leases an additional 3,215 square feet on a month-to-month basis for approximately $161 per annum. For the three and nine months ended September 30, 2008 and 2007, rent
expense under this lease was $118 and $247 and $63 and $188 under this lease, respectively.

In
July 2005, we closed on the purchase from an SL Green affiliate of a $40,000 mezzanine loan which bears interest at 11.20%. As part of that sale, the seller retained an
interest-only participation. We have determined that the yield on our mezzanine loan after giving effect to the interest-only

104

---



participation
retained by the seller is at market. The mezzanine loan is secured by the equity interests in an office property in New York, New York. As of September 30, 2008 and
December 31, 2007, the loan has a book value of $39,577 and $39,711, respectively.

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

In
March 2006, we closed on the purchase of a $25,000 mezzanine loan, which bears interest at one-month LIBOR plus 8.00%, to a joint venture in which SL Green is an equity
holder. The mezzanine loan was repaid in full on May 9, 2006, when we originated a $90,287 whole loan, which bears interest at one-month LIBOR plus 2.75%, to the joint venture. The
whole loan is secured by office and industrial properties in northern New Jersey and has a book value of $90,567 and $90,389 as of September 30, 2008 and December 31, 2007, respectively.

In
June 2006, we closed on the acquisition of a 49.75% TIC interest in 55 Corporate Drive, located in Bridgewater, New Jersey with a 0.25% interest to be acquired in the future. The
remaining 50% of the property is owned as a TIC interest by an affiliate of SL Green Operating Partnership, L.P. The property is comprised of three buildings totaling approximately six hundred
and seventy thousand square feet which is 100% net leased to an entity whose obligations are guaranteed by Sanofi-Aventis Group through April 2023. The transaction was valued at $236,000 and was
financed with a $190,000, 10-year, fixed-rate first mortgage loan.

In
August 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 Green simultaneously acquired and owns the other 50% pari-passu interest. The investment bears interest at a blended fixed rate of 10.52%.

In
December 2006, we acquired from a financial institution a pari-passu interest of $125,000 in a $200,000 mezzanine loan, which bears interest at 6.384% and is secured by a
multi-family portfolio in New York, New York. An affiliate of SL Green simultaneously acquired the remaining $75,000 pari-passu interest in the mezzanine loan. As of September 30,
2008 and December 31, 2007, the loan has a book value of $115,478 and $108,034, respectively.

In
January 2007, we originated two mezzanine loans totaling $200,000. The $150,000 loan was secured by a pledge of cash flow distributions and partial equity interests in a portfolio of
multi-family properties and bore interest at one-month LIBOR plus 6.00%. The $50,000 loan was initially secured by cash flow distributions and partial equity interests in an office
property. On March 8, 2007 the $50,000 loan was increased by $31,000 when the existing mortgage loan on the property was defeased, upon which event our loan became secured by a first mortgage
lien on the property and was reclassified as a whole loan. The whole loan currently bears interest at one-month LIBOR plus 6.00% for the initial funding and one-month LIBOR
plus 1.00% for the subsequent funding. At closing, an affiliate of SL Green acquired from us and held a 15.15% pari-passu interest in the mezzanine loan and the whole loan. As of
September 30, 2008 and December 31, 2007, our interest in the whole loan had a carrying value of $66,158 and $65,033, respectively. The investment in the mezzanine loan was repaid in
full in September 2007.

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

105

---



In April 2007, we purchased for $103,200 a 45% TIC interest to acquire the fee interest in a parcel of land located at 2 Herald Square, located along 34th Street in
New York, New York. The acquisition was financed with a $86,063 10-year fixed rate mortgage loan. The property is subject to a long-term ground lease with an unaffiliated third
party for a term of 70 years. The remaining TIC interest is owned by a wholly-owned subsidiary of SL Green. The TIC interests are pari-passu. As of September 30, 2008 and
December 31, 2007, the investment had a carrying value of $24,881 and $20,390, respectively. We recorded our pro rata share of net income of $1,237 and $3,991 and $773 and $1,871 for the three
and nine months ended September 30, 2008 and 2007, respectively.

In
July 2007, we purchased for $144,240 an investment in a 45% TIC interest to acquire a 79% fee interest and 21% leasehold interest in the fee position in a parcel of land located at
885 Third Avenue, on which is situated The Lipstick Building. The transaction was financed with a $120,443 10-year fixed rate mortgage loan. The property is subject to a
70-year leasehold ground lease with an unaffiliated third party. The remaining TIC interest is owned by a wholly-owned subsidiary of SL Green. The TIC interests are pari-passu.
As of September 30, 2008 and December 31, 2007, the investment had a carrying value of $34,866 and $28,332, respectively. We recorded our pro rata share of net income of $1,476 and
$4,815 and $946 and $946 for the three and nine months ended September 30, 2008 and 2007, respectively.

In
July 2007, we acquired for $71,871 a 100% fee interest in the property located at 292 Madison Avenue, New York, New York, purchased from SL Green. We entered into a
70-year ground lease with an unaffiliated third party which simultaneously purchased from SL Green the Class B office building situated on the property. Our acquisition of the fee
interest was financed with a $59,099 10-year fixed rate mortgage loan.

In
August 2007, we closed on the purchase from a financial institution of a $12,500 mezzanine loan on a substantially complete residential condominium project in the upper east side of
Manhattan. The investment bears interest at the current pay rate of 11% over LIBOR, and a 19% look-back internal rate of return at maturity. At closing, an affiliate of SL Green
simultaneously acquired a $12,500 pari-passu interest in the same tranche of the capital structure. The loan was retired in August 2008.

In
September 2007, we acquired a 50% interest in a $25,000 senior mezzanine loan from SL Green. Immediately thereafter we, along with SL Green, sold all of our interests in the loan to
an unaffiliated third party. Additionally, we acquired from SL Green a 100% interest in a $25,000 junior mezzanine loan associated with the same properties as the preceding senior mezzanine loan.
Immediately thereafter we participated 50% of its interest in the loan back to SL Green. As of September 30, 2008 and December 31, 2007, the loan has a book value of $12,792 and $11,917,
respectively. In October 2007, we acquired a 50% pari-passu interest in $57,795 of two additional tranches in the senior mezzanine loan from an unaffiliated third party. At closing, an
affiliate of SL Green simultaneously acquired the other 50% pari-passu interest in the two tranches. As of September 30, 2008 and December 31, 2007, the loan has a book value
of $26,882 and $26,776, respectively.

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

In
November 2007, we acquired from a syndicate comprised of financial institutions a $25,000 interest in a $100,000 junior mezzanine investment secured by a hotel portfolio and franchise
headquarters. An affiliate of SL Green simultaneously acquired and owns another $25,000 interest in the investment. The investment was purchased at a discount and bears interest at an effective spread
to one-month LIBOR of 9.50%. As of September 30, 2008 and December 31, 2007, the loan has a book value of $22,279 and $22,238, respectively.

106

---



In
December 2007, we acquired a $52,000 interest in a senior mezzanine loan from a financial institution. Immediately thereafter we participated 50% of our interest in the loan to an
affiliate of SL Green. The investment, which is secured by a retail property in New York, New York, was purchased at a discount and bears interest at an effective spread to one-month LIBOR
of 5.00%. As of September 30, 2008 and December 31, 2007, the loan has a book value of $24,234 and $23,141, respectively.

In
December 2007, we acquired a 50% interest in a $200,000 senior mezzanine loan from a financial institution. Immediately thereafter we participated 50% of our interest in the loan to
an affiliate of SL Green. The investment was purchased at a discount and bears interest at an effective spread to
one-month LIBOR of 6.50%. As of September 30, 2008 and December 31, 2007, the loan has a book value of $45,626 and $44,739, respectively.

In
connection with the closing of the acquisition of American Financial, the Company, as part of a larger financing, received financing of $50,000 from SL Green, which is described more
fully in Note 9. An affiliate of SL Green was granted 644,787 shares of common stock for services rendered, subject to a one-year vesting period. These shares had a value of
approximately $11,213 on the date of issuance.

In
August 2008, we closed on the purchase from an SL Green affiliate of a $9,375 pari-passu participation interest in a $18,750 first mortgage. The loan is secured by a
retail shopping center located in Staten Island, New York. The investment bears interest at a fixed rate of 6.50%. As of September 30, 2008, the loan has a book value of $9,362.

In
September 2008, we closed on the purchase from an SL Green affiliate of a $30,000 interest in a $135,000 mezzanine loan. The loan is secured by the borrower's interests in a retail
condominium located New York, New York. The investment bears interest at an effective spread to one-month LIBOR of 10.00%. As of September 30, 2008, the loan has a book value of
$29,910.

Bright
Star Couriers LLC, or Bright Star, provides messenger services to us. Bright Star is owned by Gary Green, a son of Stephen L. Green, our Chairman. The aggregate amount of
fees paid by us for such services for each of the three and nine months ended September 30, 2008 and 2007, was less than $1.

Funds from Operations

We present FFO because we consider it an important supplemental measure of our operating performance and believe that it is frequently
used by securities analysts, investors and other interested parties in the evaluation of REITS. We also use FFO for the calculation of the incentive fee payable to the holders of Class B
limited partner interests in our Operating Partnership and as one of several criteria to determine performance-based incentive compensation for members of our senior management, which may be payable
in cash or equity awards. The revised White Paper on FFO approved by the Board of Governors of the National Association of Real Estate Investment Trusts, or NAREIT, in April 2002 defines FFO as net
income (loss) (computed in accordance with GAAP, inclusive of the impact of straight line rents), excluding gains (or losses) from items which are not a recurring part of our business, such as sales
of properties, plus real estate-related depreciation and amortization and after adjustments for unconsolidated partnerships and joint ventures. We consider gains and losses on the sales of debt
investments to be a normal part of our recurring operations and therefore include such gains and losses when arriving at FFO. FFO does not represent
cash generated from operating activities in accordance with GAAP and should not be considered as an alternative to net income (determined in accordance with GAAP), as an indication of our financial
performance, or to cash flow from operating activities (determined in accordance with GAAP) as a measure of our liquidity, nor is it entirely indicative of funds available to fund our cash needs,
including our ability to make cash distributions. Our calculation of FFO may be different from the calculation used by other companies and, therefore, comparability may be limited.

107

---



FFO
for the three and nine months ended September 30, 2008 and 2007 are as follows (amounts in thousands, except share and per share data):

For the Three
Months Ended
September 30, 2008

For the Three
Months Ended
September 30, 2007

For the Nine
Months Ended
September 30, 2008

For the Nine
Months Ended
September 30, 2007Net income available to common stockholders

$
7,323

$
94,814

$
40,518

$
131,828Add:Depreciation and amortization


25,677


3,149


55,988


8,742FFO adjustment for unconsolidated joint ventures


104


753


469


4,647Less:Gain in sale of unconsolidated joint venture interest





(92,235
)




(92,235
)Incentive fee attributable to gain from sale of unconsolidated joint venture interest





18,994





18,994Non real estate depreciation and amortization


(2,489
)

(2,538
)

(9,402
)

(6,966
)Funds from operations

$
30,615

$
22,937

$
87,573

$
65,009Funds from operations per share-basic

$
0.60

$
0.87

$
1.92

$
2.49Funds from operations per share-diluted

$
0.60

$
0.83

$
1.91

$
2.36


Cautionary Note Regarding Forward-Looking Information

This report contains "forward-looking statements" within the meaning of Section 27A of the Securities Act and Section 21E
of the Securities Exchange Act of 1934, as amended, or the Exchange Act. You can identify forward-looking statements by the use of forward-looking expressions such as "may," "will," "should,"
"expect," "believe," "anticipate," "estimate," "intend," "plan," "project," "continue," or any negative or other variations on such expressions. Forward-looking statements include information
concerning possible or assumed future results of our operations, including any forecasts, projections, plans and objectives for future operations. Although we believe that our plans, intentions and
expectations as reflected in or suggested by those forward-looking statements are reasonable, we can give no assurance that the plans, 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-looking statements we make in this
report. These risks, uncertainties and contingencies include, but are not limited to, the following:



108

---





109

---





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

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

Recently Issued Accounting Pronouncements

In February 2007, the FASB issued Statement No. 159, or SFAS No. 159, "The Fair Value Option for Financial Assets and
Financial Liabilities." SFAS No. 159 permits entities to choose to measure many financial instruments and certain other item, at fair value. SFAS No. 159 also establishes presentation
and disclosure requirements designed to facilitate comparisons between entities that choose different measurement attributes for similar types of assets and liabilities. SFAS No. 159 applies to
reporting periods beginning after November 15, 2007. We did not elect FAS No. 159 for any of our financial assets and financial liabilities as of September 30, 2008.

In
June 2007, the American Institute of Certified Public Accountants, or AICPA, issued Statement of Position ("SOP") 07-01 "Clarification of the Scope of the Audit and
Accounting Guide for Investment Companies and Accounting by Parent Companies and Equity Method Investors for Investments in Investment Companies." SOP 07-1 clarifies the scope of
accounting for investment companies and provides guidance for determining whether an entity is within the scope of the AICPA Audit and Accounting Guide for Investment Companies or the Guide. For those
entities that are investment companies under SOP 07-1, the specialized industry accounting principles of the Guide (referred to as Investment Company accounting) should be retained
by a parent company when it consolidates its interest in the investment company or by an equity method investor when it records its interest in the investment company. The SOP also provides for
certain disclosure requirements for parent companies and equity method investors in investment companies that continue investment company accounting in the parent's consolidated financial statements
or the financial statements of the equity method investor. The SOP was to be effective for fiscal years beginning on or after December 15, 2007; however in a meeting on October 17, 2007,
the FASB voted to indefinitely defer the effective date and add to the FASB's technical agenda, consideration of amending certain provisions of the SOP. We maintain an exemption from the Investment
Company Act of 1940, as amended, and are therefore not regulated as an investment company but as a REIT, the Company is not subject to the AICPA's Investment Company Accounting and Auditing Guide. We
continue to monitor the AICPA's developments with respect to SOP 07-1.

In
December 2007, the FASB issued Statement No. 141 (revised), or SFAS No. 141(R), "Business Combination", which attempts to improve the relevance, representational
faithfulness, and comparability of the information that a reporting entity provides in its financial reports about a

110

---



business
combination and its effects. This Statement replaces SFAS No. 141, "Business Combinations." SFAS No. 141(R) retains the fundamental requirements in Statement No. 141 that
the acquisition method of accounting (which Statement 141 called the purchase method) be used for all business combinations and for an acquirer to be identified for each business combination. This
Statement also retains the guidance in SFAS No. 141 for identifying and recognizing intangible assets separately from goodwill. The most significant changes in SFAS No. 141(R) are:
(1) acquisition and restructuring costs would be now expensed; (2) stock consideration will be measured based on the quoted market price as of the acquisition date instead of the date
the deal is announced; (3) contingent consideration arising from contractual and non-contractual contingencies that meet the more-likely-than-not
recognition threshold will be measured and recognized as an asset or liability at fair value at the acquisition date using a probability-weighted discounted cash flows model, with subsequent changes
in fair value reflected in earnings, non-contractual contingencies that do not meet the more-likely-than-not criteria will continue to be recognized
when they are probable and reasonably estimable; and (4) acquirer records 100% step-up to fair value for all assets and liabilities, including the minority interest portion and
goodwill which is recorded as if a 100% interest was acquired. SFAS No. 141(R) is effective for fiscal years beginning after December 15, 2008. We are currently evaluating the effect, if
any, that this pronouncement will have on our future financial position and results of operations.

In
December 2007, the FASB issued Statement No. 160, Non-Controlling Interest on Consolidated Financial Statementsan amendment of Accounting Research
Bulletin, or
ARB No. 51. This Statement amends ARB No. 51 to establish accounting and reporting standards for the non-controlling interest in a subsidiary and for the deconsolidation of a
subsidiary. It clarifies that a non-controlling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial
statements. Additionally, this Statement requires that consolidated net income include the amount attributable to both the parent and the non-controlling interest. This Statement is
effective for interim periods beginning on or after December 15, 2008. We are currently evaluating the impact, if any, that the adoption of this Statement will have on our consolidated
financial statements.

In
February 2008, the FASB issued Staff Position No. 140-3, or FSP 140-3, "Accounting for Transfers of Financial Assets and Repurchase Financing
Transactions." FSP 140-3 provides guidance on the accounting for a purchase of a financial asset from a counterparty and contemporaneous financing of the acquisition through repurchase
agreements with the same counterparty. Under this guidance, the purchase and related financing are linked, unless all of the following conditions are met at the inception of the transaction:
(1) the purchase and corresponding financing are not contractually contingent; (2) the repurchase financing provides recourse; (3) the financial asset and repurchase financing are
readily obtainable in the marketplace and are executed at market rates; and (4) the maturity of financial asset and repurchase are not coterminous. A linked transaction would require a
determination under FAS No. 140 to conclude if the transaction meets the requirements for sale accounting. If the linked transaction does not meet sale accounting requirements, the net
investment in the linked transaction is to be recorded as a derivative with the corresponding change in fair value of the derivative being recorded through earnings. The value of the derivative would
reflect changes in the value of the underlying debt investments and changes in the value of the underlying credit provided by the counterparty. We currently presents these transactions gross, with the
acquisition of the financial assets in total assets and the related repurchase agreements as financing in total liabilities on the consolidated balance sheet and the interest income earned on the debt
investments and interest expense incurred on the repurchase obligations are reported gross on the consolidated income statements. FSP 140-3 is effective for financial statements issued for
fiscal years beginning after November 15, 2008. We are currently evaluating the effect, if any, that this pronouncement will have on our future financial position and results of operations.

111

---



In
February 2008, the FASB issued FASB Staff Position 157-1, "Application of FASB Statement No. 157 to FASB Statement No. 13 and Other
Accounting Pronouncements That Address Fair Value Measurements for Purposes of Lease Classification or Measurement under Statement 13" ("FSP 157-1") and
FSP 157-2, "Effective Date of FASB Statement No. 157" ("FSP 157-2"). FSP 157-1 amends SFAS No. 157 to remove
certain leasing transactions from its scope. FSP 157-2 provides a one-year deferral of the effective date of SFAS No. 157 for all non-financial
assets and non-financial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis. These non-financial items
include assets and liabilities such as reporting units measured at fair value in a goodwill impairment test and non-financial assets acquired and liabilities assumed in a business
combination. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15,
2007 and was adopted by us, as it applies to our financial instruments, effective January 1, 2008. The adoption of SFAS No. 157 as it relates to financial instruments did not have
a significant impact on our Consolidated Financial Statements. We will adopt the provisions of SFAS No. 157 as it relates to our non-financial assets and
non-financial liabilities effective January 1, 2009, and we are currently evaluating the effect, if any, that this pronouncement will have on our future financial position and
results of operations.

In
March 2008, the FASB issued SFAS No. 161, "Disclosures about Derivative Instruments and Hedging Activities," an amendment of FASB Statement No. 133, or SFAS
No. 161. SFAS No. 161 is intended to improve financial reporting about derivative instruments and hedging activities by requiring enhanced disclosures to enable investors to better
understand how and why an entity uses derivative instruments and their effects on an entity's financial position, financial performance and cash flows. SFAS No. 161 is effective for financial
statements issued for fiscal years and interim periods beginning after November 15, 2008 with early adoption encouraged. We are currently evaluating the effect, if any, that this pronouncement
will have on our future financial position and results of operations.

In
April 2008, the FASB directed the FASB Staff to issue FSP No. FAS 142-3. "Determination of the Useful Life of Intangible Assets." FSP FAS
No. 142-3 amends the factors that should be considered in developing a renewal or extension assumptions used for purposes of determining the useful life of a recognized intangible
asset under FASB Statement No. 142, "Goodwill and Other Intangible Assets," or SFAS No. 142. FSP FAS No. 142-3 is intended to improve the consistency between the
useful life of a recognized intangible asset under SFAS No. 142 and the period of expected cash flows used to measure the fair value of the asset under SFAS No. 141(R) and other U.S.
generally accepted accounting principles. FSP FAS No. 142-3 is effective for fiscal years beginning after December 15, 2008. Earlier application is not permitted. We believe
the impact of adopting FSP FAS No. 142-3 will not have a material effect on the consolidated financial statements.

In
April of 2008, the FASB voted to eliminate QSPEs from the guidance in SFAS No.140 and to remove the scope exception for QSPEs from FIN 46R. This will require that VIEs
previously accounted for as QSPEs will need to be analyzed for consolidation according to FIN 46R. While the revised standards have not been finalized, and deferred for potential application
until 2010, this change may affect our consolidated financial statements.

In
October 2008, the FASB issued Staff Position 157-3, Determining the Fair Value of a Financial Asset in a Market That Is Not Active ("FSP 157-3"),
which clarifies the application of SFAS 157 in an inactive market and provides an illustrative example to demonstrate how the fair value of a financial asset is determined when the market for
that financial asset is not active. The guidance provided by FSP 157-3 is consistent with our approach to valuing financial assets for which there are no active markets.

112

---





ITEM 3.    Quantitative and Qualitative Disclosure About Market Risk

Market Risk

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

During
2007 and continuing in the first three quarters of 2008, the global capital markets experienced unprecedented volatility, resulting in dramatic changes in credit spreads, prices
of financial assets, liquidity and the availability and cost of debt and equity capital. The impact has been most severe in the single-family residential real estate mortgage markets in the United
States, but has also affected the commercial real estate debt markets in which we invest. In particular, subsequent to the issuance of our third CDO in August 2007, the commercial real estate
securitization markets have experienced severe declines in transaction activity, reductions in short-term and long-term liquidity, and widening credit spreads. We have
historically relied on the securitization markets as a source of efficient match-funded financing structures for our growing portfolio of commercial loans and CMBS investment portfolio.
Overall, this environment has led to increased costs, reduced availability of efficient debt capital and reduced production volumes for us. Currently, the new issue market for
structured finance transactions including commercial real estate CDOs is dormant. This capital markets environment has led to increased cost of funds and reduced availability of efficient debt
capital, factors which have caused us to reduce our investment activity. These conditions have also adversely impacted the ability of commercial property owners to service their debt and refinance
their loans as they mature and for our tenants to service their leases.

We
believe our businesses will ultimately benefit in the long run, from a market environment where assets are priced and structured more conservatively. In addition, our acquisition of
American Financial will combine the existing operating platforms of American Financial with our own to create an integrated commercial real estate finance and operating company, and will transform us
from primarily a specialty finance company into a diversified enterprise with complementary business lines consisting of commercial real estate finance and property investments.

Real Estate Risk

Commercial and multi-family property values and net operating income derived from such properties are subject to volatility and may be
affected adversely by a number of factors, including, but not limited to, national, regional and local economic conditions which may be adversely affected by industry slowdowns and other factors),
local real estate conditions (such as an oversupply of retail, industrial, office or other commercial or multi-family space), changes or continued weakness in specific industry segments, construction
quality, age and design, 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 losses to us. In addition, decreases in property values reduce the value of the collateral and the potential proceeds available
to a borrower to repay our loans, which could also cause us to suffer losses. Even when a property's net operating income is sufficient to cover the property's debt service at the time a loan is made,
there can be no assurance that this will continue in the future. We employ careful business selection, rigorous underwriting and credit approval processes and attentive asset management to mitigate
these risks.

113

---



Interest Rate Risk

Interest rate risk is highly sensitive to many factors, including governmental monetary and tax policies, domestic and international
economic and political considerations and other factors beyond our control.

Our
operating results will depend in large part on differences between the income from our assets and our borrowing costs. Most of our assets and borrowings are variable-rate
instruments that we finance with variable rate debt. The objective of this strategy is to minimize the impact of interest rate changes on the spread between the yield on our assets and our cost of
funds. We enter into hedging transactions with respect to all liabilities relating to fixed rate assets. If we were to finance fixed rate assets with variable rate debt and the benchmark for our
variable rate debt increased, our net income would decrease. Furthermore, since some of our available financing provides for an ability of the lender to mark-to-market our
assets and make margin calls based on a change in the value of assets pledged to secure this financing, funding fixed rate assets with this debt creates the risk that an increase in fixed rate
benchmarks (such as "swap" yields) would decrease the value of our fixed rate assets. To hedge against this risk, we have entered into certain swap transactions in anticipation of drawing upon our
mark-to-market debt. Some of our loans are subject to various interest rate floors. As a result, if interest rates fall below the floor rates, the spread between the yield on
our assets and our cost of funds will increase, which will generally increase our returns. Because Gramercy Finance generates income principally from the spread between the yields on our assets and
the cost of our borrowing and hedging activities, our net income will generally increase if LIBOR increases and decreases if LIBOR decreases, but this may not always be true in the future. A
hypothetical 100 basis point increase in interest rates along the entire interest rate curve for the three and nine months ended September 30, 2008 would have increased our interest cost by
approximately $26,372 offset by an increase in our investment income of approximately $15,464.

Our
exposure to interest rates will also be affected by our overall corporate leverage, which we generally target to be 70% to 80% of the carrying value of our assets, although our
actual leverage may vary depending on our mix of assets.

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

114

---



The
aggregate carrying values, allocated by product type and weighted average coupons of our loans and other lending investments and CMBS investments as of September 30, 2008 and
December 31, 2007, including loans held for sales, were as follows (dollars in thousands):

Carrying Value(1)

Allocation by
Investment Type

Fixed Rate:
Average Yield

Floating Rate:
Average Spread over
LIBOR(2)2008

2007

2008

2007

2008

2007

2008

2007Whole loans, floating rate

$
1,245,982

$
1,594,338


55.9
%

60.5
%







372 bps


332 bpsWhole loans, fixed rate


164,618


204,192


7.4
%

7.7
%

7.10
%

7.79
%




Subordinate interests in whole loans, floating rate


101,179


146,901


4.5
%

5.6
%







401 bps


447 bpsSubordinate interests in whole loans, fixed rate


62,832


61,890


2.8
%

2.3
%

9.26
%

8.78
%




Mezzanine loans, floating rate


432,117


413,813


19.4
%

15.7
%







670 bps


607 bpsMezzanine loans, fixed rate


212,052


203,753


9.5
%

7.7
%

9.49
%

8.91
%




Preferred equity, fixed rate


11,990


11,858


0.5
%

0.5
%

10.22
%

10.09
%




Subtotal/ Weighted average


2,230,770


2,636,745


100.0
%

100.0
%

8.61
%

8.45
%

446 bps


395 bpsCMBS, floating rate


69,460


23,817


8.1
%

3.0
%







687 bps


593 bpsCMBS, fixed rate


787,942


768,166


91.9
%

97.0
%

6.22
%

6.13
%




Subtotal/ Weighted average


857,402


791,983


100.0
%

100.0
%

6.22
%

6.13
%

687 bps


593 bpsTotal

$
3,088,172

$
3,428,728


100.0
%

100.0
%

7.09
%

7.02
%

455 bps


397 bps


---

As of September 30, 2008, the Company's loans and other lending investments, excluding CMBS investments, had the following maturity
characteristics:

Year of Maturity

Number of
Investments
Maturing

Current
Carrying Value
(In thousands)

% of Total2008 (October 1December 31)


7

$
232,009


10.4
%2009


38


1,208,962


54.2
%2010


13


390,473


17.5
%2011


2


30,890


1.4
%2012


2


63,086


2.8
%Thereafter


10


305,350


13.7
%Total


72

$
2,230,770


100
%Weighted average maturity(1)





1.9 years


---

115

---



Combined
aggregate principal maturities of our consolidated CDOs, Goldman repurchase facility, Wachovia credit facility and term loan trust preferred securities, mortgage loans
(including the Goldman Mortgage and Senior and Junior Mezzanine Loans and the proportionately consolidated mortgage note payable related to our TIC interest in 55 Corporate Drive), and the KeyBank
credit facility as of September 30, 2008 are as follows (dollars in thousands):

CDOs

Wachovia
Credit Facility
and Goldman
Repurchase
Facility

Trust
Preferred
Securities

Mortgage
and
Mezzanine
Loans

KeyBank Credit
Facility

Total2008 (October 1December 31)

$


$


$


$
7,553

$


$
7,5532009





31.855





75,926





107,7812010





76,139





879,925


172,301


1,128,3652011











33,824





33,8242012











80,256





80,256Thereafter


2,662,955





150,000


1,468,289,





4,257,295Total

$
2,662,955

$
107,994

$
150,000

$
2,545,773

$
172,301

$
5,639,023


The
following table summarizes the notional and fair value of the Company's derivative financial instruments at September 30, 2008. The notional value is an indication of the
extent of the Company's involvement in this instrument at that time, but does not represent exposure to credit, interest rate or market risks (dollars in thousands):

Benchmark Rate

Notional Value

Strike
Rate

Effective
Date

Expiration
Date

Fair
ValueInterest Rate Swap

1 month LIBOR

$
3,465


4.280
%

7/2005


12/2009

$
(44
)Interest Rate Swap

3 month LIBOR


3,465


5.178
%

4/2006


3/2010


(90
)Interest Rate Swap

3 month LIBOR


14,650


4.425
%

11/2007


7/2015


(392
)Interest Rate Swap

3 month LIBOR


12,000


3.063
%

1/2008


7/2010


43Interest Rate Swap

3 month LIBOR


12,000


9.850
%

8/2006


8/2011


(517
)Interest Rate Swap

3 month LIBOR


2,000


3.073
%

1/2008


7/2010


7Interest Rate Swap

3 month LIBOR


347,908


5.408
%

8/2007


5/2017


(22,278
)Interest Rate Swap

3 month LIBOR


699,441


5.331
%

8/2007


1/2018


(54,579
)Interest Rate Swap

1 month LIBOR


42,718


4.990
%

1/2007


1/2017


(3,114
)Interest Rate Swap

3 month LIBOR


24,143


5.114
%

2/2008


1/2017


(1,501
)Interest Rate Swap

3 month LIBOR


16,412


5.203
%

2/2008


5/2017


(1,103
)Interest Rate Swap

3 month LIBOR


4,700


3.170
%

4/2008


4/2012


57Interest Rate Cap

1 month LIBOR


250,000


5.250
%

4/2008


3/2010


128Interest Rate Cap

1 month LIBOR


600,000


5.250
%

8/2008


3/2010


308Interest Rate Cap

1 month LIBOR


9,375


4.260
%

8/2008


1/2015


(206
)Total



$
2,042,277










$
(83,281
)


ITEM 4.    Controls and Procedures

Evaluation of Disclosure Controls and Procedures

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Exchange
Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms, and that such information is accumulated and communicated to our management,
including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure based closely

116

---



on
the definition of "disclosure controls and procedures" in Rule 13a-15(e). Notwithstanding the foregoing, a control system, no matter how well designed and operated, can provide
only reasonable, not absolute, assurance that it will detect or uncover failures within our company to disclose material information otherwise required to be set forth in our periodic reports. Also,
we may have investments in certain unconsolidated entities. As we do not control these entities, our disclosure controls and procedures with respect to such entities are necessarily substantially more
limited than those we maintain with respect to our consolidated subsidiaries.

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

Changes in Internal Controls over Financial Reporting

Except as discussed below, there were no changes in our internal control over financial reporting identified in connection with the
evaluation of such internal control that occurred during our last fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial
reporting.

On
April 1, 2008, we completed the acquisition of American Financial Realty Trust. As a result of this acquisition, we adopted certain new accounting policies and accounting
systems relating to our property investment business. This acquisition did not require any material changes to our internal control over financial reporting with respect to our commercial real estate
finance business and its operations. We continue to evaluate additional processes and other components of internal control over financial
reporting resulting from this acquisition, including American Financial Realty Trust's historical internal control over financial reporting and the integration of those internal controls into our own
internal controls. This ongoing evaluation and integration may lead to our making additional changes in our internal control over financial reporting in future fiscal periods.

117

---





PART II OTHER INFORMATION

ITEM 1.    LEGAL PROCEEDINGS

None

ITEM 1A.    RISK FACTORS

Other than the risk factors set forth herein, there have been no material changes to the risk factors set forth in Item 1A of
our Annual Report on Form 10-K for the year ended December 31, 2007 and Part II, Item A of our Quarterly Report on
Form 10-Q for the period ended June 30, 2008. As used in this Item 1A., unless the context otherwise requires, the terms "we," "us," "our" and "our company" refer to
all entities owned or controlled by Gramercy Capital Corp., including GKK Capital LP, its operating partnership, and American Financial.

There are conflicts of interest in our relationship with our Manager, which could result in decisions that are not in the best interest of holders of our securities.

We are subject to potential conflicts of interest arising out of our relationship with SL Green and our Manager. Two of SL Green's
executive officers are also directors of our company and each of our executive officers also serve as officers of our Manager. As a result, the management agreement was not negotiated at arm's-length
and its terms, including fees payable, may not be as favorable to us as if it had been negotiated with an unaffiliated third party.

In
addition, our Manager and our executives may have conflicts between their duties to us and their duties to, and interests in, SL Green and/or our Manager. Our Manager is not required
to devote a specific amount of time to our operations. There may also be conflicts in allocating investments which are suitable both for us and SL Green. SL Green has agreed generally that it will not
acquire fixed income or preferred equity investments during the term of the management agreement. However, there are several exceptions, including debt instruments with equity characteristics,
distressed debt and refinancings of existing SL Green debt investments. As a result, SL Green may compete with us with respect to certain investments which we may want to acquire, and as a result we
may either not be presented with the opportunity or have to compete with SL Green to acquire these investments. Our Manager and our executive officers may choose to allocate favorable investments to
SL Green instead of to us.

We
pay our Manager substantial base management fees regardless of the performance of our portfolio. SL Green, our Manager and certain other parties, including certain of our officers and
directors, also own Class B limited partner interests in our operating partnership, which entitles them to receive (except for the period July 1, 2009 through December 31, 2009)
quarterly distributions based on financial performance. In evaluating investments and other management strategies, this may lead our Manager to place emphasis on the maximization of revenues at the
expense of other criteria, such as preservation of capital. Investments with higher yield potential are generally riskier or more speculative. This could result in increased risk to the value of our
invested portfolio.

Termination
of or failure to renew the management agreement without cause requires us to pay a termination fee and redeem the Class B limited partner interests. If the management
agreement is terminated or not renewed other than for cause, we will be required to pay a termination fee equal to the management fee earned by our Manager during the 12-month period
immediately preceding the effective date of the termination, unless we become self-managed, in which event no termination fee shall be due and payable to our Manager. We are also required
to redeem the Class B limited partner interests upon termination of the management agreement. These
provisions may increase the effective cost to us of terminating or failing to renew the management agreement, thereby adversely affecting our ability to terminate or not renew the management agreement
without cause.

118

---



There can be no assurance that the actions of the U.S. government, Federal Reserve and other governmental and regulatory bodies for the purpose of stabilizing the financial
markets, or market response to those actions, will achieve the intended effect, our business may not benefit from these actions and further government or market developments could adversely impact us.

In response to the financial issues affecting the banking system and financial markets and going concern threats to investment banks
and other financial institutions, the Emergency Economic Stabilization Act of 2008, or the EESA, was recently enacted. The EESA provides the U.S. Secretary of Treasury with the authority to establish
a Troubled Asset Relief Program, or TARP, to purchase from financial institutions up to $700 billion of residential or commercial mortgages and any securities, obligations, or other instruments
that are based on, or related to, such mortgages, that in each case was originated or issued on or before March 14, 2008, as well as any other financial instrument that the U.S. Secretary of
Treasury, after consultation with the Chairman of the Board of Governors of the Federal Reserve System, determines the purchase of which is necessary to promote financial market stability, upon
transmittal of such determination, in writing, to the appropriate committees of the U.S. Congress. In addition, the U.S. Secretary of Treasury has the authority to establish a program to guarantee,
upon request from a financial institution, the timely payment of principal and interest on these financial assets.

These
can be no assurance that the EESA will have a beneficial impact on the financial markets, including current extreme levels of volatility. To the extent the market does not respond
favorably to the TARP or the TARP does not function as intended, our business may not receive the anticipated positive impact from the legislation. In addition, the U.S. Government, Federal Reserve
and other governmental and regulatory bodies have taken or are considering taking other actions to address the financial crisis. We cannot predict whether or when such actions may occur or what
impact, if any, such actions could have on our business, results of operations and financial condition.

119

---



ITEM 2.    UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

None

ITEM 3.    DEFAULTS UPON SENIOR SECURITIES

None

ITEM 4.    SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None

ITEM 5.    OTHER INFORMATION

None

120

---





ITEM 6.    EXHIBITS

Exhibit No.

Description3.1

Articles of Incorporation of the Company (incorporated by reference to Exhibit 3.1 of the Company's Amendment No. 5 to its Registration Statement on Form S-11/A (No. 333-114673), which was filed with
the Commission on July 26, 2004 and declared effective by the Commission on July 27, 2004).3.2

Articles Supplementary designating the Company's 8.125% Series A Cumulative Redeemable Preferred Stock, liquidation preference $25.00 per share, par value $.001 per share (incorporated by reference to
Exhibit 3.1 of the Company's Form 8-K (No. 001-32248) which was filed with the Commission on April 18, 2007).3.3

Amended and Restated Bylaws of the Company (incorporated by reference to Exhibit 3.2 of the Company's Current Report on Form 8-K (No. 001-32248) which was filed with the Commission on December 14,
2007).4.1

Form of specimen stock certificate evidencing the common stock of the Company, par value $.001 per share (incorporated by reference to Exhibit 4.1 of the Company's Form 8-K (No. 001-32248) which was
filed with the Commission on April 18, 2007).4.2

Form of stock certificate evidencing the 8.125% Series A Cumulative Redeemable Preferred Stock of the Company, liquidation preference $25.00 per share, par value $.001 per share (incorporated by reference to
Exhibit 4.2 of the Company's Form 8-K (No. 001-32248) which was filed with the Commission on April 18, 2007).10.1

Credit Agreement, dated as of July 22, 2008, by and among Gramercy Warehouse Funding I LLC and GKK Trading Warehouse I LLC, as borrowers, Gramercy Capital Corp., GKK Capital LP, Gramercy Investment
Trust and GKK Trading Corp., as guarantors, and Wachovia Bank, National Association, as administrative agent, and Wachovia Capital Markets, LLC, as the sole lead arranger and sole book-runner (incorporated by reference to Exhibit 10.1 of
the Company's Form 8-K (No. 001-32248) which was filed with the SEC on July 28, 2008).10.2

Guarantee Agreement, dated as of July 22, 2008, by and among Gramercy Capital Corp., GKK Capital LP, Gramercy Investment Trust and GKK Trading Corp., as guarantors, and Wachovia Bank, National Association,
as administrative agent (incorporated by reference to Exhibit 10.2 of the Company's Form 8-K (No. 001-32248) which was filed with the SEC on July 28, 2008).10.3

Amendment to Loan Agreement, dated as of August 22, 2008, among Goldman Sachs Mortgage Company, Citicorp North America, Inc. and SL Green Realty Corp., collectively, as lender, and certain subsidiaries of
Gramercy Capital Corp., as borrower (incorporated by reference to Exhibit 10.1 of the Company's Form 8-K (No. 001-32248) which was filed with the SEC on August 28, 2008).10.4

Amended and Restated Senior Mezzanine Loan Agreement, dated as of August 22, 2008, among Goldman Sachs Mortgage Company and Citicorp North America, Inc., collectively, as lender, and American Financial
Realty Trust, First States Group, L.P., GKK Stars Acquisition LLC, First States Group, LLC, and certain subsidiaries of Gramercy Capital Corp., as borrower (incorporated by reference to Exhibit 10.2 of the Company's Form 8-K
(No. 001-32248) which was filed with the SEC on August 28, 2008).


121

---



Exhibit No.

Description10.5

Junior Mezzanine Loan Agreement, dated as of August 22, 2008, among Goldman Sachs Mortgage Company, Citicorp North America, Inc. and SL Green Realty Corp., collectively, as lender, and GKK Stars Junior Mezz
2 LLC, as borrower (incorporated by reference to Exhibit 10.3 of the Company's Form 8-K (No. 001-32248) which was filed with the SEC on August 28, 2008).10.6

Omnibus Amendment to Second Amended and Restated Master Repurchase Agreement, dated as of August 29, 2008, among Goldman Sachs Mortgage Company, Gramercy Warehouse Funding II LLC, GKK Trading Warehouse
II LLC, Gramercy Capital Corp., GKK Capital LP, Gramercy Investment Trust and GKK Trading Corp (incorporated by reference to Exhibit 10.1 of the Company's Form 8-K (No. 001-32248) which was filed with the SEC on
September 5, 2008).10.7

Omnibus Amendment to Second Amended and Restated Master Repurchase Agreement, dated as of August 29, 2008, among Goldman Sachs Mortgage Company, Gramercy Warehouse Funding II LLC, GKK Trading Warehouse
II LLC, Gramercy Capital Corp., GKK Capital LP, Gramercy Investment Trust and GKK Trading Corp (incorporated by reference to Exhibit 10.1 of the Company's Form 8-K (No. 001-32248) which was filed with the SEC on
September 5, 2008).10.8

Second Amended and Restated Management Agreement, dated as of October 27, 2008, by and among Gramercy Capital Corp., GKK Capital LP and GKK Manager LLC (incorporated by reference to Exhibit 10.1 of
the Company's Form 8-K (No. 001-32248) which was filed with the SEC on October 31, 2008).10.9

Services Agreement, dated as of October 27, 2008, by and among GKK Capital LP, Gramercy Capital Corp., SL Green Operating Partnership, L.P. and SL Green Realty Corp. (incorporated by reference to
Exhibit 10.2 of the Company's Form 8-K (No. 001-32248) which was filed with the SEC on October 31, 2008).10.10

Letter Agreement, dated as of October 27, 2008, by and among Gramercy Capital Corp., GKK Capital LP, SL Green Operating Partnership, L.P., the individual limited partners of GKK Capital LP party
thereto and GKK Manager LLC (incorporated by reference to Exhibit 10.3 of the Company's Form 8-K (No. 001-32248) which was filed with the SEC on October 31, 2008).10.11

Termination of Amended and Restated Asset Servicing Agreement, dated as of October 27, 2008, by and between GKK Manager LLC and SLG Gramercy Services LLC, and acknowledged and agreed to by Gramercy
Capital Corp. (incorporated by reference to Exhibit 10.4 of the Company's Form 8-K (No. 001-32248) which was filed with the SEC on October 31, 2008).10.12

Termination of Amended and Restated Outsource Agreement, dated as of October 27, 2008, by and between GKK Manager LLC and SL Green Operating Partnership, L.P. (incorporated by reference to
Exhibit 10.5 of the Company's Form 8-K (No. 001-32248) which was filed with the SEC on October 31, 2008).10.13

Severance Agreement, dated as of October 27, 2008, by and between Gramercy Capital Corp. and Roger M. Cozzi (incorporated by reference to Exhibit 10.6 of the Company's Form 8-K (No. 001-32248)
which was filed with the SEC on October 31, 2008).10.14

Second Amendment to the Third Amended and Restated Agreement of Limited Partnership of GKK Capital LP, dated as of October 27, 2008, filed herewith.10.15

Amended and Restated 2004 Equity Incentive Plan, filed herewith.


122

---



Exhibit No.

Description10.16

First Amendment to Amended and Restated 2004 Equity Incentive Plan, filed herewith.31.1

Certification by the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, filed herewith.31.2

Certification by the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, filed herewith.32.1

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

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


123

---





SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned thereunto duly authorized.

GRAMERCY CAPITAL CORP.By:

/s/ JOHN B. ROCHE John B. Roche Chief Financial Officer


Date:
November 10, 2008

124

---



QuickLinks