Table ofContents

 

 

 

**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 

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

**SECURITIESEXCHANGE ACT OF 1934**

 

**For the quarterly period ended September 30, 2010**

 

**Commission File Number: 000-51961**

 

**BehringerHarvard Opportunity REIT I, Inc.**

(Exact Name of Registrant as Specified in Its Charter)

 

| **Maryland**                                                    | ** ** | **20-1862323**                        |
|-----------------------------------------------------------------|------------|---------------------------------------|
| (State or other Jurisdiction of Incorporation or  Organization) |       | (I.R.S. Employer  Identification No.) |

 

**15601 Dallas Parkway, Suite 600, Addison, Texas75001**

(Address of Principal Executive Offices) (ZIP Code)

 

Registrant’s Telephone Number, Including Area Code:  **(866)655-3600**

 

**None**

(Former name, former address and former fiscal year, if changed sincelast report)

 

Indicateby check mark whether the Registrant:  (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the Registrant was required to file such reports) and (2) hasbeen subject to such filing requirements for the past 90 days.  Yes x  No o

 

Indicate by check markwhether the Registrant has submitted electronically and posted on its corporateWeb site, if any, every Interactive Data File required to be submitted andposted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter)during the preceding 12 months (or for such shorter period that the registrantwas required to submit and post such files). Yes o  No o

 

Indicateby check mark whether the Registrant is a large accelerated filer, anaccelerated filer, a non-accelerated filer, or a smaller reportingcompany.  See the definitions of “largeaccelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2of the Exchange Act:

 

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

 

Indicateby check mark whether the Registrant is a shell company (as defined in Rule 12b-2of the Exchange Act).  Yes o  No x

 

Asof October 29, 2010, the Registrant had 56,264,133 shares of common stockoutstanding.

 

 

 

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Table ofContents

 

**BEHRINGER HARVARD OPPORTUNITY REIT I, INC.**

**FORM 10-Q**

**QuarterEnded September 30, 2010**

 
| ** **                | ** **                                                                                                                     | **Page** |
|---------------------------|--------------------------------------------------------------------------------------------------------------------------------|----------|
|                      |                                                                                                                           |     |
| **PART I**           |                                                                                                                           |
| **FINANCIAL INFORMATION** |                                                                                                                           |
|                      |                                                                                                                           |     |
| **Item 1.**               | **Financial  Statements (Unaudited)**                                                                                          |     |
|                      |                                                                                                                           |     |
|                      | Consolidated  Balance Sheets as of September 30, 2010 and December 31, 2009                                          | 3        |
|                      |                                                                                                                           |     |
|                      | Consolidated  Statements of Operations and Comprehensive Loss for the Three and Nine Months  Ended September 30, 2010 and 2009 | 5        |
|                      |                                                                                                                           |     |
|                      | Consolidated Statements of Equity for the Nine Months  Ended September 30, 2010 and 2009                                  | 6        |
|                      |                                                                                                                           |     |
|                      | Consolidated Statements of Cash Flows for the Nine  Months Ended September 30, 2010 and 2009                              | 7        |
|                      |                                                                                                                           |     |
|                      | Notes to Consolidated Financial Statements                                                                                     | 8        |
|                      |                                                                                                                           |     |
| **Item 2.**               | **Management’s  Discussion and Analysis of Financial Condition and Results of Operations**                                | 34       |
|                      |                                                                                                                           |     |
| **Item 3.**               | **Quantitative  and Qualitative Disclosures About Market Risk**                                                                | 52       |
|                      |                                                                                                                           |     |
| **Item 4.**               | **Controls and Procedures**                                                                                                    | 52       |
|                      |                                                                                                                           |     |
| **PART II**          |                                                                                                                           |
| **OTHER  INFORMATION**    |                                                                                                                           |
|                      |                                                                                                                           |     |
| **Item  1.**              | **Legal  Proceedings**                                                                                                         | 53       |
|                      |                                                                                                                           |     |
| **Item  1A.**             | **Risk  Factors**                                                                                                              | 53       |
|                      |                                                                                                                           |     |
| **Item 2.**               | **Unregistered  Sales of Equity Securities and Use of Proceeds**                                                               | 53       |
|                      |                                                                                                                           |     |
| **Item 3.**               | **Defaults  Upon Senior Securities**                                                                                           | 54       |
|                      |                                                                                                                           |     |
| **Item  4.**              | **(Removed  and Reserved)**                                                                                                    | 54       |
|                      |                                                                                                                           |     |
| **Item  5.**              | **Other  Information**                                                                                                         | 54       |
|                      |                                                                                                                           |     |
| **Item 6.**               | **Exhibits**                                                                                                                   | 54       |
|                      |                                                                                                                           |     |
| **Signature**             |                                                                                                                           | 55       |

 

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**PART I**

**FINANCIAL INFORMATION**

 

**Item 1. Financial Statements.**

 

**Behringer Harvard Opportunity REIT I, Inc.**

**ConsolidatedBalance Sheets**

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

(Unaudited)

 
| ** **                                   | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|----------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                   | ** ** | **2010 (1)**      | ** ** | **2009 (1)**     | ** ** |
| **Assets**                                   |       |                   |       |                  |       |
| Real estate                                  |       |                   |       |                  |       |
| Land and improvements, net                   |       | $                      | 84,210     |                  | $          | 130,254 |   |
| Buildings and improvements, net              |       | 335,246                |       | 408,786               |       |
| Real estate under development                |       | 37,373                 |       | 20,701                |       |
| Total real estate                            |       | 456,829                |       | 559,741               |       |
|                                         |       |                   |       |                  |       |
| Condominium inventory                        |       | 61,638                 |       | 86,485                |       |
| Cash and cash equivalents                    |       | 3,531                  |       | 9,511                 |       |
| Restricted cash                              |       | 3,118                  |       | 8,585                 |       |
| Accounts receivable, net                     |       | 9,264                  |       | 8,169                 |       |
| Prepaid expenses and other assets            |       | 2,996                  |       | 2,138                 |       |
| Leasehold interests, net                     |       | 16,167                 |       | 16,406                |       |
| Investments in unconsolidated joint ventures |       | 66,938                 |       | 63,552                |       |
| Furniture, fixtures and equipment, net       |       | 8,319                  |       | 11,836                |       |
| Deferred financing fees, net                 |       | 2,405                  |       | 3,827                 |       |
| Notes receivable, net                        |       | 47,403                 |       | 42,557                |       |
| Lease intangibles, net                       |       | 18,279                 |       | 21,228                |       |
| Other intangibles, net                       |       | 7,840                  |       | 8,348                 |       |
| Receivables from related parties             |       | 1,578                  |       | 1,548                 |       |
| Total assets                                 |       | $                      | 706,305    |                  | $          | 843,931 |   |

 

----

(1)As a result of the adoption of Accounting Standards Codification (“ASC”) Topic810, (“ASC 810”), effective as of January 1, 2010, the Company is required toseparately disclose on its consolidated balance sheets the assets ofconsolidated variable interest entities (“VIEs”) that are owned by the VIEs andnon-recourse liabilities of consolidated VIEs.

 

Asof December 31, 2009, total assets include $91.4 million related to AlexanBlack Mountain and Tanglewood at Voss (“Consolidated VIEs”) of which $25.2million is included in land and improvements, net; $62 million in buildings andimprovements, net; $1 million in cash and cash equivalents; $0.5 million inrestricted cash; less than $0.1 million in accounts receivable, net; $2.4million in furniture, fixtures and equipment, net; and $0.3 million in deferredfinancing fees, net.

 

Asof January 1, 2010, we deconsolidated the assets and liabilities associatedwith Alexan Black Mountain and Tanglewood at Voss (see Note 8 to theConsolidated Financial Statements).

 

*See Notes to Consolidated Financial Statements.*

 

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**Behringer Harvard Opportunity REIT I, Inc.**

**Consolidated Balance Sheets - Continued**

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

(Unaudited)

 
| ** **                                                                                                                                                                                              | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                              | ** ** | **2010 (1)**      | ** ** | **2009 (1)**     | ** ** |
| **Liabilities and Equity**                                                                                                                                                                              |       |                   |       |                  |       |
| Notes payable                                                                                                                                                                                           |       | $                      | 346,997    |                  | $          | 429,787 |   |
| Accounts payable                                                                                                                                                                                        |       | 3,660                  |       | 1,885                 |       |
| Payables to related parties                                                                                                                                                                             |       | 2,939                  |       | 1,790                 |       |
| Acquired below-market leases, net                                                                                                                                                                       |       | 10,421                 |       | 12,726                |       |
| Accrued and other liabilities                                                                                                                                                                           |       | 20,334                 |       | 23,322                |       |
| Total liabilities                                                                                                                                                                                       |       | 384,351                |       | 469,510               |       |
|                                                                                                                                                                                                    |       |                   |       |                  |       |
| **Commitments and contingencies**                                                                                                                                                                       |       |                   |       |                  |       |
|                                                                                                                                                                                                    |       |                   |       |                  |       |
| **Equity**                                                                                                                                                                                              |       |                   |       |                  |       |
|                                                                                                                                                                                                    |       |                   |       |                  |       |
| Behringer Harvard Opportunity REIT I, Inc.  Equity:                                                                                                                                                |       |                   |       |                  |       |
| Preferred stock, $.0001 par value per share; 50,000,000  shares authorized, none outstanding                                                                                                            |       | —                 |       | —                |       |
| Convertible stock, $.0001 par value per share; 1,000  shares authorized, 1,000 shares issued and outstanding                                                                                            |       | —                 |       | —                |       |
| Common stock, $.0001 par value per share; 350,000,000  shares authorized, and 56,311,451 55,825,078 shares issued and outstanding at  September 30, 2010, and December 31, 2009, respectively |       | 6                      |       | 6                     |       |
| Additional paid-in capital                                                                                                                                                                              |       | 501,554                |       | 497,648               |       |
| Accumulated distributions and net loss                                                                                                                                                                  |       | (180,086               | )          | (115,496              | )          |
| Accumulated other comprehensive loss                                                                                                                                                                    |       | (3,572                 | )          | (3,412                | )          |
| Total Behringer Harvard Opportunity REIT  I, Inc. equity                                                                                                                                           |       | 317,902                |       | 378,746               |       |
| Noncontrolling interest                                                                                                                                                                                 |       | 4,052                  |       | (4,325                | )          |
| Total equity                                                                                                                                                                                            |       | 321,954                |       | 374,421               |       |
| Total liabilities and equity                                                                                                                                                                            |       | $                      | 706,305    |                  | $          | 843,931 |   |

 

----

(1)As a result of the adoption of ASC 810, effective as of January 1, 2010, theCompany is required to separately disclose on its consolidated balance sheetsthe assets of consolidated VIEs that are owned by the VIEs and non-recourseliabilities of consolidated VIEs.

 

Asof December 31, 2009, total liabilities include $102 million related toConsolidated VIEs of which $68.5 million is included in notes payable; lessthan $0.1 million in accounts payable; $32.2 million in payables to relatedparties; and $1.3 million in accrued and other liabilities.    .

 

Asof January 1, 2010, we deconsolidated the assets and liabilities associatedwith Alexan Black Mountain and Tanglewood at Voss (see Note 8 to theConsolidated Financial Statements).

 

*See Notes to Consolidated Financial Statements.*

 

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**Behringer Harvard Opportunity REIT I, Inc.**

**ConsolidatedStatements of Operations and Comprehensive Loss**

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

(Unaudited)

 
| ** **                                                                                                 | ** ** | **Three Months Ended   September 30,** | ** ** | **Nine Months Ended   September 30,** | ** ** |
|------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                                                                                                 | ** ** | **2010**                                                   | ** ** | **2009**                                                  | ** ** | **2010** | ** ** | **2009** | ** ** |
| **Revenues**                                                                                               |       |                                                       |       |                                                      |       |   |   |   |   |
| Rental revenue                                                                                             |       | $                                                          | 11,468     |                                                      | $          | 14,400 |   | $ | 34,325 |   | $ | 42,828 |   |
| Hotel revenue                                                                                              |       | 1,720                                                      |       | 1,513                                                     |       | 3,769 |   | 3,011 |   |
| Condominium sales                                                                                          |       | 664                                                        |       | 1,964                                                     |       | 26,228 |   | 13,893 |   |
| Interest income from notes receivable                                                                      |       | —                                                     |       | —                                                    |       | 6,434 |   | — |   |
|                                                                                                       |       |                                                       |       |                                                      |       |   |   |   |   |
| Total revenues                                                                                             |       | 13,852                                                     |       | 17,877                                                    |       | 70,756 |   | 59,732 |   |
|                                                                                                       |       |                                                       |       |                                                      |       |   |   |   |   |
| **Expenses**                                                                                               |       |                                                       |       |                                                      |       |   |   |   |   |
| Property operating expenses                                                                                |       | 4,909                                                      |       | 6,223                                                     |       | 14,398 |   | 18,266 |   |
| Bad debt expense                                                                                           |       | 89                                                         |       | 10,146                                                    |       | 366 |   | 10,489 |   |
| Cost of condominium sales                                                                                  |       | 773                                                        |       | 1,983                                                     |       | 26,710 |   | 14,003 |   |
| Interest expense                                                                                           |       | 3,932                                                      |       | 4,112                                                     |       | 10,570 |   | 11,708 |   |
| Real estate taxes                                                                                          |       | 1,588                                                      |       | 1,609                                                     |       | 5,174 |   | 5,871 |   |
| Impairment charge                                                                                          |       | 21,033                                                     |       | 7,109                                                     |       | 21,033 |   | 9,841 |   |
| Provision for loan losses                                                                                  |       | —                                                     |       | —                                                    |       | 7,136 |   | — |   |
| Property management fees                                                                                   |       | 589                                                        |       | 553                                                       |       | 1,587 |   | 1,615 |   |
| Asset management fees                                                                                      |       | 1,448                                                      |       | 1,336                                                     |       | 4,450 |   | 4,014 |   |
| General and administrative                                                                                 |       | 1,605                                                      |       | 1,406                                                     |       | 4,206 |   | 4,389 |   |
| Depreciation and amortization                                                                              |       | 5,588                                                      |       | 6,274                                                     |       | 16,576 |   | 19,470 |   |
|                                                                                                       |       |                                                       |       |                                                      |       |   |   |   |   |
| Total expenses                                                                                             |       | 41,554                                                     |       | 40,751                                                    |       | 112,206 |   | 99,666 |   |
|                                                                                                       |       |                                                       |       |                                                      |       |   |   |   |   |
| Interest income                                                                                            |       | 20                                                         |       | 40                                                        |       | 89 |   | 119 |   |
| Other income (expense), net                                                                                |       | (72                                                        | )          | —                                                    |       | (31 | ) | — |   |
| Loss on troubled debt restructuring                                                                        |       | (5,036                                                     | )          | —                                                    |       | (5,036 | ) | — |   |
|                                                                                                       |       |                                                       |       |                                                      |       |   |   |   |   |
| Loss from continuing operations before income  taxes and equity in losses of unconsolidated joint ventures |       | (32,790                                                    | )          | (22,834                                                   | )          | (46,428 | ) | (39,815 | ) |
|                                                                                                       |       |                                                       |       |                                                      |       |   |   |   |   |
| Benefit (provision) for income taxes                                                                       |       | (390                                                       | )          | (54                                                       | )          | (211 | ) | (152 | ) |
| Equity in losses of unconsolidated joint ventures                                                          |       | (2,491                                                     | )          | (1,059                                                    | )          | (4,074 | ) | (2,640 | ) |
| Loss from continuing operations                                                                            |       | (35,671                                                    | )          | (23,947                                                   | )          | (50,713 | ) | (42,607 | ) |
|                                                                                                       |       |                                                       |       |                                                      |       |   |   |   |   |
| Loss from discontinued operations                                                                          |       | (2,601                                                     | )          | (293                                                      | )          | (7,926 | ) | (1,136 | ) |
|                                                                                                       |       |                                                       |       |                                                      |       |   |   |   |   |
| Gain on sale of real estate                                                                                |       | 3,935                                                      |       | —                                                    |       | 3,935 |   | — |   |
|                                                                                                       |       |                                                       |       |                                                      |       |   |   |   |   |
| Net loss                                                                                                   |       | (34,337                                                    | )          | (24,240                                                   | )          | (54,704 | ) | (43,743 | ) |
|                                                                                                       |       |                                                       |       |                                                      |       |   |   |   |   |
| Noncontrolling interest in continuing operations                                                           |       | 499                                                        |       | 3,791                                                     |       | 1,104 |   | 8,868 |   |
|                                                                                                       |       |                                                       |       |                                                      |       |   |   |   |   |
| Net loss attributable to common shareholders                                                               |       | $                                                          | (33,838    | )                                                         | $          | (20,449 | ) | $ | (53,600 | ) | $ | (34,875 | ) |
|                                                                                                       |       |                                                       |       |                                                      |       |   |   |   |   |
| Weighted average shares outstanding:                                                                       |       |                                                       |       |                                                      |       |   |   |   |   |
| Basic and diluted                                                                                          |       | 56,261                                                     |       | 55,431                                                    |       | 56,127 |   | 55,226 |   |
|                                                                                                       |       |                                                       |       |                                                      |       |   |   |   |   |
| Loss per share attributable to common  shareholders:                                                       |       |                                                       |       |                                                      |       |   |   |   |   |
| Basic and diluted:                                                                                         |       |                                                       |       |                                                      |       |   |   |   |   |
| Continuing operations                                                                                      |       | $                                                          | (0.55      | )                                                         | $          | (0.36 | ) | $ | (0.81 | ) | $ | (0.61 | ) |
| Discontinued operations                                                                                    |       | (0.05                                                      | )          | (0.01                                                     | )          | (0.14 | ) | (0.02 | ) |
| Basic and diluted loss per share                                                                           |       | $                                                          | (0.60      | )                                                         | $          | (0.37 | ) | $ | (0.95 | ) | $ | (0.63 | ) |
|                                                                                                       |       |                                                       |       |                                                      |       |   |   |   |   |
| Amounts attributable to common shareholders:                                                               |       |                                                       |       |                                                      |       |   |   |   |   |
| Continuing operations                                                                                      |       | $                                                          | (31,237    | )                                                         | $          | (20,156 | ) | $ | (45,674 | ) | $ | (33,739 | ) |
| Discontinued operations                                                                                    |       | (2,601                                                     | )          | (293                                                      | )          | (7,926 | ) | (1,136 | ) |
|                                                                                                       |       | $                                                          | (33,838    | )                                                         | $          | (20,449 | ) | $ | (53,600 | ) | $ | (34,875 | ) |
|                                                                                                       |       |                                                       |       |                                                      |       |   |   |   |   |
| **Comprehensive income (loss):**                                                                           |       |                                                       |       |                                                      |       |   |   |   |   |
| Net loss                                                                                                   |       | $                                                          | (34,337    | )                                                         | $          | (24,240 | ) | $ | (54,704 | ) | $ | (43,743 | ) |
| Other comprehensive loss:                                                                                  |       |                                                       |       |                                                      |       |   |   |   |   |
| Foreign currency translation gain (loss)                                                                   |       | 2,306                                                      |       | (669                                                      | )          | (1,171 | ) | 879 |   |
| Unrealized gain (loss) on interest rate  derivatives                                                       |       | (336                                                       | )          | 450                                                       |       | 383 |   | 1,033 |   |
| Reclassifications due to hedging activities                                                                |       | 617                                                        |       | 24                                                        |       | 662 |   | 240 |   |
| Total other comprehensive income (loss)                                                                    |       | 2,587                                                      |       | (195                                                      | )          | (126 | ) | 2,152 |   |
| Comprehensive loss                                                                                         |       | (31,750                                                    | )          | (24,435                                                   | )          | (54,830 | ) | (41,591 | ) |
| Comprehensive income (loss) attributable to the  noncontrolling interest                                   |       | 515                                                        |       | 2,234                                                     |       | 1,070 |   | 8,336 |   |
| Comprehensive loss attributable to common  shareholders                                                    |       | $                                                          | (31,235    | )                                                         | $          | (22,201 | ) | $ | (53,760 | ) | $ | (33,255 | ) |

 

*See Notes to Consolidated Financial Statements.*

 

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**Behringer Harvard Opportunity REIT I, Inc.**

**ConsolidatedStatements of Equity**

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

(Unaudited)

 
| ** **                                                     | ** ** | ** **                 | ** ** | ** **            | ** ** | ** **         | ** ** | ** **        | ** ** | ** **  | ** ** | **Accumulated**   | ** ** | **Accumulated**        | ** ** | ** **         | ** ** | ** ** | ** ** |
|----------------------------------------------------------------|------------|----------------------------|------------|-----------------------|------------|--------------------|------------|-------------------|------------|-------------|------------|-------------------|------------|------------------------|------------|--------------------|------------|------------|------------|
| ** **                                                     | ** ** | **Convertible Stock** | ** ** | **Common Stock** | ** ** | **Additional**     | ** ** | **Distributions** | ** ** | **Other**   | ** ** | ** **        | ** ** | ** **             | ** ** |
| ** **                                                     | ** ** | **Number of**         | ** ** | **Par**               | ** ** | **Number of** | ** ** | **Par**           | ** ** | **Paid-In** | ** ** | **and**           | ** ** | **Comprehensive**      | ** ** | **Noncontrolling** | ** ** | **Total**  | ** ** |
| ** **                                                     | ** ** | **Shares**                 | ** ** | **Value**             | ** ** | **Shares**         | ** ** | **Value**         | ** ** | **Capital** | ** ** | **Net Loss** | ** ** | **Income (Loss)** | ** ** | **Interest**       | ** ** | **Equity** | ** ** |
| Balance at January 1, 2009                                |       | 1,000                      |       | $                     | —     |               | 54,836,985 |              | $          | 5           |       | $                 | 489,139    |                   | $          | (66,085            | )          | $          | (5,194     | ) | $ | 5,502 |   | $ | 423,367 |   |
|                                                           |       |                       |       |                  |       |               |       |              |       |        |       |              |       |                   |       |               |       |       |       |
| Issuance of common stock, net                                  |       |                       |       |                  |       |               |       |              |       |        |       |              |       |                   |       |               |       |       |       |
|                                                           |       |                       |       |                  |       |               |       |              |       |        |       |              |       |                   |       |               |       |       |       |
| Redemption of common stock                                     |       |                       |       |                  |       | (105,381           | )          |              |       | (992        | )          |              |       |                   |       |               |       | (992       | )          |
|                                                           |       |                       |       |                  |       |               |       |              |       |        |       |              |       |                   |       |               |       |       |       |
| Distributions declared on common stock                         |       |                       |       |                  |       |               |       |              |       |        |       | (8,210            | )          |                   |       |               |       | (8,210     | )          |
|                                                           |       |                       |       |                  |       |               |       |              |       |        |       |              |       |                   |       |               |       |       |       |
| Contributions from non-controlling interest                    |       |                       |       |                  |       |               |       |              |       |        |       |              |       |                   |       | 215                |       | 215        |       |
|                                                           |       |                       |       |                  |       |               |       |              |       |        |       |              |       |                   |       |               |       |       |       |
| Shares issued pursuant to Distribution Reinvestment  Plan, net |       |                       |       |                  |       | 786,813            |       | 1                 |       | 6,996       |       |              |       |                   |       |               |       | 6,997      |       |
|                                                           |       |                       |       |                  |       |               |       |              |       |        |       |              |       |                   |       |               |       |       |       |
| Comprehensive loss:                                            |       |                       |       |                  |       |               |       |              |       |        |       |              |       |                   |       |               |       |       |       |
| Net loss                                                       |       |                       |       |                  |       |               |       |              |       |        |       | (34,875           | )          |                   |       | (8,868             | )          | (43,743    | )          |
|                                                           |       |                       |       |                  |       |               |       |              |       |        |       |              |       |                   |       |               |       |       |       |
| Other comprehensive income:                                    |       |                       |       |                  |       |               |       |              |       |        |       |              |       |                   |       |               |       |       |       |
| Foreign currency translation gain (loss)                       |       |                       |       |                  |       |               |       |              |       |        |       |              |       | 465                    |       | 414                |       | 879        |       |
| Unrealized gains (losses) on interest rate  derivatives        |       |                       |       |                  |       |               |       |              |       |        |       |              |       | 915                    |       | 118                |       | 1,033      |       |
| Reclassifications due to hedging activities                    |       |                       |       |                  |       |               |       |              |       |        |       |              |       | 240                    |       | —             |       | 240        |       |
|                                                           |       |                       |       |                  |       |               |       |              |       |        |       |              |       |                   |       |               |       |       |       |
| Total comprehensive loss                                       |       |                       |       |                  |       |               |       |              |       |        |       |              |       |                   |       | (8,336             | )          | (41,591    | )          |
|                                                           |       |                       |       |                  |       |               |       |              |       |        |       |              |       |                   |       |               |       |       |       |
| Balance at September 30, 2009                             |       | 1,000                      |       | $                     | —     |               | 55,518,417 |              | $          | 6           |       | $                 | 495,143    |                   | $          | (109,170           | )          | $          | (3,574     | ) | $ | (2,619 | ) | $ | 379,786 |   |
|                                                           |       |                       |       |                  |       |               |       |              |       |        |       |              |       |                   |       |               |       |       |       |
|                                                           |       |                       |       |                  |       |               |       |              |       |        |       |              |       |                   |       |               |       |       |       |
| Balance at January 1, 2010                                |       | 1,000                      |       | $                     | —     |               | 55,825,078 |              | $          | 6           |       | $                 | 497,648    |                   | $          | (115,496           | )          | $          | (3,412     | ) | $ | (4,325 | ) | $ | 374,421 |   |
|                                                           |       |                       |       |                  |       |               |       |              |       |        |       |              |       |                   |       |               |       |       |       |
| Cumulative effect of adoption of accounting  standard          |       |                       |       |                  |       |               |       |              |       |        |       | (3,995            | )          |                   |       | 9,412              |       | 5,417      |       |
|                                                           |       |                       |       |                  |       |               |       |              |       |        |       |              |       |                   |       |               |       |       |       |
| Issuance of common stock, net                                  |       |                       |       |                  |       |               |       |              |       |        |       |              |       |                   |       |               |       | —     |       |
|                                                           |       |                       |       |                  |       |               |       |              |       |        |       |              |       |                   |       |               |       |       |       |
| Redemption of common stock                                     |       |                       |       |                  |       | (104,557           | )          |              |       | (839        | )          |              |       |                   |       |               |       | (839       | )          |
|                                                           |       |                       |       |                  |       |               |       |              |       |        |       |              |       |                   |       |               |       |       |       |
| Distributions declared on common stock                         |       |                       |       |                  |       |               |       |              |       |        |       | (6,995            | )          |                   |       | (43                | )          | (7,038     | )          |
|                                                           |       |                       |       |                  |       |               |       |              |       |        |       |              |       |                   |       |               |       |       |       |
| Contributions from noncontrolling interest                     |       |                       |       |                  |       |               |       |              |       |        |       |              |       |                   |       | 78                 |       | 78         |       |
|                                                           |       |                       |       |                  |       |               |       |              |       |        |       |              |       |                   |       |               |       |       |       |
| Shares issued pursuant to Distribution Reinvestment  Plan, net |       |                       |       |                  |       | 590,930            |       |              |       | 4,745       |       |              |       |                   |       |               |       | 4,745      |       |
|                                                           |       |                       |       |                  |       |               |       |              |       |        |       |              |       |                   |       |               |       |       |       |
| Comprehensive loss:                                            |       |                       |       |                  |       |               |       |              |       |        |       |              |       |                   |       |               |       |       |       |
| Net loss                                                       |       |                       |       |                  |       |               |       |              |       |        |       | (53,600           | )          |                   |       | (1,104             | )          | (54,704    | )          |
|                                                           |       |                       |       |                  |       |               |       |              |       |        |       |              |       |                   |       |               |       |       |       |
| Other comprehensive income:                                    |       |                       |       |                  |       |               |       |              |       |        |       |              |       |                   |       |               |       |       |       |
| Foreign currency translation gain (loss)                       |       |                       |       |                  |       |               |       |              |       |        |       |              |       | (1,206                 | )          | 35                 |       | (1,171     | )          |
| Unrealized gains (losses) on interest rate  derivatives        |       |                       |       |                  |       |               |       |              |       |        |       |              |       | 351                    |       | 32                 |       | 383        |       |
| Reclassifications due to hedging activities                    |       |                       |       |                  |       |               |       |              |       |        |       |              |       | 695                    |       | (33                | )          | 662        |       |
|                                                           |       |                       |       |                  |       |               |       |              |       |        |       |              |       |                   |       |               |       |       |       |
| Total comprehensive loss                                       |       |                       |       |                  |       |               |       |              |       |        |       |              |       |                   |       | (1,070             | )          | (54,830    | )          |
|                                                           |       |                       |       |                  |       |               |       |              |       |        |       |              |       |                   |       |               |       |       |       |
| Balance at September 30, 2010                             |       | 1,000                      |       | $                     | —     |               | 56,311,451 |              | $          | 6           |       | $                 | 501,554    |                   | $          | (180,086           | )          | $          | (3,572     | ) | $ | 4,052 |   | $ | 321,954 |   |

 

*See Notes to Consolidated Financial Statements.*

 

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**Behringer Harvard Opportunity REIT I, Inc.**

**ConsolidatedStatements of Cash Flows**

**(in thousands)**

(Unaudited)

 
| ** **                                                                             | ** ** | **Nine Months Ended September 30,** | ** ** |
|----------------------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                                             | ** ** | **2010**                                                | ** ** | **2009** | ** ** |
| **Cash flows from operating  activities:**                                             |       |                                                    |       |   |   |
| Net loss                                                                               |       | $                                                       | (54,704    | ) | $ | (43,743 | ) |
| Adjustments to reconcile net loss to net cash  flows provided by operating activities: |       |                                                    |       |   |   |
| Depreciation and amortization                                                          |       | 15,347                                                  |       | 18,452 |   |
| Amortization of deferred financing fees                                                |       | 2,078                                                   |       | 2,365 |   |
| Loss on troubled debt restructuring                                                    |       | 5,036                                                   |       | — |   |
| Loss on debt extinguishment                                                            |       | 2,253                                                   |       | — |   |
| Gain on sale of real estate                                                            |       | (3,935                                                  | )          | — |   |
| Impairment charge                                                                      |       | 25,263                                                  |       | 9,841 |   |
| Provision for loan losses                                                              |       | 7,136                                                   |       | — |   |
| Bad debt expense                                                                       |       | 366                                                     |       | 10,620 |   |
| Equity in losses of unconsolidated joint ventures                                      |       | 4,074                                                   |       | 2,640 |   |
| Gain on derivatives                                                                    |       | (2,432                                                  | )          | (567 | ) |
| Change in accounts receivable                                                          |       | (2,383                                                  | )          | (3,462 | ) |
| Change in condominium inventory                                                        |       | 19,997                                                  |       | 1,993 |   |
| Change in prepaid expenses and other assets                                            |       | (900                                                    | )          | 1,806 |   |
| Change in accounts payable                                                             |       | 1,004                                                   |       | (834 | ) |
| Change in accrued and other liabilities                                                |       | (2,790                                                  | )          | 3,700 |   |
| Change in payables to related parties                                                  |       | 1,157                                                   |       | 2,098 |   |
| Addition of lease intangibles                                                          |       | (1,447                                                  | )          | (1,402 | ) |
| Cash provided by operating activities                                                  |       | 15,120                                                  |       | 3,507 |   |
|                                                                                   |       |                                                    |       |   |   |
| **Cash flows from investing  activities:**                                             |       |                                                    |       |   |   |
| Proceeds from sale of real estate                                                      |       | 2,770                                                   |       | — |   |
| Investment in unconsolidated joint ventures                                            |       | (2,850                                                  | )          | (3,331 | ) |
| Capital expenditures for real estate under  development                                |       | (6,990                                                  | )          | (9,874 | ) |
| Capital expenditures for real estate under  development of consolidated borrowers      |       | —                                                  |       | (583 | ) |
| Additions of property and equipment                                                    |       | (3,727                                                  | )          | (7,139 | ) |
| Change in restricted cash                                                              |       | 1,811                                                   |       | (2,735 | ) |
| Cash assumed from conversion of mezzanine loan to  equity                              |       | 407                                                     |       | — |   |
| Investment in notes receivable                                                         |       | (3,841                                                  | )          | (6,495 | ) |
| Proceeds from payments on note receivables                                             |       | 600                                                     |       | — |   |
| Cash used in investing activities                                                      |       | (11,820                                                 | )          | (30,157 | ) |
|                                                                                   |       |                                                    |       |   |   |
| **Cash flows from financing  activities:**                                             |       |                                                    |       |   |   |
| Financing costs                                                                        |       | (866                                                    | )          | (480 | ) |
| Proceeds from notes payable                                                            |       | 7,151                                                   |       | 18,823 |   |
| Proceeds from mortgages of consolidated borrowers                                      |       | —                                                  |       | 1,700 |   |
| Deposits received under sales contracts                                                |       | 6,025                                                   |       | — |   |
| Net borrowings on senior secured revolving credit  facility                            |       | 7,482                                                   |       | 15,400 |   |
| Payments on notes payable                                                              |       | (26,624                                                 | )          | (12,226 | ) |
| Redemptions of common stock                                                            |       | (840                                                    | )          | (992 | ) |
| Distributions                                                                          |       | (2,250                                                  | )          | (2,611 | ) |
| Contributions from noncontrolling interest holders                                     |       | 78                                                      |       | 2,525 |   |
| Distributions to noncontrolling interest holders                                       |       | (43                                                     | )          | (254 | ) |
| Cash provided by (used in) financing activities                                        |       | (9,887                                                  | )          | 21,885 |   |
|                                                                                   |       |                                                    |       |   |   |
| Effect of exchange rate changes on cash and cash  equivalents                          |       | 1,618                                                   |       | (1,354 | ) |
|                                                                                   |       |                                                    |       |   |   |
| Net change in cash and cash equivalents                                                |       | (4,969                                                  | )          | (6,119 | ) |
| Cash and cash equivalents at beginning of the  period                                  |       | 9,511                                                   |       | 25,260 |   |
|                                                                                   |       |                                                    |       |   |   |
| Decrease in cash from deconsolidation due to  adoption of accounting standard          |       | (1,011                                                  | )          | — |   |
|                                                                                   |       |                                                    |       |   |   |
| Cash and cash equivalents at end of the period                                         |       | $                                                       | 3,531      |   | $ | 19,141 |   |

 

*See Notes to Consolidated Financial Statements.*

 

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Table ofContents

 

**BehringerHarvard Opportunity REIT I, Inc.**

**Notes to Consolidated Financial Statements**

**(Unaudited)**

 

**1.         Business**

 

***Organization***

 

BehringerHarvard Opportunity REIT I, Inc. (which may be referred to as the “Company,”“we,” “us,” or “our”) was incorporated in November 2004 as a Marylandcorporation and has elected to be taxed, and currently qualifies, as a realestate investment trust (“REIT”) for federal income tax purposes.

 

Weoperate commercial real estate or real estate-related assets located in andoutside the United States on an opportunistic basis.  In particular, we have focused on acquiringproperties with significant possibilities for short-term capital appreciation,such as those requiring development, redevelopment, or repositioning, or thoselocated in markets and submarkets with higher volatility, lower barriers toentry, and high growth potential.  Wehave acquired a wide variety of properties, including office, industrial,retail, hospitality, recreation and leisure, multifamily, and otherproperties.  We have purchased existingand newly constructed properties and properties under development orconstruction, including multifamily properties. We have also originated two mezzanine loans related to two multifamilyproperties.  We completed our firstproperty acquisition in March 2006, and, as of September 30, 2010, wewholly owned ten properties and consolidated six properties through investmentsin joint ventures.  In addition, we arethe mezzanine lender for one multifamily property.  We also have noncontrolling, unconsolidatedownership interests in four properties and one investment in a joint ventureconsisting of 22 properties that are accounted for using the equity method.

 

Substantially all of ourbusiness is conducted through Behringer Harvard Opportunity OP I, LP, a Texaslimited partnership organized in November 2004 (“Behringer Harvard OP I”),or subsidiaries thereof.  Our whollyowned subsidiary, BHO, Inc., a Delaware corporation, owns less than a 0.1%interest in Behringer Harvard OP I as its sole general partner.  The remaining interest of Behringer HarvardOP I is held as a limited partnership interest by BHO Business Trust, aMaryland business trust, which is our wholly owned subsidiary.

 

We are externally managed and advised by Behringer Harvard OpportunityAdvisors I, LLC (“Behringer Opportunity Advisors I”), a Texas limited liabilitycompany formed in June 2007. Behringer Opportunity Advisors I is responsible for managing ourday-to-day affairs and for identifying and making acquisitions and investmentson our behalf.

 

Our office is located at 15601 Dallas Parkway, Suite 600, Addison,Texas 75001, and our toll-free telephone number is (866) 655-3600.  The name Behringer Harvard is the property ofBehringer Harvard Holdings, LLC (“Behringer Harvard Holdings”) and is used bypermission.

 

**2.         Interim Unaudited Financial Information**

 

The accompanyingconsolidated financial statements should be read in conjunction with theconsolidated financial statements and notes thereto included in our AnnualReport on Form 10-K for the year ended December 31, 2009, which wasfiled with the Securities and Exchange Commission (“SEC”) on March 19,2010.  Certain information and footnotedisclosures normally included in financial statements prepared in accordancewith accounting principles generally accepted in the United States of America (“GAAP”)have been condensed or omitted in this report on Form 10-Q pursuant to therules and regulations of the SEC.

 

The results for the interimperiods shown in this report are not necessarily indicative of future financialresults.  The accompanying consolidatedbalance sheet and consolidated statement of equity as of September 30,2010, the consolidated statements of operations and comprehensive loss for thethree and nine months ended September 30, 2010 and 2009, and theconsolidated statements of cash flows and equity for the nine months ended September 30,2010 and 2009 have not been audited by our independent registered publicaccounting firm.  In the opinion ofmanagement, the accompanying unaudited consolidated financial statementsinclude all adjustments necessary to fairly present our consolidated financialposition as of September 30, 2010 and our consolidated results ofoperations, equity, and cash flows for the periods ended September 30,2010 and 2009.  Such adjustments are of anormal recurring nature.

 

**3.         Summary of Significant Accounting Policies**

 

***Use of Estimates in thePreparation of Financial Statements***

 

Thepreparation of financial statements in conformity with GAAP requires managementto make estimates and assumptions that affect the reported amounts of assetsand liabilities and disclosure of contingent assets and liabilities at the dateof the financial statements and the reported amounts of revenues and expensesduring the reporting period.  Theseestimates include such items as purchase price allocation for real estateacquisitions, impairment of long-lived assets, 

 

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Table ofContents

 

**BehringerHarvard Opportunity REIT I, Inc.**

**Notes toConsolidated Financial Statements**

**(Unaudited)**

 

depreciationand amortization, allowance for doubtful accounts, and allowance for loanlosses.  Actual results could differ fromthose estimates.

 

***Principles of Consolidation and Basis ofPresentation***

 

Ourconsolidated financial statements include our accounts and the accounts ofother subsidiaries over which we have control. All inter-company transactions, balances, and profits have beeneliminated in consolidation.  Interestsin entities acquired will be evaluated based on applicable GAAP, which includesthe requirement to consolidate entities deemed to be variable interest entities(“VIE”) in which we are the primary beneficiary.  If the interest in the entity is determinednot to be a VIE, then the entities will be evaluated for consolidation based onlegal form, economic substance, and the extent to which we have control and/orsubstantive participating rights under the respective ownership agreement.   In the Notes to Consolidated FinancialStatements, except for per share amounts, all dollar and share amounts intabulation are in thousands of dollars and shares, respectively, unlessotherwise noted.

 

Thereare judgments and estimates involved in determining if an entity in which wehave made an investment is a VIE and, if so, whether we are the primarybeneficiary.  The entity is evaluated todetermine if it is a VIE by, among other things, calculating the percentage ofequity being risked compared to the total equity of the entity.  Determining expected future losses involvesassumptions of various possibilities of the results of future operations of theentity, assigning a probability to each possibility and using a discount rateto determine the net present value of those future losses.  A change in the judgments, assumptions, andestimates outlined above could result in consolidating an entity that shouldnot be consolidated or accounting for an investment using the equity methodthat should in fact be consolidated, the effects of which could be material toour financial statements.

 

To conform to the currentyear presentation, which presents advertising expense as a component ofproperty operating expense on our consolidated statements of operations andcomprehensive income, we reclassified from advertising expense to propertyoperating expense $0.2 million and $0.6 million for the three and nine monthsended September 30, 2009, respectively.

 

Wehave evaluated subsequent events for recognition or disclosure in ourconsolidated financial statements.

 

***Real Estate***

 

Upon the acquisition of real estate properties, we recognize the assetsacquired, the liabilities assumed, and any noncontrolling interest as of theacquisition date, measured at their fair values.  The acquisition date is the date on which weobtain control of the real estate property. These assets acquired and liabilities assumed may consist of buildings,any assumed debt, identified intangible assets and asset retirementobligations.  Identified intangibleassets generally consist of the above-market and below-market leases, in-placeleases, in-place tenant improvements and tenant relationships.  Goodwill is recognized as of the acquisitiondate and measured as the aggregate fair value of the consideration transferredand any noncontrolling interests in the acquiree over the fair value ofidentifiable net assets acquired. Likewise, a bargain purchase gain is recognized in current earnings whenthe aggregate fair value of the consideration transferred and anynoncontrolling interests in the acquiree is less than the fair value of theidentifiable net assets acquired. Acquisition-related costs are expensed in the period incurred.

 

Initialvaluations are subject to change until our information is finalized, which isno later than twelve months from the acquisition date.

 

Wedetermine the fair value of assumed debt by calculating the net present valueof the scheduled mortgage payments using interest rates for debt with similarterms and remaining maturities that management believes we could obtain.  Any difference between the fair value andstated value of the assumed debt is recorded as a discount or premium andamortized over the remaining life of the loan.

 

Thefair value of any tangible assets acquired, consisting of land, landimprovements, buildings, building improvements, tenant improvements, andfurniture, fixtures and equipment, is determined by valuing the property as ifit were vacant, and the “as-if-vacant” value is then allocated to the tangibleassets.  Land values are derived fromappraisals and building values are calculated as replacement cost lessdepreciation or management’s estimates of the relative fair value of theseassets using discounted cash flow analyses or similar methods.  Furniture, fixtures, and equipment values aredetermined based on current reproduction or replacement cost less depreciationand other estimated allowances based on physical, functional, or economicfactors.  The values of the buildings aredepreciated over their respective estimated useful lives ranging from 25 yearsfor commercial office property to 39 years for hotel/mixed-use property usingthe straight-line method.  Buildingimprovements are depreciated over their estimated useful lives ranging from 7to 25 years.  Tenant improvements aredepreciated over the term of the respective leases.  Land improvements are depreciated over the 

 

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**BehringerHarvard Opportunity REIT I, Inc.**

**Notes toConsolidated Financial Statements**

**(Unaudited)**

 

estimateduseful life of 15 years, and furniture, fixtures, and equipment are depreciatedover estimated useful lives ranging from five to seven years using thestraight-line method.  Our leasehold interestis depreciated over its remaining contractual life, or approximately 99 years.

 

Wedetermine the value of above-market and below-market in-place leases foracquired properties based on the present value (using an interest rate thatreflects the risks associated with the leases acquired) of the differencebetween (1) the contractual amounts to be paid pursuant to the in-placeleases and (2) management’s estimate of current market lease rates for thecorresponding in-place leases, measured over a period equal to (a) theremaining non-cancelable lease term for above-market leases, or (b) theremaining non-cancelable lease term plus any fixed rate renewal options forbelow-market leases.  We record the fairvalue of above-market and below-market leases as intangible assets orintangible liabilities, respectively, and amortize them as an adjustment torental income over the determined lease term.

 

Thetotal value of identified real estate intangible assets for acquired propertiesis further allocated to in-place lease values and tenant relationships based onour evaluation of the specific characteristics of each tenant’s lease and ouroverall relationship with that respective tenant.  The aggregate value of in-place leasesacquired and tenant relationships is determined by applying a fair valuemodel.  The estimates of fair value ofin-place leases include an estimate of carrying costs during the expectedlease-up periods for the respective spaces considering current marketconditions.  In estimating fair value ofin-place leases, we consider items such as real estate taxes, insurance andother operating expenses as well as lost rental revenue during the expectedlease-up period and carrying costs that would have otherwise been incurred hadthe leases not been in place, including tenant improvements andcommissions.  The estimates of the fairvalue of tenant relationships also include costs to execute similar leasesincluding leasing commissions, legal costs, and tenant improvements as well asan estimate of the likelihood of renewal as determined by management on atenant-by-tenant basis.

 

Weamortize the value of in-place leases acquired in the future to expense overthe term of the respective leases.  Thevalue of tenant relationship intangibles is amortized to expense over theinitial term and any anticipated renewal periods, but in no event does theamortization period for intangible assets exceed the remaining depreciable lifeof the building.  Should a tenantterminate its lease, the unamortized portion of the in-place lease value andtenant relationship intangibles would be charged to expense.  As of September 30, 2010, the estimatedremaining useful lives for acquired lease intangibles range from less than oneyear to approximately ten years.

 

Otherintangible assets include the value of identified hotel trade names andin-place property tax abatements.  Thesefair values are based on management’s estimates of the relative fair value ofthese assets using discounted cash flow analyses or similar methods.  The value of the trade names is amortizedover its respective estimated useful life of 20 years using the straight-linemethod and the value of the in-place property tax abatement is amortized overits estimated term of ten years using the straight-line method.

 

Anticipatedamortization expense associated with the acquired lease intangibles andacquired other intangible assets for each of the following five years as of September 30,2010 is as follows:

 
| ** **                                     | ** ** | **Lease / Other  Intangibles** | ** ** |
|------------------------------------------------|------------|------------------------------------------|------------|
| October 1, 2010 -  December 31, 2010 |       | $                                        | 313        |   |
| 2011                                           |       | 1,117                                    |       |
| 2012                                           |       | 848                                      |       |
| 2013                                           |       | 679                                      |       |
| 2014                                           |       | 705                                      |       |
|                                                |            |                                          |            |  |

 

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**BehringerHarvard Opportunity REIT I, Inc.**

**Notes toConsolidated Financial Statements**

**(Unaudited)**

 

Accumulateddepreciation and amortization related to our consolidated investments in realestate assets and intangibles were as follows:

 
| ** **                                       | ** ** | ** **             | ** ** | ** **        | ** ** | ** **      | ** ** | **Acquired**     | ** ** | ** **    | ** ** | ** **      | ** ** |
|--------------------------------------------------|------------|------------------------|------------|-------------------|------------|-----------------|------------|------------------|------------|---------------|------------|-----------------|------------|
| ** **                                       | ** ** | **Buildings and** | ** ** | **Land and** | ** ** | **Lease**       | ** ** | **Below-Market** | ** ** | **Leasehold** | ** ** | **Other**       | ** ** |
| **As of September 30, 2010** | ** ** | **Improvements**       | ** ** | **Improvements**  | ** ** | **Intangibles** | ** ** | **Leases**       | ** ** | **Interest**  | ** ** | **Intangibles** | ** ** |
| Cost                                             |       | $                      | 375,407    |              | $          | 84,688          |       | $                | 32,698     |          | $          | (20,648         | )          | $ | 16,861 |   | $ | 10,439 |   |
| Less: depreciation and amortization              |       | (40,161                | )          | (478              | )          | (14,419         | )          | 10,227           |       | (694          | )          | (2,599          | )          |
|                                             |       |                   |       |              |       |            |       |             |       |          |       |            |       |
| Net                                              |       | $                      | 335,246    |              | $          | 84,210          |       | $                | 18,279     |          | $          | (10,421         | )          | $ | 16,167 |   | $ | 7,840 |   |

 
| ** **                                      | ** ** | ** **             | ** ** | ** **        | ** ** | ** **      | ** ** | **Acquired**     | ** ** | ** **    | ** ** | ** **      | ** ** |
|-------------------------------------------------|------------|------------------------|------------|-------------------|------------|-----------------|------------|------------------|------------|---------------|------------|-----------------|------------|
| ** **                                      | ** ** | **Buildings and** | ** ** | **Land and** | ** ** | **Lease**       | ** ** | **Below-Market** | ** ** | **Leasehold** | ** ** | **Other**       | ** ** |
| **As of December 31, 2009** | ** ** | **Improvements**       | ** ** | **Improvements**  | ** ** | **Intangibles** | ** ** | **Leases**       | ** ** | **Interest**  | ** ** | **Intangibles** | ** ** |
| Cost                                            |       | $                      | 448,121    |              | $          | 130,786         |       | $                | 34,151     |          | $          | (21,392         | )          | $ | 16,981 |   | $ | 10,439 |   |
| Less: depreciation and amortization             |       | (39,335                | )          | (532              | )          | (12,923         | )          | 8,666            |       | (575          | )          | (2,091          | )          |
|                                            |       |                   |       |              |       |            |       |             |       |          |       |            |       |
| Net                                             |       | $                      | 408,786    |              | $          | 130,254         |       | $                | 21,228     |          | $          | (12,726         | )          | $ | 16,406 |   | $ | 8,348 |   |

 

***Condominium Inventory***

 

Condominiuminventory is stated at the lower of cost or fair market value.  In addition to land acquisition costs, landdevelopment costs, and construction costs, costs include interest and real estatetaxes, which are capitalized during the period beginning with the commencementof development and ending with the completion of construction.  At September 30, 2010, condominiuminventory consisted of $29.8 million of finished units and $31.8 million ofwork in progress.  As of December 31,2009, condominium inventory consisted of $31.5 million of finished units and$55 million of work in progress.

 

Forcondominium inventory, at each reporting date, management compares theestimated fair value less costs to sell to the carrying value.  An adjustment is recorded to the extent thatthe fair value less costs to sell is less than the carrying value.  We determine the estimated fair value ofcondominiums based on comparable sales in the normal course of business underexisting and anticipated market conditions. This evaluation takes into consideration estimated future sellingprices, costs incurred to date, estimated additional future costs, andmanagement’s plans for the property.

 

Thenationwide downturn in the housing and related condominium market that beganduring 2007 and has continued through 2010 has resulted in lower than expectedsales volume and reduced selling prices, among other effects.  As a result of our evaluations, we recognizeda non-cash charge of $4.8 million during the nine months endedSeptember 30, 2010 to reduce the carrying value of condominiums at ThePrivate Residences — Chase Park Plaza, which is classified as an impairmentcharge in the accompanying consolidated statement of operations.  There were no impairment charges related toour condominium inventory for the nine months ended September 30,2009.  In the event that marketconditions continue to decline in the future or the current difficult marketconditions extend beyond our expectations, additional adjustments may benecessary in the future.

 

***Cash and Cash Equivalents***

 

Weconsider investments in highly-liquid money market funds or investments withoriginal maturities of three months or less to be cash equivalents.

 

***Restricted Cash***

 

Asrequired by our lenders, restricted cash is held in escrow accounts for realestate taxes and other reserves for our consolidated properties.

 

***Accounts Receivable***

 

Accountsreceivable primarily consist of straight-line rental revenue receivables of$6.8 million and $5.6 million as of September 30, 2010 and December 31,2009, respectively, and receivables from our hotel operators and tenantsrelated to our other consolidated properties of $3.1 million and $2.9 millionas of September 30, 2010 and December 31, 2009, respectively.  The allowance for doubtful accounts was $0.6million and $0.3 million as of September 30, 2010 and December 31,2009, respectively.

 

***Prepaid Expenses and Other Assets***

 

Prepaidexpenses and other assets include prepaid directors’ and officers’ insurance,prepaid advertising, the fair value of certain derivative instruments, as wellas inventory, prepaid insurance, and real estate taxes of our consolidated

 

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**BehringerHarvard Opportunity REIT I, Inc.**

**Notes toConsolidated Financial Statements**

**(Unaudited)**

 

properties.  Inventory consists of food, beverages,linens, glassware, china, and silverware and is carried at the lower of cost ormarket value.

 

***Furniture, Fixtures, and Equipment***

 

Furniture,fixtures, and equipment are recorded at cost and are depreciated using thestraight-line method over their estimated useful lives of five to sevenyears.  Maintenance and repairs arecharged to operations as incurred while renewals or improvements to such assetsare capitalized.  Accumulated depreciationassociated with our furniture, fixtures, and equipment was $7.3 million and$6.1 million as of September 30, 2010 and December 31, 2009,respectively.

 

***Investment Impairment***

 

Forreal estate we consolidate, we monitor events and changes in circumstancesindicating that the carrying amounts of the real estate assets may not be recoverable.  When such events or changes in circumstancesare present, we assess potential impairment by comparing estimated futureundiscounted operating cash flows expected to be generated over the life of theasset and from its eventual disposition to the carrying amount of theasset.  In the event that the carryingamount exceeds the estimated future undiscounted operating cash flows, werecognize an impairment loss to adjust the carrying amount of the asset to estimatedfair value.  We consider projected futureundiscounted cash flows, trends, strategic decisions regarding futuredevelopment plans, and other factors in our assessment of whether impairmentconditions exist.  While we believe ourestimates of future cash flows are reasonable, different assumptions regardingfactors such as market rents, economic conditions, and occupancy rates couldsignificantly affect these estimates.

 

Duringthe third quarter of 2010, we evaluated certain real estate properties forimpairment as a result of changes in expected holding periods.   Accordingly, we recognized an impairmentcharge of $1.8 million related to our Regency Center property for the ninemonths ended September 30, 2010.  Asa result of general weakness in market rental rates and vacancies at our Crossroadsproperty, we recognized an $8.1 million impairment charge for the nine monthsended September 30, 2010.

 

Duringthe first quarter of 2010, we evaluated Ferncroft Corporate Center forimpairment, and, accordingly, recognized a $4.2 million impairment charge forthe three months ended March 31, 2010, which is included in loss fromdiscontinued operations on the accompanying statement of operations and othercomprehensive loss for the nine months ended September 30, 2010.  On August 17, 2010, pursuant to adeed-in-lieu of foreclosure, we transferred ownership of Ferncroft CorporateCenter to the lender associated with the property and, accordingly, recognizeda loss on the extinguishment of debt of $2.3 million, which is included in theloss from discontinued operations in the accompanying consolidated statement ofoperations and other comprehensive loss for the three and nine months ended September 30,2010.  See Note 18.

 

Wealso evaluate our investments in unconsolidated joint ventures at eachreporting date.  If we believe there isan other than temporary decline in market value, we will record an impairmentcharge based on these evaluations.  Weassess potential impairment by comparing our portion of estimated futureundiscounted operating cash flows expected to be generated by the joint ventureover the life of the joint venture’s assets to the carrying amount of the jointventure.  In the event that the carryingamount exceeds our portion of estimated future undiscounted operating cashflows, we recognize an impairment loss to adjust the carrying amount of thejoint venture to its estimated fair value.

 

Dueto uncertainties surrounding the timing of development activities at RoyalIsland, we recognized an impairment charge related to our unconsolidated 30.38%investment in Royal Island totaling $6.3 million for the three and nine monthsended September 30, 2010.

 

Wealso evaluate our investments in notes receivable as of each reportingdate.  If we believe that it is probablewe will not collect all principal and interest in accordance with the terms ofthe loans, we consider the loan impaired. When evaluating loans for potential impairment, we compare the carryingamount of the loans to the present value of future cash flows discounted at theloan’s effective interest rate, or, if a loan is collateral dependent, to theestimated fair value of the related collateral net of any senior loans.  For impaired loans, a provision is made forloan losses to adjust the reserve for loan losses.  The reserve for loan losses is a valuationallowance that reflects our current estimate of loan losses as of the balancesheet date.  The reserve is adjustedthrough the provision for loan losses account on our consolidated statement ofoperations.

 

Inthe first quarter of 2010, we recorded a reserve for loan losses totaling $11.1million related to our mezzanine loan associated with Alexan Black Mountain,including $7.1 million recognized as a provision to loan losses on ourconsolidated statement of operations and other comprehensive loss for the ninemonths ended September 30, 2010, and the 

 

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**BehringerHarvard Opportunity REIT I, Inc.**

**Notes toConsolidated Financial Statements**

**(Unaudited)**

 

remaining$4 million as a cumulative effect adjustment to the opening balance ofaccumulated distributions and net loss in our consolidated statement of equityfor the nine months ended September 30, 2010.

 

Inevaluating our investments for impairment, management may use appraisals andmake estimates and assumptions, including, but not limited to, the projecteddate of disposition of the properties, the estimated future cash flows of theproperties during our ownership, and the projected sales price of each of theproperties.  A change in these estimatesand assumptions could result in understating or overstating the book value ofour investments, which could be material to our financial statements.  The value of our properties held fordevelopment depends on market conditions, including estimates of the projectstart date as well as estimates of future demand for the property type underdevelopment.  We have analyzed trends andother information related to each potential development and incorporated thisinformation as well as our current outlook into the assumptions we use in ourimpairment analyses.  Due to the judgmentand assumptions applied in the estimation process with respect to impairments,including the fact that limited market information regarding the value ofcomparable land exists at this time, it is possible actual results could differsubstantially from those estimated.

 

Otherthan the impairment charges discussed above, we believe the carrying value ofour operating real estate assets, properties under development, investments inunconsolidated joint ventures, and notes receivable is currentlyrecoverable.  However, if marketconditions worsen beyond our current expectations, or if our assumptionsregarding expected future cash flows from the use and eventual disposition ofour assets decrease or our expected hold periods decrease, or if changes in ourdevelopment strategy significantly affect any key assumptions used in our fairvalue calculations, we may need to take additional charges in future periodsfor impairments related to existing assets. Any such non-cash charges would have an adverse effect on ourconsolidated financial position and results of operations.

 

***Deferred Financing Fees***

 

Deferredfinancing fees are recorded at cost and are amortized to interest income fornotes receivable and interest expense for notes payable using a straight-linemethod that approximates the effective interest method over the life of the relateddebt.  Accumulated amortization ofdeferred financing fees was $7.7 million and $7.4 million as of September 30,2010 and December 31, 2009, respectively.

 

***Derivative Financial Instruments***

 

Ourobjective in using derivatives is to add stability to interest expense and tomanage our exposure to interest rate movements or other identified risks and tominimize the variability caused by foreign currency translation risk related toour net investment in foreign real estate. To accomplish these objectives, we use various types of derivativeinstruments to manage fluctuations in cash flows resulting from interest raterisk attributable to changes in the benchmark interest rate of LIBOR.  These instruments include LIBOR-basedinterest rate swaps and caps.  For ournet investments in foreign real estate, we may use foreign exchange put/calloptions to eliminate the impact of foreign currency exchange movements on ourfinancial position.

 

Wemeasure our derivative instruments and hedging activities at fair value andrecord them as an asset or liability, depending on our rights or obligationsunder the applicable derivative contract. For derivatives designated as fair value hedges, the changes in the fairvalue of both the derivative instrument and the hedged items are recorded inearnings.  Derivatives used to hedge theexposure to variability in expected future cash flows, or other types offorecasted transactions, are considered cash flow hedges.  For derivatives designated as cash flowhedges, the effective portions of changes in fair value of the derivatives arereported in other comprehensive income (loss) and are subsequently reclassifiedinto earnings when the hedged item affects earnings.  For derivatives designated as net investmenthedges, changes in fair value are reported in other comprehensive income (loss)as part of the foreign currency translation gain or loss.  Changes in fair value of derivativeinstruments not designated as hedges and ineffective portions of hedges arerecognized in earnings in the affected period. We assess the effectiveness of each hedging relationship by comparingthe changes in fair value or cash flows of the derivative hedging instrumentwith the changes in fair value or cash flows of the designated hedged item ortransaction.

 

As of September 30, 2010, we do not have any derivativesdesignated as fair value hedges, nor are derivatives being used for trading orspeculative purposes.  See Notes 5 and 13for further information regarding our derivative financial instruments.

 

***Foreign Currency Translation***

 

Forour international investments where the functional currency is other than theUS dollar, assets and liabilities are translated using period-end exchangerates, while the statement of operations amounts are translated using theaverage exchange rates for the respective period.  Differences arising from the translation ofassets and liabilities in comparison with 

 

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**BehringerHarvard Opportunity REIT I, Inc.**

**Notes toConsolidated Financial Statements**

**(Unaudited)**

 

thetranslation of the previous periods or from initial recognition during theperiod are included as a separate component of accumulated other comprehensiveincome (loss).

 

The British pound is the functional currency for ourBecket House investment operating in London, England and the Euro is thefunctional currency for the operations of our Central Europe JointVenture.  We also maintain Euro-denominated bankaccounts that are translated into U.S. dollars at the current exchange rate ateach reporting period.  Theresulting translation adjustments are recorded as a separate component ofaccumulated other comprehensive income (loss) in our consolidated statements ofequity.  The foreign currency translationadjustment was a loss of $1.2 million and a gain of $0.9 million for the ninemonths ended September 30, 2010 and 2009, respectively.

 

***Accumulated Other Comprehensive Income (Loss)***

 

Accumulated othercomprehensive income (loss) (“AOCI”), which is reported in the accompanyingconsolidated statement of equity, consists of gains and losses affecting equitythat are excluded from net income (loss) under GAAP.  The components of AOCI consist of foreigncurrency translation gains and losses and unrealized gains and losses onderivatives designated as hedges.

 

***Revenue Recognition***

 

Werecognize rental income generated from leases on real estate assets on astraight-line basis over the terms of the respective leases, including theeffect of rent holidays, if any. Straight-line rental revenue of $2 million and $1.6 million wasrecognized in rental revenues for the nine months ended September 30, 2010and 2009, respectively.  Hotel revenue isderived from the operations of The Lodge & Spa at Cordillera andconsists of guest room, food and beverage, and other revenue, and is recognizedas the services are rendered.

 

Revenuesfrom the sales of condominiums are recognized when sales are closed and titlepasses to the new owner, the new owner’s initial and continuing investment isadequate to demonstrate a commitment to pay for the condominium, the new owner’sreceivable is not subject to future subordination, and we do not have asubstantial continuing involvement with the new condominium.  Amounts received prior to closing on sales ofcondominiums are recorded as deposits in our financial statements.

 

Werecognize interest income from notes receivable on an accrual basis over thelife of the loan using the interest method. Direct loan origination fees and origination or acquisition costs, aswell as acquisition premiums or discounts, are amortized over the life of theloan as an adjustment to interest income. We will stop accruing interest on loans when there is concern as to theultimate collection of principal or interest of the loan.  In the event that we stop accruing intereston a loan, we will generally not recognize subsequent interest income untilcash is received or we make the decision to restart interest accrual on theloan.

 

***Income Taxes***

 

Weelected to be taxed, and qualified, as a REIT under Sections 856 through 860 ofthe Internal Revenue Code of 1986, as amended (the “Code”), beginning with theyear ended December 31, 2006.  Weare organized and operate in such a manner as to qualify for taxation as a REITunder the Code, and we intend to continue to operate in such a manner, but noassurance can be given that we will operate in a manner so as to qualify orremain qualified as a REIT.  To qualifyas a REIT, we must meet a number of organizational and operationalrequirements, including a requirement that we distribute at least 90% of ourREIT taxable income to our stockholders. As a REIT, we generally will not be subject to federal income tax at thecorporate level except for the operations of our wholly-owned taxable REITsubsidiaries.  We have three taxable REITsubsidiaries that own and/or provide management and development services to certainof our investments in real estate and real estate under development.

 

Wehave reviewed our tax positions under GAAP guidance that clarifies the relevantcriteria and approach for the recognition and measurement of uncertain taxpositions.  The guidance prescribes arecognition threshold and measurement attribute for the financial statementrecognition of a tax position taken, or expected to be taken, in a taxreturn.  A tax position may only berecognized in the financial statements if it is more likely than not that thetax position will be sustained upon examination.  We believe it is more likely than not thatthe tax positions taken relative to our status as a REIT will be sustained inany tax examination.  In addition, webelieve that it is more likely than not that the tax positions taken relativeto the taxable REIT subsidiaries will be sustained in any tax examination.

 

OnMay 18, 2006, the State of Texas enacted a law which replaced the existingstate franchise tax with a “margin tax” effective January 1, 2007.  For both of the nine months ended September 30,2010 and 2009, we recognized a current and deferred tax provision related tothe Texas margin tax of approximately $0.2 million.

 

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**BehringerHarvard Opportunity REIT I, Inc.**

**Notes toConsolidated Financial Statements**

**(Unaudited)**

 

***Stock-Based Compensation***

 

Wehave a stock-based incentive award plan for our directors and consultants andfor employees, directors, and consultants of our affiliates.  Awards are granted at the fair market valueon the date of grant with fair value estimated using the Black-Scholes-Mertonoption valuation model, which incorporates assumptions surrounding volatility,dividend yield, the risk-free interest rate, expected life, and the exerciseprice as compared to the underlying stock price on the grant date.  The tax benefits associated with theseshare-based payments are classified as financing activities in the consolidatedstatement of cash flows.  For the ninemonths ended September 30, 2010 and 2009, we had no significantcompensation cost related to our incentive award plan.

 

***Concentration of Credit Risk***

 

AtSeptember 30, 2010 and December 31, 2009, we had cash and cashequivalents deposited in certain financial institutions in excess of federallyinsured levels.  We have diversified ourcash and cash equivalents between several banking institutions in an attempt tominimize exposure to any one of these entities. We regularly monitor the financial stability of these financialinstitutions and believe that we are not exposed to any significant credit riskin cash and cash equivalents or restricted cash.

 

***Noncontrolling Interest***

 

Noncontrollinginterest represents the noncontrolling ownership interest’s proportionate shareof the equity in our consolidated real estate investments, including the lessthan 1%, 5%, 6%, 9%, and 20% unaffiliated partners’ share of the equity in RioSalado Business Center, Chase Park Plaza, The Lodge & Spa atCordillera, Frisco Square, and Becket House, respectively.  Income and losses are allocated tononcontrolling interest holders based on their ownership percentage.

 

***Reportable Segments***

 

Wehave determined that we have one reportable segment, with activities related tothe ownership, development and management of real estate assets.  Our income producing properties generated100% of our consolidated revenues for the nine months ended September 30,2010 and 2009.  Our chief operating decisionmaker evaluates operating performance on an individual property level.  Therefore, our properties are aggregated intoone reportable segment.

 

***Earnings per Share***

 

Earnings(loss) per share is calculated based on the weighted average number of sharesoutstanding during each period.  As ofeach period ended September 30, 2010 and 2009, we had options to purchase69,583 shares of common stock outstanding at a weighted average exercise priceof $8.99.  These options are excludedfrom the calculation of earnings per share for the nine months ended September 30,2010 and 2009 because the effect would be anti-dilutive.

 

***Inflation***

 

Thereal estate market has not been affected significantly by inflation in the pastseveral years due to the relatively low inflation rate.  However, we include provisions in themajority of our tenant leases that would protect us from the impact ofinflation.  These provisions includereimbursement billings for common area maintenance charges, real estate tax andinsurance reimbursements on a per square foot basis, or in some cases, annualreimbursement of operating expenses above a certain per square foot allowance.

 

**4.         NewAccounting Pronouncements**

 

InJanuary 2010, the FASB updated the disclosure requirements for fair valuemeasurements.  The updated guidancerequires companies to disclose separately the investments that transfer in andout of Levels 1 and 2 and the reasons for those transfers.  Additionally, in the reconciliation for fairvalue measurements using significant observable inputs (Level 3), companiesshould present separately information about purchases, sales, issuances andsettlements.  We adopted the guidance on January 1,2010, except for the disclosures about purchases, sales, issuances andsettlements n the Level 3 reconciliation, which are effective for fiscal yearsbeginning after December 15, 2010. We will adopt the remaining guidance on January 1, 2011.  The adoption of the required guidance did nothave a material impact on our financial statements or disclosures.  We do not expect that the adoption of theremaining guidance will have an impact on our financial statements ordisclosures.

 

InJuly 2010, the FASB updated accounting guidance related to receivableswhich requires additional disclosures about the credit quality of a company’sfinancing receivables and allowances for credit losses.  These disclosures will provide financialstatement users with additional information about the nature of credit risksinherent in our financing receivables, how we analyze and assess credit risk indetermining our allowance for credit losses, and the reasons for any

 

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**Behringer HarvardOpportunity REIT I, Inc.**

**Notes toConsolidated Financial Statements**

**(Unaudited)**

 

changeswe may make in our allowance for credit losses. This update is generallyeffective for interim and annual reporting periods ending on or after December 15,2010; however, certain aspects of the update pertaining to activity that occursduring a reporting period are effective for interim and annual reportingperiods beginning on or after December 15, 2010.  We expect that the adoption of this updatewill primarily result in increased notes receivable disclosures, but will nothave any other impact on our financial statements.

 

**5.         Assets andLiabilities Measured at Fair Value**

 

Fairvalue measurements are determined based on the assumptions that marketparticipants would use in pricing the asset or liability.  As a basis for considering market participantassumptions in fair value measurements, a fair value hierarchy thatdistinguishes between market participant assumptions based on market dataobtained from sources independent of the reporting entity (observable inputsthat are classified within Levels 1 and 2 of the hierarchy) and the reportingentity’s own assumptions about market participant assumptions (unobservableinputs classified within Level 3 of the hierarchy) has been established.

 

Level1 inputs utilize quoted prices (unadjusted) in active markets for identicalassets and liabilities that we have the ability to access.  Level 2 inputs are inputs other than quotedprices included in Level 1 that are observable for the asset or liability,either directly or indirectly.  Level 2inputs may include quoted prices for similar assets and liabilities in activemarkets, as well as inputs that are observable for the asset or liability(other than quoted prices), such as interest rates, foreign exchange rates, andyield curves that are observable at commonly quoted intervals.  Level 3 inputs are unobservable inputs forthe asset or liability that are typically based on an entity’s own assumptions,as there is little, if any, related market activity.  In instances where the determination of thefair value measurement is based on inputs from different levels of the fairvalue hierarchy, the level in the fair value hierarchy within which the fairvalue measurement falls is based on the lowest level input that is significantto the fair value measurement in its entirety. Our assessment of the significance of a particular input to the fairvalue measurement in its entirety requires judgment, and considers factorsspecific to the asset or liability.

 

***Recurring Fair Value Measurements***

 

*Derivative financial instruments*

 

Currently,we use interest rate swaps and caps to manage our interest rate risk andforeign exchange put/call options to manage the impact of foreign currency movementson our financial position for our net investments in foreign real estate jointventures.  The valuation of theseinstruments is determined using widely accepted valuation techniques includingdiscounted cash flow analysis on the expected cash flows of eachderivative.  This analysis reflects thecontractual terms of the derivatives, including the period to maturity, anduses observable market-based inputs, including interest rate curves, impliedvolatilities, and foreign currency exchange rates.

 

Weincorporate credit valuation adjustments to appropriately reflect both our ownnonperformance risk and the respective counterparty’s performance risk in thefair value measurements.  Although wehave determined that the majority of the inputs used to value our derivativesfall within Level 2 of the fair value hierarchy, the credit valuationadjustments associated with our derivatives utilize Level 3 inputs, such asestimates of current credit spreads, to evaluate the likelihood of default byitself and its counterparties.  However,as of September 30, 2010 and December 31, 2009, we have assessed thesignificance of the impact of the credit valuation adjustments on the overallvaluation of our derivative positions and have determined that the creditvaluation adjustments are not significant to the overall valuation of ourderivatives.  As a result, we havedetermined that our derivative valuations in their entirety are classified inLevel 2 of the fair value hierarchy.

 

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**BehringerHarvard Opportunity REIT I, Inc.**

**Notes toConsolidated Financial Statements**

**(Unaudited)**

 

Thefollowing fair value hierarchy table presents information about our assets andliabilities measured at fair value on a recurring basis as of September 30,2010 and December 31, 2009:

 
| **September 30, 2010** | ** ** | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Total**  | ** ** |
|----------------------------------|------------|------------------|------------|------------------|------------|------------------|------------|------------|------------|
| **Assets**                       | ** ** | ** **       | ** ** | ** **       | ** ** | ** **       | ** ** | ** ** | ** ** |
| Derivative financial instruments |       | $                | —     |             | $          | 19               |       | $          | —     |   | $ | 19 |   |
|                             |       |             |       |             |       |             |       |       |       |
| **Liabilities**                  |       |             |       |             |       |             |       |       |       |
| Derivative financial instruments |       | $                | —     |             | $          | 606              |       | $          | —     |   | $ | 606 |   |

 
| **December 31, 2009**  | ** ** | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Total**  | ** ** |
|----------------------------------|------------|------------------|------------|------------------|------------|------------------|------------|------------|------------|
| **Assets**                       | ** ** | ** **       | ** ** | ** **       | ** ** | ** **       | ** ** | ** ** | ** ** |
| Derivative financial instruments |       | $                | —     |             | $          | 204              |       | $          | —     |   | $ | 204 |   |
|                             |       |             |       |             |       |             |       |       |       |
| **Liabilities**                  |       |             |       |             |       |             |       |       |       |
| Derivative financial instruments |       | $                | —     |             | $          | 3,081            |       | $          | —     |   | $ | 3,081 |   |

 

Derivative financial instruments classified as assets are included inother assets on the balance sheet while derivative financial instrumentsclassified as liabilities are included in other liabilities.  See Notes 3 and 13 for further informationregarding our use of hedging instruments.

 

***Nonrecurring Fair Value Measurements***

 

*Impairments*

 

Forthe nine months ended September 30, 2010, we recorded impairment chargestotaling $14.7 million related to our Regency Center, Crossroads, and ThePrivate Residences — Chase Park Plaza properties, and a $6.3 million impairmentcharge to our 30.38% unconsolidated interest in Royal Island.  In addition, we recognized a provision to thereserve for loan losses of $7.1 million related to our Alexan Black Mountainnote receivable for the nine months ended September 30, 2010.

 

Theinputs used to calculate the fair value of these assets included projected cashflows and a risk-adjusted rate of return that we estimated would be used by amarket participant in valuing these assets. This fair value estimate is considered Level 3 of the fair valuehierarchy.

 

Thefollowing fair value hierarchy table presents information about our assetsmeasured at fair value on a nonrecurring basis during the nine months ended September 30,2010:

 
| **September 30, 2010**           | ** ** | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Total Fair Value** | ** ** | **Gain /  (Loss)(1)** | ** ** |
|--------------------------------------------|------------|------------------|------------|------------------|------------|------------------|------------|--------------------------------|------------|----------------------------|------------|
| **Assets**                                 | ** ** | ** **       | ** ** | ** **       | ** ** | ** **       | ** ** | ** **                     |       |                       |       |
| Note receivable, net                       |       | $                | —     |             | $          | —           |       | $                              | 2,540      |                       | $          | 2,540 |   | $ | (7,136 | ) |
| Land                                       |       |             |       |             |       | 11,625           |       | 11,625                         |       | (2,805                     | )          |
| Buildings and improvements, net            |       | —           |       | —           |       | 29,978           |       | 29,978                         |       | (6,772                     | )          |
| Real estate intangibles, net               |       |             |       |             |       | 2,210            |       | 2,210                          |       | (339                       | )          |
| Condominium inventory                      |       | —           |       | —           |       | 44,717           |       | 44,717                         |       | (4,775                     | )          |
| Investment in unconsolidated joint venture |       |             |       |             |       | 15,392           |       | 15,392                         |       | (6,342                     | )          |
| Total                                      |       | $                | —     |             | $          | —           |       | $                              | 106,462    |                       | $          | 106,462 |   | $ | (28,169 | ) |

 

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(1)  Excludes $4.2 million in impairment loss of our discontinuedoperations that was disposed of as of September 30, 2010.

 

**6.             Fair Value Disclosure of FinancialInstruments**

 

Wedetermined the following disclosure of estimated fair values using availablemarket information and appropriate valuation methodologies.  However, considerable judgment is necessaryto interpret market data and develop the related estimates of fair value.  Accordingly, the estimates presented hereinare not necessarily indicative of the amounts that could be realized upondisposition of the financial instruments. The use of different market assumptions and/or estimation methodologiesmay have a material effect on the estimated fair value amounts.

 

Asof September 30, 2010 and December 31, 2009, management estimatedthat the carrying value of cash and cash equivalents, restricted cash, accountsreceivable, accounts payable, accrued expenses, other liabilities,payables/receivables 

 

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**BehringerHarvard Opportunity REIT I, Inc.**

**Notes toConsolidated Financial Statements**

**(Unaudited)**

 

fromrelated parties, and distributions payable were at amounts that reasonablyapproximated their fair value based on their highly-liquid nature and/orshort-term maturities and the carrying value of notes receivable reasonablyapproximated fair value based on expected interest rates for notes to similarborrowers with similar terms and remaining maturities.

 

Thenotes payable totaling $347 million and $429.8 million as of September 30,2010 and December 31, 2009, respectively, have a fair value ofapproximately $351.2 million and $435.3 million, respectively, based uponinterest rates for mortgages with similar terms and remaining maturities thatmanagement believes we could obtain. Interest rate swaps and caps along with our foreign currency exchangeforward contract are recorded at their respective fair values in prepaidexpenses and other assets for those derivative instruments that have an assetbalance and in other liabilities for those derivative instruments that areliabilities.  See Note 5.

 

Thefair value estimates presented herein are based on information available to ourmanagement as of September 30, 2010 and December 31, 2009.  Although our management is not aware of anyfactors that would significantly affect the estimated fair value amounts, suchamounts have not been comprehensively revalued for purposes of theseconsolidated financial statements since that date, and current estimates offair value may differ significantly from the amounts presented herein.

 

**7.             Real EstateInvestments**

 

Asof September 30, 2010, we wholly owned ten properties and consolidated sixproperties through investments in joint ventures.  We are the mezzanine lender for onemultifamily property which, prior to January 1, 2010, we consolidated asthe primary beneficiary of the VIE (see Note 8).  In addition, we have noncontrolling,unconsolidated ownership interests in four properties and one investment in ajoint venture consisting of 22 properties that are accounted for using theequity method.  Capital contributions,distributions, and profits and losses of these properties are allocated inaccordance with the terms of the applicable partnership agreement.

 

*Santa Clara Tech Center*

 

TheSanta Clara Tech Center property consists of three buildings:  the 700, 750, and 800 buildings.  The mortgage and mezzanine loans(collectively, the “Original Loans”) associated with the Santa Clara TechCenter matured on June 9, 2010.  Asof the maturity date, due to ongoing negotiations with an unaffiliated thirdparty (the “Santa Clara JV Partner”) to create the joint ventures discussedbelow, we had not yet reached an agreement with the lender to extend the termsof the Original Loans and accordingly, we were granted a forbearance by thelender through August 5, 2010.

 

OnAugust 5, 2010, we reached agreements to sell a 50% interest in the SantaClara Tech Center to the Santa Clara JV Partner, to create two joint ventureswith the Santa Clara JV Partner to own the Santa Clara Tech Center, and tosever and replace the Original Loans with new loans from the Santa Clara lenderas describe below.

 

Further,on August 5, 2010, we entered into the following arrangements:

 

·                  We entered into an agreement with the SantaClara JV Partner to sell a 50% interest in the Santa Clara Tech Center propertyfor $8.8 million in cash;

 

·                  We entered into two joint ventures with theSanta Clara JV Partner so that one joint venture holds the 700 and 750buildings (the “700/750 Joint Venture”) separately from the joint venture thatholds the 800 building (the “800 Joint Venture”).  We contributed our remaining 50% interest inthe Santa Clara Tech Center along with an aggregate $8.8 million of cash inexchange for 50% interests in each of the two new joint ventures.  The Santa Clara JV Partner also contributedan aggregate $8.8 million of cash and their 50% interest in the Santa ClaraTech Center in exchange for their respective 50% interests.   In addition, the Santa Clara JV Partneracquired preferred equity interests in the joint ventures for an aggregate $7.5million in cash, which was used to pay down the Original Loans’ outstandingbalance discussed below;

 

·                  The agreements associated with the OriginalLoans were severed and replaced by new loan agreements with the same lender bybifurcating the Original Loans into two new loans (the “Replacement Loans”)such that specific debt is associated with the 700 & 750 buildingsseparate from debt associated with the 800 building;

 

·                  The new joint ventures paid down the OriginalLoans’ balance by an aggregate $7 million, such that the balances of theReplacement Loans at inception were an aggregate of $45.5 million; and

 

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**BehringerHarvard Opportunity REIT I, Inc.**

**Notes toConsolidated Financial Statements**

**(Unaudited)**

 

·                  The capital contributed to the 700/750 JointVenture and 800 Joint Venture will be used to construct and develop the vacantspace in the 800 building as data center pods. Accordingly, cash contributions received into the 700/750 Joint Venturewere subsequently contributed to the 800 Joint Venture.

 

The700/750 Joint Venture agreement provides the Santa Clara JV Partner with a putoption that could require us to re-acquire the Santa Clara JV Partners’ 50%interest in the 700/750 Joint Venture at a fixed price upon satisfaction ofcertain conditions.  Under GAAP, thecondition of retaining the substantial risk or rewards of ownership such as aput option precludes us from recognizing the sale of the 700 and 750 buildingsto the Santa Clara JV Partner. Accordingly, we will continue to reflect the assets and liabilities ofthe 700 and 750 buildings in our consolidated balance sheet as if a sale hadnot occurred.  Further, we haverecognized the $6 million cash contribution received from the Santa Clara JVPartner for their respective 50% interest in the 700/750 Joint Venture as a depositin accrued and other liabilities in our consolidated balance sheet at September 30,2010 pending termination or cancellation of the put option or until the sale isconsidered consummated under GAAP.  The800 Joint Venture agreement does not contain a put option provision.

 

Ourinterest in the 800 Joint Venture is a noncontrolling, unconsolidated interest,for which we account using the equity method of accounting.  Accordingly, effective August 5, 2010,we deconsolidated the assets and liabilities of the 800 building on ourconsolidated financial statements. Further, we recognized a $3.9 million gain on deconsolidation to theequity method, of which $2.8 million relates to the remeasurement of ourretained 50% interest to its fair value.

 

*Tanglewood at Voss*

 

In2006, we provided secured mezzanine financing totaling $13 million to anunaffiliated third-party entity that owned and developed Tanglewood at Voss(the “Voss Developer”).  The VossDeveloper also had a secured construction loan with a third-party lender, withan aggregate principal amount of up to $39.5 million.  Our mezzanine loan to the Voss Developer wassubordinate to the senior construction loan.

 

OnSeptember 30, 2010, we reached an agreement with the Voss Developer andthe third-party lender to obtain 100% fee simple interest in Tanglewood atVoss, including assumption of the senior construction loan, in exchange for thefull satisfaction of our mezzanine loan balance plus accrued interest (the “VossTransaction”).  Following the Voss Transaction,the Voss Developer does not have any continuing involvement with Tanglewood atVoss.  The receipt of Tanglewood at Vossin full satisfaction of our mezzanine loan receivable represents a troubleddebt restructuring.  The carrying amountof our mezzanine loan receivable plus accrued interest at the time of the VossTransaction was $18.3 million.

 

Thevaluation basis for the troubled debt restructuring of our mezzanine loanreceivable is based on the fair value of Tanglewood at Voss, which secures thesenior construction loan, less the fair value of the senior constructionloan.  Accordingly, the fair value ofconsideration transferred in the Voss Transaction was $13.3 million resultingin a loss on troubled debt restructuring of $5 million in the accompanyingconsolidated statement of operations and other comprehensive loss for the threeand nine months ended September 30, 2010.

 

Inaccordance with GAAP, we have accounted for the assets and liabilities ofTanglewood at Voss received in full satisfaction of our mezzanine loanreceivable as if the assets had been acquired for cash.

 

Dueto the timing of the Voss Transaction, Tanglewood at Voss did not contributeany meaningful rental revenue or earnings for the three and nine months ended September 30,2010.  We had consolidated Tanglewood atVoss as the primary beneficiary of a VIE for the nine months ended September 30,2009.  Consequently, the historicaloperations were already reported in revenue, net loss, and net loss per sharefor the respective period.  Therefore, weonly present the following unaudited pro forma summary consolidated informationas if the business combination had occurred on January 1, 2010.

 
| ** **                  | ** ** | **Pro Forma for the  Nine Months  Ended  September 30,** | ** ** |
|-----------------------------|------------|-----------------------------------------------------------------------------------|------------|
| ** **                  | ** ** | **2010**                                                                          | ** ** |
| Revenue                     |       | $                                                                                 | 73,003     |   |
| Net income (loss)           |       | $                                                                                 | (55,403    | ) |
| Net income (loss) per share |       | $                                                                                 | (0.99      | ) |

 

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**BehringerHarvard Opportunity REIT I, Inc.**

**Notes toConsolidated Financial Statements**

**(Unaudited)**

 

Thesepro forma amounts have been calculated after applying our accounting policiesand adjusting the results of Tanglewood at Voss to reflect additionaldepreciation and amortization that would have been charged assuming the fairvalue adjustments to the tangible and intangible assets had been applied from January 1,2010.

 

Asa result of obtaining the fee simple interest in Tanglewood at Voss, theidentifiable assets acquired and liabilities assumed were measured at fairvalue.  In determining fair value, weobtained an appraisal and utilized assumptions including estimated cash flows,discount rates, and capitalization rates. During the nine months ended September 30, 2010, we incurred $0.1million of acquisition expenses related to the Tanglewood at Vossacquisition.  The following tablesummarizes the amounts of identified assets acquired and liabilities assumed atthe acquisition date.

 
| ** **                        | ** ** | **Tanglewood at  Voss** | ** ** |
|-----------------------------------|------------|------------------------------|------------|
| Land                              |       | $                            | 8,403      |   |
| Land improvements                 |       | 1,006                        |       |
| Building                          |       | 41,895                       |       |
| Furniture, fixtures and equipment |       | 448                          |       |
| Lease intangibles, net            |       | 1,064                        |       |
| Acquired below-market leases, net |       | (116                         | )          |
| Working capital (net)             |       | 68                           |       |
| Debt                              |       | (39,539                      | )          |
|                              |       |                         |       |
| Total identifiable net assets     |       | $                            | 13,229     |   |

 

Weare in the process of finalizing our acquisition allocations, which are subjectto change until our information is finalized, no later than twelve months fromthe acquisition date.

 

***Investments in Unconsolidated Joint Ventures***

 

Thefollowing table presents certain information about our unconsolidatedinvestments as of September 30, 2010 and December 31, 2009:

 
| ** **                    | ** ** | ** **              | ** ** | **Carrying Value of Investment** | ** ** |
|-------------------------------|------------|-------------------------|------------|-------------------------------------------------|------------|
| **Property Name**        | ** ** | **Ownership  Interest** | ** ** | **September 30,  2010**                    | ** ** | **December 31,  2009** | ** ** |
| Royal Island                  |       | 30.38                   | %          | $                                               | 15,392     |   | $ | 22,594 |   |
| GrandMarc at Westberry Place  |       | 50.00                   | %          | 6,485                                           |       | 7,348 |   |
| GrandMarc at the Corner       |       | 50.00                   | %          | 6,037                                           |       | 6,559 |   |
| Santa Clara 800 Joint Venture |       | 50.00                   | %          | 15,001                                          |       | — |   |
| Central Europe Joint Venture  |       | 47.27                   | %          | 24,023                                          |       | 27,051 |   |
| Total                         |       |                    |       | $                                               | 66,938     |   | $ | 63,552 |   |

 

Dueto uncertainties surrounding the timing of development activities at RoyalIsland, we recognized an impairment charge totaling $6.3 million related to ourunconsolidated joint venture investment in Royal Island for the three and ninemonths ended September 30, 2010.

 

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**BehringerHarvard Opportunity REIT I, Inc.**

**Notes toConsolidated Financial Statements**

**(Unaudited)**

 

Our investments in unconsolidated joint ventures asof September 30, 2010 and December 31, 2009 consisted of ourproportionate share of the combined assets and liabilities of our investmentproperties as follows:

 
| ** **                   | ** ** | **September 30, 2010** | ** ** | **December 31, 2009** | ** ** |
|------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| Real estate assets, net      |       | $                                | 400,930    |                            | $          | 382,061 |   |
| Cash and cash equivalents    |       | 24,511                           |       | 15,628                          |       |
| Other assets                 |       | 3,452                            |       | 3,528                           |       |
| Total assets                 |       | $                                | 428,893    |                            | $          | 401,217 |   |
|                         |       |                             |       |                            |       |
| Notes payable                |       | $                                | 262,496    |                            | $          | 246,176 |   |
| Other liabilities            |       | 23,149                           |       | 19,846                          |       |
| Total liabilities            |       | 285,645                          |       | 266,022                         |       |
|                         |       |                             |       |                            |       |
| Equity                       |       | 143,248                          |       | 135,195                         |       |
| Total liabilities and equity |       | $                                | 428,893    |                            | $          | 401,217 |   |

 

For the three and nine months ended September 30,2010, we recognized $2.5 million and $4.1 million, respectively, of equity inlosses.  Our equity in losses from theseinvestments is our proportionate share of the combined losses of ourunconsolidated joint ventures for the three and nine months ended September 30,2010 and 2009 as follows:

 
| ** **                       | ** ** | **Three Months Ended September 30,** | ** ** | **NIne Months Ended September 30,** | ** ** |
|----------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                       | ** ** | **2010**                                                 | ** ** | **2009**                                                | ** ** | **2010** | ** ** | **2009** | ** ** |
| Revenue                          |       | $                                                        | 5,975      |                                                    | $          | 6,208 |   | $ | 18,386 |   | $ | 17,580 |   |
|                             |       |                                                     |       |                                                    |       |   |   |   |   |
| Operating expenses:              |       |                                                     |       |                                                    |       |   |   |   |   |
| Operating expenses               |       | 2,793                                                    |       | 1,816                                                   |       | 5,569 |   | 4,888 |   |
| Property taxes                   |       | 199                                                      |       | 205                                                     |       | 610 |   | 612 |   |
| Total operating expenses         |       | 2,992                                                    |       | 2,021                                                   |       | 6,179 |   | 5,500 |   |
|                             |       |                                                     |       |                                                    |       |   |   |   |   |
| Operating income                 |       | 2,983                                                    |       | 4,187                                                   |       | 12,207 |   | 12,080 |   |
|                             |       |                                                     |       |                                                    |       |   |   |   |   |
| Non-operating expenses:          |       |                                                     |       |                                                    |       |   |   |   |   |
| Depreciation and amortization    |       | 2,430                                                    |       | 2,508                                                   |       | 7,138 |   | 7,413 |   |
| Interest and other, net          |       | 6,887                                                    |       | 3,913                                                   |       | 14,689 |   | 10,157 |   |
| Total non-operating expenses     |       | 9,317                                                    |       | 6,421                                                   |       | 21,827 |   | 17,570 |   |
|                             |       |                                                     |       |                                                    |       |   |   |   |   |
| Net loss                         |       | $                                                        | (6,334     | )                                                       | $          | (2,234 | ) | $ | (9,620 | ) | $ | (5,490 | ) |
|                             |       |                                                     |       |                                                    |       |   |   |   |   |
| Company’s share of net loss |       | $                                                        | (2,491     | )                                                       | $          | (1,059 | ) | $ | (4,074 | ) | $ | (2,640 | ) |

 

**8.         Variable InterestEntities**

 

GAAP requires the consolidation of VIEs in which anenterprise has a controlling financial interest.  A controlling financial interest will haveboth of the following characteristics: (a) the power to direct theactivities of a VIE that most significantly impact the VIE’s economicperformance and (b) the obligation to absorb losses of the VIE that couldpotentially be significant to the VIE or the right to receive benefits from theVIE that could potentially be significant to the VIE.

 

Our variable interest in VIEs may be in the form of(1) equity ownership and/or (2) loans provided by us to a VIE, orother partner.  We examine specificcriteria and use judgment when determining if we are the primary beneficiary ofa VIE.  Factors considered in determiningwhether we are the primary beneficiary include risk and reward sharing,experience and financial condition of other partner(s), voting rights,involvement in day-to-day capital and operating decisions, representation on aVIE’s executive committee, existence of unilateral kick-out rights or votingrights, level of economic disproportionality between us and the otherpartner(s), and contracts to purchase assets from VIEs.

 

*Tanglewood at Voss and Alexan Black Mountain*

 

In2006, we agreed to provide secured mezzanine financing with an aggregateprincipal amount of up to $22.7 million to unaffiliated third-party entitiesthat own multifamily communities under development, Tanglewood at Voss andAlexan Black Mountain.  These entitiesalso obtained construction loans with third-party lenders, with an aggregateprincipal amount of up to $68.6 million. Our mezzanine loans were subordinate to the construction loans.  In addition, we

 

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**BehringerHarvard Opportunity REIT I, Inc.**

**Notes toConsolidated Financial Statements**

**(Unaudited)**

 

enteredinto option agreements allowing us to purchase the ownership interests inTanglewood at Voss and Alexan Black Mountain after each project’s substantialcompletion and upon notification of completion from the developer.  In the second quarter of 2009, the optionagreement allowing us to purchase Alexan Black Mountain expired.

 

Basedon our evaluation, we determined that these entities met the criteria of VIEsunder GAAP and, prior to January 1, 2010, we were the primary beneficiaryof these variable interest entities. Therefore, prior to January 1, 2010, we consolidated the entities,including the related real estate assets and third-party constructionfinancing.  As of December 31, 2009,there was $87.2 million of real estate assets related to Tanglewood at Voss andAlexan Black Mountain, which collateralized the outstanding principal balanceof the construction loans.  Thethird-party construction lenders had no recourse to our general credit, buttheir loans were guaranteed by the owners of the variable interest entities.  As of December 31, 2009, the outstandingprincipal balance under our mezzanine loans was $22.7 million, which waseliminated, along with accrued interest and loan origination fees, uponconsolidation.

 

InJune 2009, the FASB issued an amendment to the accounting and disclosurerequirements for the consolidation of variable interest entities.  The guidance eliminates exceptions toconsolidating qualifying special-purpose entities, contains new criteria fordetermining the primary beneficiary, and increases the frequency of requiredreassessments to determine whether a company is the primary beneficiary of avariable interest entity.  It alsocontains a new requirement that any term, transaction, or arrangement that doesnot have a substantive effect on an entity’s status as a variable interest entity,a company’s power over a variable interest entity, or a company’s obligation toabsorb losses or its rights to receive benefits of an entity must bedisregarded.

 

Asa result of this new accounting guidance, on January 1, 2010, wedeconsolidated the assets and liabilities of Tanglewood at Voss and AlexanBlack Mountain along with the associated revenue and expenses, resulting inneither a net gain nor loss as we had no equity interest in theseinvestments.  While the Alexan BlackMountain entity was a VIE and, through September 30, 2010, the date of theVoss Transaction, the Tanglewood at Voss entity was a VIE, we determined thatthe power to direct the activities that most significantly impact the VIEseconomic performance generally resides with the general partner and mezzanineborrowers.  Following the deconsolidationof Alexan Black Mountain, our continuing involvement with the entity is limitedto our mezzanine loan.  Prior to the VossTransaction, our continuing involvement with Tanglewood at Voss was limited toour mezzanine loan.  The deconsolidationon January 1, 2010 did not result in either Tanglewood at Voss or AlexanBlack Mountain becoming one of our related parties.

 

OnSeptember 30, 2010, we reached an agreement with the Voss Developer andthe third-party lender to obtain 100% fee simple interest in Tanglewood atVoss, including assumption of the senior construction loan, in exchange for thefull satisfaction of our mezzanine loan balance plus accrued interest.Following the Voss Transaction, the Voss Developer does not have any continuinginvolvement with Tanglewood at Voss and we own 100% of the equityinterests.  As of September 30,2010, we have determined that Tanglewood at Voss is no longer a VIE.  See Notes 7 and 9.

 

*Royal Island*

 

InMay 2007, for an initial cash investment of $20 million, we acquired anapproximate 31% equity interest as a limited partner in the development andconstruction of a resort hotel, spa, golf course, marina, and residences onthree islands located in the Commonwealth of Bahamas (“Royal Island”).  In December 2007, we participated in abridge loan financing arrangement and committed up to $40 million as a bridgeloan to the Royal Island entity for the continuing construction and developmentof the property.  In June 2009, wepurchased the interest in the first of two superior tranches for $3.1million.  In March 2010, wepurchased the interest in two notes in the second tranche for $2.2million.  The total amount outstanding tous at September 30, 2010, including accrued interest and fees, was $45million.  See Note 9.

 

Basedon our evaluation, we have determined that the entity meets the criteria of avariable interest entity but that we are not the primary beneficiary because wedo not have the power to direct the activities of Royal Island that mostsignificantly affect the entity’s economic performance.  The power to direct these activities resideswith the general partner.  Accordingly,we do not consolidate the Royal Island entity and instead account for ourequity investment under the equity method of accounting.  At September 30, 2010, there wasapproximately $149.1 million of real estate assets related to Royal Island.

 

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**BehringerHarvard Opportunity REIT I, Inc.**

**Notes toConsolidated Financial Statements**

**(Unaudited)**

 

At September 30, 2010 and December 31,2009, our recorded investment in VIEs that are unconsolidated and our maximumexposure to loss were as follows:

 

**As of September 30, 2010**

 
| ** **                | ** ** | **Investments in  Unconsolidated VIEs** | ** ** | **Our Maximum  Exposure to Loss** | ** ** |
|---------------------------|------------|---------------------------------------------------|------------|--------------------------------------------------|------------|
| Alexan Black Mountain (1) |       | $                                                 | —     |                                             | $          | 2,540 |   |
| Royal Island (2)          |       | 15,392                                            |       | 60,365                                           |       |
|                      |       | $                                                 | 15,392     |                                             | $          | 62,905 |   |

 

**As of December 31, 2009**

 
| ** **       | ** ** | **Investment in  Unconsolidated VIE** | ** ** | **Our Maximum  Exposure to Loss** | ** ** |
|------------------|------------|-------------------------------------------------|------------|--------------------------------------------------|------------|
| Royal Island (2) |       | $                                               | 22,594     |                                             | $          | 64,661 |   |
|                  |            |                                                 |            |                                                  |            |  |  |

 

----

(1)  We have no equity investment in Alexan Black Mountain.  Our maximum exposure to loss is limited tothe net outstanding balance of the note receivable for Alexan Black Mountain. Priorto January 1, 2010, we consolidated Alexan Black Mountain.

 

(2) Our maximum exposure to loss for Royal Island is limited tothe investment in the unconsolidated VIE of $15.4 million and $22.6 million asof September 30, 2010 and December 31, 2009, respectively, plus thenet outstanding balance of the notes receivable for Royal Island of $45 millionand $42.1 million as of September 30, 2010 and December 31, 2009, respectively.

 

**9.         Notes Receivable**

 

*Chase Park Plaza Working Capital Loan*

 

Welease the hotel portion of the Chase Park Plaza property to the hotel operator,an unaffiliated entity that owns the remaining 5% of Chase Park Plaza.  In conjunction with the lease agreement, wemade a working capital and inventory loan of up to $1.9 million to the hoteloperator in December 2006.  Theinterest rate under the note is fixed at 5% per annum.  The term of the note is the earlier of December 31,2016 or the termination of the related hotel lease agreement.  Annual payments of interest only are requiredeach December with any remaining balance payable at the maturitydate.  In accordance with the hotel leaseagreement, the tenant will receive a reduction in its base rental payment duein January in the amount of the interest paid on the promissory note inthe previous December.  This reduction inthe lease payment is reflected as a straight-line adjustment to base rentalrevenue.  At September 30, 2010, thenote receivable balance was $1.3 million.

 

*Tanglewood at Voss and Alexan Black MountainMezzanine Loans*

 

In2006, we agreed to provide secured mezzanine financing with an aggregateprincipal amount of up to $22.7 million to unaffiliated third-party entitiesthat own Tanglewood at Voss and Alexan Black Mountain.  Alexan Black Mountain also has a securedconstruction loan with a third-party lender with an aggregate balance of $29million at September 30, 2010.  Ourmezzanine loan to Alexan Black Mountain is subordinate to the constructionloan.  At September 30, 2010, thecarrying amount of the Alexan Black Mountain mezzanine loan was $2.5 million.

 

OnSeptember 30, 2010, we reached an agreement with the Voss Developer andthe third-party lender to obtain the 100% fee simple interest in Tanglewood atVoss including assumption of the senior construction loan in exchange for thefull satisfaction of our mezzanine loan balance plus accrued interest.  Following the Voss Transaction, the VossDeveloper does not have any continuing involvement with Tanglewood atVoss.  The receipt of Tanglewood at Vossin full satisfaction of our mezzanine loan receivable represents a troubleddebt restructuring.  The carrying amountof our mezzanine loan receivable plus accrued interest at the time of the VossTransaction was $18.3 million.

 

Thevaluation basis for the troubled debt restructuring of our mezzanine loanreceivable is based on the fair value of Tanglewood at Voss, which secures thesenior construction loan, less the fair value of the senior constructionloan.  Accordingly, the fair value ofconsideration transferred in the Voss Transaction was $13.3 million resultingin a loss on 

 

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**BehringerHarvard Opportunity REIT I, Inc.**

**Notes toConsolidated Financial Statements**

**(Unaudited)**

 

troubleddebt restructuring of $5 million in the accompanying consolidated statement ofoperations and other comprehensive loss for the three and nine months ended September 30,2010.

 

*Royal Island Bridge Loan*

 

InDecember 2007, we participated in a bridge loan financing arrangement forthe continuing development and construction of Royal Island.  Theaggregate principal amount available under the bridge loan was $60 millionconsisting of three tranches.  Under the bridge loan we agreed to lend atranche of up to $40 million, which is subordinate to the other twotranches.  The bridge loan accrued interest at the one-month LIBOR rateplus 8% per annum with accrued interest and principal payable at the maturitydate, December 20, 2008, and is secured by the Royal Island property.  In June 2009, we purchased the interestin the first of the two superior tranches, the A-1, for $3.1 million.  In March 2010, we purchased the interestin two notes in the A-2 tranche for $2.2 million.

 

Underthe terms of the loan documents, the bridge loan could be extended once for aperiod of six months upon the satisfaction of certain conditions upon noticegiven by the borrower by November 20, 2008 and a payment of an extensionfee.  At the maturity date, not all of the conditions were satisfied and,as a result, the bridge loan went into default and became a non-earningloan.  The balance owed to us at the timeof default was $37.7 million including accrued interest and fees.  Discussions between the bridge loan lendersand the borrower to complete a satisfactory workout plan have begun; however,there are no assurances that a workout plan will be completed or that the loanwill be reinstated by the borrower. Accordingly, we may seek other actions under the loan documents toprotect our investment, including foreclosure, exercise of power of sale, orconveyance in satisfaction of debt.  Inaccordance with GAAP, from the time the loan went into default until the timethat a foreclosure occurs, a satisfactory workout is completed, or the loan isreinstated by the borrower, we do not recognize interest income on the loan.

 

InJanuary 2010, we collected $5.5 million in unpaid interest and fees fromthe borrower.  At September 30,2010, the loan balance owed to us was $45 million, which included $1.5 millionof accrued interest and fees included in receivables from related parties at September 30,2010.  We have not recorded an allowanceagainst the recorded balance as our estimate of the fair value of the RoyalIsland property securing the bridge loan exceeds the current carrying value ofthe loan.  Accordingly, we believe it isprobable that all of the outstanding balance is collectible.

 

Currentmarket conditions with respect to credit availability and to fundamentalswithin the real estate markets instill significant levels of uncertainty.  Accordingly, future adverse developments inmarket conditions would cause us to re-evaluate our conclusions regarding thecollectability of our notes receivable and could result in material impairmentcharges.

 

OnSeptember 14, 2010, we entered into a forbearance agreement with theborrower pursuant to which, among other things, the borrower agreed not tocontest or oppose any foreclosure, exercise of power of sale, or similar actionthat we may seek in order to protect our investment.  Further, the borrower agreed to fully cooperateto expedite the proceedings should we take such a course of action.

 

**10.      Capitalized Costs**

 

Wecapitalize interest, property taxes, insurance, and construction costs to realestate under development.  During thenine months ended September 30, 2010, we capitalized $6.2 million of such costsassociated with real estate under development and certain investments accountedfor by the equity method.  During thenine months ended September 30, 2009, we capitalized $7.1 million of suchcosts associated with real estate under development and certain investmentsaccounted for by the equity method, including $1.3 million in interestcosts.  Capitalized interest costsinclude interest expense and amortization of deferred financing costs.

 

Certainredevelopment costs including interest, property taxes, insurance, andconstruction costs associated with Chase Park Plaza and The Lodge &Spa at Cordillera have been capitalized to condominium inventory on ourconsolidated balance sheet at September 30, 2010.  During the nine months ended September 30,2010, we capitalized a total of $6 million of such costs associated with thecondominium redevelopment at Chase Park Plaza and The Lodge & Spa atCordillera.  During the nine months endedSeptember 30, 2009, we capitalized a total of $11.3 million of such costsassociated with the condominium redevelopment at Chase Park Plaza and The Lodge &Spa at Cordillera.

 

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**BehringerHarvard Opportunity REIT I, Inc.**

**Notes toConsolidated Financial Statements**

**(Unaudited)**

 

**11.      Notes Payable**

 

Thefollowing table sets forth our notes payable on our consolidated properties,including the debt obligations of properties we consolidated at September 30,2010 and December 31, 2009:

 
| ** **                     | ** ** | **September 30,** | ** **    | **December 31,** | ** ** | **Interest**                                                | ** ** | **Maturity** | ** ** |
|--------------------------------|------------|------------------------|---------------|-----------------------|------------|-------------------------------------------------------------|------------|--------------|------------|
| **Description**                | ** ** | **2010**               | ** **    | **2009**              | ** ** | **Rate**                                                    | ** ** | **Date**     | ** ** |
| Chase Park Plaza Hotel         |       | 77,474                 |          | 77,474                |       | Prime Rate, or 30-day LIBOR + spread(2)(4)                  |       | 11/15/10     |       |
| Chase - The Private Residences |       | 9,132                  |          | 23,317                |       | Prime Rate, or 30-day LIBOR + spread(2)(4)                  |       | 11/15/10     |       |
| Senior Secured Credit Facility |       | 70,082                 |          | 62,600                |       | Prime Rate (4)                                              |       | 02/13/11     |       |
| Becket House - RBS             |       | 18,497                 |          | 18,636                |       | 90-day LIBOR + 2.5%(3)                                      |       | 03/09/11     |       |
| Crossroads                     |       | 25,316                 |          | 25,023                |       | 30-day LIBOR + 2.85%(2)                                     |       | 06/30/11     |       |
| Frisco Square I, LLC (Land)    |       | 23,218                 |          | 24,503                |       | 30-day LIBOR + 4.5%(2)                                      |       | 07/28/11     |       |
| Frisco Square II, LLC          |       | 7,801                  |          | 7,856                 |       | 30-day LIBOR + 3.5%(2)                                      |       | 07/28/11     |       |
| Frisco Square III, LLC         |       | 8,515                  |          | 8,515                 |       | 30-day LIBOR + 3.5%(2)                                      |       | 07/28/11     |       |
| Frisco Square IV, LLC          |       | 14,569                 |          | 14,665                |       | 30-day LIBOR + 3.5%(2)                                      |       | 07/28/11     |       |
| Bent Tree Green                |       | 6,700                  |          | 6,700                 |       | Greater of 5.75% or Prime + 1%(4)                           |       | 05/19/12     |       |
| Tanglewood at Voss             |       | 39,539                 |          | 39,539                |       | 30-day LIBOR + 1.6% (2)                                     |       | 08/20/12     |       |
| Alexan Black Mountain (1)      |       | —                 |          | 29,000                |       | 30-day LIBOR + 3%, or Prime Rate + 2%. Floor of 5.5% (2)(4) |       | 12/29/12     |       |
| Santa Clara 700/750            |       | 20,000                 |          | —                |       | 30-day LIBOR + 4.75%(2)                                     |       | 06/09/13     |       |
| Santa Clara 700/750            |       | 5,000                  |          | —                |       | 30-day LIBOR + 8.50%(2)                                     |       | 06/09/13     |       |
| Santa Clara Tech Center        |       | —                 |          | 52,479                |       | 30-day LIBOR + 1.75%(2)                                     |       | 06/09/10     |       |
| Ferncroft Corporate Center(5)  |       | —                 |          | 18,000                |       | 6.33%                                                       |       | 09/01/13     |       |
| Northborough Tower             |       | 21,154                 |          | 21,480                |       | 5.67%                                                       |       | 01/11/16     |       |
|                           |       | $                      |  346,997 |                  | $          | 429,787                                                     |       |         |       |   |   |
|                                |            |                        |               |                       |            |                                                             |            |              |            |  |  |

 

----

(1)           We deconsolidated Alexan BlackMountain as of January 1, 2010.  SeeNote 8.

(2)           30-day London Interbank Offer Rate (“LIBOR”)was 0.256% at September 30, 2010.

(3)           90-day London Interbank Offer Rate (“LIBOR”)was 0.290% at September 30, 2010.

(4)           Prime rate was 3.25% at September 30,2010.

(5)           Loan was extinguished throughdeed-in-lieu of foreclosure.  See Note18.

 

Ournotes payable balance was $347 million at September 30, 2010, as comparedto $429.8 million at December 31, 2009 and consists of borrowings andassumptions of debt related to our property acquisitions and our borrowingsunder our $75 million senior secured credit facility.  As of December 31, 2009, notes payablealso included the notes payable of our mezzanine borrowers that we consolidatedas variable interest entities under GAAP, Tanglewood at Voss and Alexan Black Mountain. In the first quarter of 2010, we deconsolidated the assets and liabilities ofTanglewood at Voss and Alexan Black Mountain, which include the notes payableof our mezzanine borrowers totaling $68.5 million.  Each of our notes payable is collateralizedby one or more of our properties.  At September 30, 2010, our notespayable interest rates ranged from 2% to 8.8%, with a weighted average interestrate of approximately 3.4%.  Of our $347 million in notes payable atSeptember 30, 2010, $325.8 million represented debt subject to variableinterest rates.  At September 30, 2010, our notes payable hadmaturity dates that ranged from November 2010 to January 2016. We have unconditionally guaranteed payment of the notes payable related toFrisco Square, Northborough Tower, Bent Tree Green, Crossroads Office Park, andTanglewood at Voss.  We haveunconditionally guaranteed 50% of the payment of the notes payable related toChase Park Plaza Hotel and Chase — Private Residences

 

Ournotes payable related to Chase Park Plaza Hotel, The Private Residences — ChasePark Plaza, Becket House, Crossroads, and Frisco Square properties along withour senior secured credit facility all mature within the next twelvemonths.  With respect to our debt duewithin the next twelve months, we are working with our lenders to either extendthe maturity dates of the loans or refinance the loans under differentterms.  We currently expect to use fundsgenerated by our 

 

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**BehringerHarvard Opportunity REIT I, Inc.**

**Notes toConsolidated Financial Statements**

**(Unaudited)**

 

operatingproperties, additional borrowings, and proceeds from the disposition ofproperties to continue making our scheduled debt service payments until thematurity dates of the loans are extended, the loans are refinanced, or theoutstanding balance of the loans are completely paid off.  However, there is no guarantee that we willbe able to refinance our borrowings with more or less favorable terms or extendthe maturity dates of such loans.

 

*Santa Clara Tech Center*

 

OnAugust 5, 2010, concurrent with entering into two new joint ventures withthe Santa Clara JV Partner discussed at Note 7, we reached an agreement withthe lender to modify and extend Santa Clara’s Original Loans in the followingmanner:

 

·                  The agreements associated with the OriginalLoans were severed and replaced by new loan agreements with the same lender bybifurcating the Original Loans into two new Replacement Loans such thatspecific debt is associated with the 700 and 750 buildings separate from debtassociated with the 800 building;

 

·                  The new joint ventures paid down the OriginalLoans’ balance by an aggregate $7 million, such that the balance of theReplacement Loans at inception was an aggregate $45.5 million, $25 millionassociated with the 700 and 750 buildings and $20.5 million associated with the800 building;

 

·                  The maturity date of the Replacement Loans isJune 9, 2013;

 

·                  The Replacement Loans require payment ofinterest only until maturity at a rate equal to:

 

·                  Replacement mortgage loans —either (i) the greater of 1% or the 30-day LIBOR, plus 4.75% (the “LIBOROption”), or (ii) the prime rate plus the difference between the LIBOROption and the prime rate; and

 

·                  Replacement mezzanine loans —either (i) the greater of 1% or the 30-day LIBOR, plus 8.5% (the “MezzanineLIBOR Option”), or (ii) the prime rate plus the difference between theMezzanine LIBOR Option and the prime rate; and

 

·                  There is no penalty for prepayment of theReplacement Loans, subject to certain conditions.

 

Asfurther described in Note 7, we will continue to consolidate the assets andliabilities of the 700 and 750 buildings, including the Replacement Loansassociated with these two buildings.  Asof September 30, 2010, the aggregate balance due under the ReplacementLoans associated with the 700 and 750 buildings is $25 million.

 

*Tanglewood at Voss*

 

OnSeptember 30, 2010, related to the Voss Transaction (described at Note 7),we assumed the outstanding senior loan in the amount of $39.5 million andextended its maturity date to August 20, 2012.   As a condition of entering into the VossTransaction, the loan is secured by a first mortgage lien on the assets ofTanglewood at Voss and The Lodge & Spa at Cordillera, including theland, fixtures, improvements, contracts, leases, rents, and reserves.  The loan requires payment of interest at arate equal to 30-day LIBOR plus 1.6%. The loan requires excess cash flows, if any, of Tanglewood at Voss, tobe applied first to the loan as a principal payment.  In addition, the excess cash flows, if any,of The Lodge & Spa at Cordillera, are to be applied first to thefunding of a reserve account until the balance equals $0.5 million and second,to the loan as a principal payment.  Wehave one option to extend the maturity date one year upon meeting certainconditions.  We have unconditionallyguaranteed payment of the Tanglewood at Voss loan.

 

*Becket House*

 

Ourloan agreements generally stipulate that we comply with certain reporting andfinancial covenants.  These covenantsinclude, among other things, notifying the lender of any change in managementand maintaining minimum debt service coverage ratios.  As a result of the difficult economicconditions negatively impacting both occupancy and rental rates at the BecketHouse, lease renewals and new leases have been executed at substantially lowerrates per square foot, and we were unable to meet certain financial covenantsunder the Becket House loan agreement as of September 30, 2010.  Failure to meet the loan covenants under theloan agreement constitutes a technical default and, absent a waiver ormodification of the loan agreement, the lender may accelerate maturity with anyunpaid interest and principal immediately due and payable.  At September 30, 2010, the outstandingprincipal balance of the Becket House loan was $18.5 million.  We are currently in negotiations with thelender to waive the event of noncompliance or modify the loan agreement.  However, there are no assurances that we willbe successful in our negotiations with the lender.  The Becket House loan is non-recourse to us.

 

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**BehringerHarvard Opportunity REIT I, Inc.**

**Notes toConsolidated Financial Statements**

**(Unaudited)**

 

*Credit Facility*

 

InFebruary 2008, we entered into a senior secured revolving credit facilityproviding for up to $75 million of secured borrowings.  The initial credit facility allowed us toborrow up to $75 million in revolving loans, of which up to $20 million wasavailable for issuing letters of credit. We have unconditionally guaranteed payment of the senior securedrevolving credit facility.  Theavailability of credit under the revolving credit facility is limited by theterms of the credit agreement.  As of September 30,2010, the maximum availability and the outstanding balance under the revolvingcredit facility was $70.1 million.

 

Thefollowing table summarizes our aggregate contractual obligations for principalpayments as of September 30, 2010:

 
| **Principal Payments Due:**          | ** ** | ** ** | ** ** |
|------------------------------------------------|------------|------------|------------|
| October 1, 2010 -  December 31, 2010 |       | $          | 87,240     |   |
| 2011                                           |       | 168,459    |       |
| 2012                                           |       | 45,840     |       |
| 2013                                           |       | 25,341     |       |
| 2014                                           |       | 361        |       |
| Thereafter                                     |       | 18,883     |       |
| Unamortized premium                            |       | 873        |       |
|                                           |       |       |       |
|                                           |       | $          | 346,997    |   |

 

**12.          Leasing Activity**

 

Future minimum base rentalpayments due to us under non-cancelable leases in effect as of September 30,2010 for our consolidated properties are as follows:

 
| ** **                                     | ** ** | **Future  Minimum  Lease  Payments** | ** ** |
|------------------------------------------------|------------|--------------------------------------|------------|
| October 1, 2010 -  December 31, 2010 |       | $                                    | 7,953      |   |
| 2011                                           |       | 31,113                               |       |
| 2012                                           |       | 25,414                               |       |
| 2013                                           |       | 22,052                               |       |
| 2014                                           |       | 16,640                               |       |
| Thereafter                                     |       | 40,275                               |       |
|                                           |       |                                 |       |
| Total                                          |       | $                                    | 143,447    |   |

 

Asof September 30, 2010, none of our tenants accounted for 10% or more ofour aggregate annual rental revenues from our consolidated properties.  Included in rental revenue for both the threeand nine months ended September 30, 2010 was less than $0.1 million ofcontingent rent.  Approximately $0.1million and $0.3 million of contingent rent was included in rental revenue forthe three and nine months ended September 30, 2009, respectively.

 

**13.      Derivative Instruments and Hedging Activities**

 

Wemay be exposed to the risk associated with variability of interest rates thatmight impact our cash flows and the results of operations.  Thehedging strategy of entering into interest rate caps and swaps, therefore, isto eliminate or reduce, to the extent possible, the volatility of cashflows.  In addition, we may be exposed to foreign currency exchangerisk related to our net investments in the Becket House leasehold interest andthe Central Europe Joint Venture.  Accordingly,our hedging strategy is to protect our net investments in foreign currencydenominated entities against the risk of adverse changes in foreign currency toU.S. dollar exchange rates.

 

InAugust 2010, we entered into two new interest rate cap agreements relatedto the debt on our Santa Clara 700 and 750 buildings.  In July 2010, our foreign currencyput/call option related to Central Europe expired.

 

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**BehringerHarvard Opportunity REIT I, Inc.**

**Notes toConsolidated Financial Statements**

**(Unaudited)**

 

Derivativeinstruments classified as assets were reported at their combined fair values ofless than $0.1 million and $0.2 million in prepaid expenses and other assets atSeptember 30, 2010 and December 31, 2009, respectively.  Derivative instruments classified asliabilities were reported at their combined fair values of $0.6 million and$3.1 million in accrued and other liabilities at September 30, 2010 and December 31,2009, respectively.  During the ninemonths ended September 30, 2010, we recorded an unrealized gain of $0.4million to AOCI in our statement of equity to adjust the carrying amount of theinterest rate swaps and caps qualifying as hedges at September 30,2010.  Unrealized gains on interest ratederivatives for the nine months ended September 30, 2010 reflect areclassification of $0.7 million of unrealized gains from accumulated othercomprehensive loss to interest expense.

 

Thefollowing table summarizes the notional values of our derivative financialinstruments as of September 30, 2010. The notional values provide an indication of the extent of ourinvolvement in these instruments at September 30, 2010, but do notrepresent exposure to credit, interest rate, or market risks:

 

 
| **Type / Description**            | ** ** | **Notional  Value** | ** ** | **Interest Rate /  Strike Rate** | ** ** | **Maturity** | ** **             | **Fair Value  Asset /  (Liability)** | ** ** |
|---------------------------------------------|------------|---------------------|------------|-------------------------------------------------|------------|--------------|------------------------|------------------------------------------------|------------|
| Cash Flow Hedges                            | ** ** | ** **          | ** ** | ** **                                      | ** ** | ** **   | ** **             | ** **                                     | ** ** |
| Interest rate cap - Santa Clara 700/750     |       | $                   | 20,000     |                                            | 4.00       | %            | June 15, 2013     |                                           | $          | 15 |   |
| Interest rate cap - Santa Clara 700/750     |       | $                   | 5,000      |                                            | 4.00       | %            | June 15, 2013     |                                           | $          | 4 |   |
| Interest rate cap - Becket House            |       | £              | 12,700     |                                            | 5.75       | %            | November 21, 2010 |                                           | $          | — |   |
| Interest rate swap - Crossroads             |       | $                   | 25,000     |                                            | 3.10       | %            | November 1, 2010  |                                           | $          | (120 | ) |
|                                        |       |                |       |                                            |       |         |                   |                                           |       |
| Other                                       |       |                |       |                                            |       |         |                   |                                           |       |
| Interest rate swap - Chase Park Plaza Hotel |       | $                   | 80,594     |                                            | 3.82       | %            | November 15, 2010 |                                           | $          | (486 | ) |

 

Thetable below presents the fair value of our derivative financial instruments aswell as their classification on the consolidated balance sheets as of September 30,2010 and December 31, 2009.

 
| ** **                                              | ** ** | ** **                        | ** ** | **Asset Derivatives**                            | ** ** | **Liability Derivatives**                       | ** ** |
|---------------------------------------------------------|------------|-----------------------------------|------------|-------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                              | ** ** | **Balance  Sheet  Location**      | ** ** | **Fair Value at  September 30,  2010** | ** ** | **Fair Value at  December 31,  2009** | ** ** | **Fair Value at  September 30,  2010** | ** ** | **Fair Value at  December 31,  2009** | ** ** |
| **Derivatives designated as hedging  instruments:**     |       |                              |       |                                                  |       |                                                 |       |   |   |   |   |
|                                                    |       |                              |       |                                                  |       |                                                 |       |   |   |   |   |
| Interest rate derivative contracts                      |       | Accrued and other liabilities     |       | $                                                     | 19         |                                                 | $          | — |   | $ | (120 | ) | $ | (611 | ) |
| Foreign exchange contracts                              |       | Prepaid expenses and other assets |       | —                                                |       | 204                                                  |       | — |   | — |   |
|                                                    |       |                              |       |                                                  |       |                                                 |       |   |   |   |   |
| Total derivatives designated as hedging  instruments    |       |                              |       | $                                                     | 19         |                                                 | $          | 204 |   | $ | (120 | ) | $ | (611 | ) |
|                                                    |       |                              |       |                                                  |       |                                                 |       |   |   |   |   |
| **Derivatives not designated as  hedging instruments:** |       |                              |       |                                                  |       |                                                 |       |   |   |   |   |
|                                                    |       |                              |       |                                                  |       |                                                 |       |   |   |   |   |
| Interest rate derivative contract                       |       | Accrued and other liabilities     |       | $                                                     | —     |                                                 | $          | — |   | $ | (486 | ) | $ | (2,470 | ) |
|                                                    |       |                              |       |                                                  |       |                                                 |       |   |   |   |   |
| Total derivatives                                       |       |                              |       | $                                                     | 19         |                                                 | $          | 204 |   | $ | (606 | ) | $ | (3,081 | ) |

 

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**BehringerHarvard Opportunity REIT I, Inc.**

**Notes toConsolidated Financial Statements**

**(Unaudited)**

 

Thetables below present the effect of our derivative financial instruments on theconsolidated statements of operations as of September 30, 2010 and 2009.

 

**Derivatives in Cash Flow Hedging Relationships**

 
| ** **                          | ** ** | **Amount of Gain or (Loss)  Recognized in AOCI on  Derivative (Effective Portion)** | ** ** | **Amount of Gain or (Loss)  Reclassified from AOCI into  Income (Effective Portion)(1)** | ** ** | **Amount of Gain or (Loss)  Recognized in AOCI on  Derivative (Effective Portion)** | ** ** | **Amount of Gain or (Loss)  Reclassified from AOCI into  Income (Effective Portion)(1)** | ** ** |
|-------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                          | ** ** | **Three months ended September 30,**                                                                         | ** ** | **Three months ended September 30,**                                                                              | ** ** | **Nine months ended September 30,**                                                                          | ** ** | **NIne months ended September 30,**                                                                               | ** ** |
| ** **                          | ** ** | **2010**                                                                                                                         | ** ** | **2009**                                                                                                                              | ** ** | **2010**                                                                                                                         | ** ** | **2009**                                                                                                                              | ** ** | **2010** | ** ** | **2009** | ** ** | **2010** | ** ** | **2009** | ** ** |
| Interest  rate derivative contracts |       | $                                                                                                                                | (336       | )                                                                                                                                     | $          | 256                                                                                                                              |       | $                                                                                                                                     | 617        |   | $ | 24 |   | $ | 383 |   | $ | 663 |   | $ | 662 |   | $ | 55 |   |
|                                     |            |                                                                                                                                  |            |                                                                                                                                       |            |                                                                                                                                  |            |                                                                                                                                       |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

----

(1)        Amounts related tointerest rate derivative contracts are included in interest expense.

 

**Derivatives in Net Investment Hedging Relationships**

 
| ** **                  | ** ** | **Amount of Gain or (Loss)  Recognized in AOCI on  Derivative (Effective Portion)** | ** ** | **Amount of Gain or (Loss)  Reclassified from AOCI into  Income (Effective Portion)(1)** | ** ** | **Amount of Gain or (Loss)  Recognized in Income on Derivative  (Ineffective Portion)** | ** ** |
|-----------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                  | ** ** | **Three months ended September 30,**                                                                         | ** ** | **Three months ended September 30,**                                                                              | ** ** | **Three months ended September 30,**                                                                             | ** ** |
| ** **                  | ** ** | **2010**                                                                                                                         | ** ** | **2009**                                                                                                                              | ** ** | **2010**                                                                                                                             | ** ** | **2009** | ** ** | **2010** | ** ** | **2009** | ** ** |
| Foreign  exchange contracts |       | $                                                                                                                                | (2         | )                                                                                                                                     | $          | (127                                                                                                                                 | )          | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
|                             |            |                                                                                                                                  |            |                                                                                                                                       |            |                                                                                                                                      |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

----

(1)   We do not expect to reclassify any gain orloss from AOCI into income until the sale or upon complete or substantiallycomplete liquidation of the respective investment in the foreign entity.

 
| ** **                  | ** ** | **Amount of Gain or (Loss)  Recognized in AOCI on  Derivative (Effective Portion)** | ** ** | **Amount of Gain or (Loss)  Reclassified from AOCI into  Income (Effective Portion)(1)** | ** ** | **Amount of Gain or (Loss)  Recognized in Income on Derivative  (Ineffective Portion)** | ** ** |
|-----------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                  | ** ** | **Nine months ended September 30,**                                                                          | ** ** | **Nine months ended September 30,**                                                                               | ** ** | **Nine months ended September 30,**                                                                              | ** ** |
| ** **                  | ** ** | **2010**                                                                                                                         | ** ** | **2009**                                                                                                                              | ** ** | **2010**                                                                                                                             | ** ** | **2009** | ** ** | **2010** | ** ** | **2009** | ** ** |
| Foreign  exchange contracts |       | $                                                                                                                                | (10        | )                                                                                                                                     | $          | (1,052                                                                                                                               | )          | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
|                             |            |                                                                                                                                  |            |                                                                                                                                       |            |                                                                                                                                      |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

----

(1) We do not expect to reclassify any gain or loss from AOCI intoincome until the sale or upon complete or substantially complete liquidation ofthe respective investment in the foreign entity.

 

**DerivativesNot Designated as Hedging Instruments**

 
| ** **                         | ** ** | **Location  of Gain or (Loss)** | ** ** | **Amount  of Gain or (Loss)  Recognized in Income on  Derivative** | ** ** | **Amount  of Gain or (Loss)  Recognized in Income on  Derivative** | ** ** |
|------------------------------------|------------|---------------------------------|------------|--------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                         | ** ** | **Recognized  in Income on**    | ** ** | **Three months ended September 30,**           | ** ** | **Nine months ended September 30,**            | ** ** |
| ** **                         | ** ** | **Derivative**                  | ** ** | **2010**                                                           | ** ** | **2009**                                                           | ** ** | **2010** | ** ** | **2009** | ** ** |
| Interest  rate derivative contract |       | Interest expense                |       | $                                                                  | (43        | )                                                                  | $          | 293 |   | $ | 343 |   | $ | 1,047 |   |
|                                    |            |                                 |            |                                                                    |            |                                                                    |            |  |  |  |  |  |  |  |  |

 

*Credit risk and collateral*

 

Ourcredit exposure related to interest rate and foreign currency derivativeinstruments is represented by the fair value of contracts with a net liabilityfair value at the reporting date.  Theseoutstanding instruments may expose us to credit loss in the event ofnonperformance by the counterparties to the agreements.  However, we have not experienced any creditloss as a result of counterparty nonperformance in the past.  To manage credit risk, we select and willperiodically review counterparties based on credit ratings and limit ourexposure to any single counterparty. Under our agreement with the counterparty related to our interest ratecaps of the Santa Clara 700 and 750 buildings, cash deposits may be required tobe posted by the counterparty whenever their credit rating falls below certainlevels.  Based on our agreement with thecounterparty related to our Crossroads Office Park interest rate swap, we maybe required to post cash collateral of up to $0.6 million if the lender’sobligation to lend under our senior secured credit facility is terminated orthe lender ceases to be a party to the senior secured credit facility; thevalue of the derivative is a liability on our consolidated balance sheet.  At September 30, 2010, no collateral hasbeen posted with our counterparties nor have our counterparties postedcollateral with us related to our derivative instruments.  See Notes 3 and 5 for further information onour derivative instruments.

 

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**BehringerHarvard Opportunity REIT I, Inc.**

**Notes toConsolidated Financial Statements**

**(Unaudited)**

 

**14.      Distributions**

 

We initiated the payment ofmonthly distributions in August 2006. In April 2007, and through March 2009, the declareddistributions rate was a 3% annualized rate of return, calculated on a dailyrecord basis of $0.0008219 per share. Pursuant to our Third Amended and Restated Distribution ReinvestmentPlan (the “DRP”), stockholders may elect to reinvest any cash distribution inadditional shares of common stock.  Werecord all distributions when declared, except that the stock issued throughthe DRP is recorded when the shares are actually issued.

 

Priorto April 2, 2009, our Board declared daily distributions in advance of theperiod to which the distributions applied and the daily distributions were paidmonthly in arrears.  On April 2,2009, our Board of Directors voted to declare distributions on a quarterlybasis in arrears to generate significant cost savings to our stockholders.  On October 18, 2010, our Boardauthorized a quarterly distribution in the amount of $0.025 per share of commonstock, which is equivalent to an annual distribution of 1% assuming a $10 priceper share, payable to the common stockholders of record at the close ofbusiness on September 30, 2010.  Thedistribution will be paid on or before November 16, 2010.

 

**15.      Related Party Transactions**

 

BehringerOpportunity Advisors I and certain of its affiliates receive fees andcompensation in connection with the acquisition, management, and sale of ourassets.

 

We pay Behringer Opportunity Advisors I or its affiliates a debtfinancing fee equal to 1% of the amount of any debt made available to us.  We incurred debt financing fees of $0.2million for the nine months ended September 30, 2010.  We incurred debt financing fees of $0.1million for the nine months ended September 30, 2009.

 

Wepay HPT Management Services LP, Behringer Harvard Real Estate Services, LLC, orBehringer Harvard Opportunity Management Services, LLC (collectively, “BHProperty Management”), affiliates of our advisor and our property managers,fees for management, leasing, and construction supervision of our properties,which may be subcontracted to unaffiliated third parties.  Such fees are equal to 4.5% of gross revenuesplus leasing commissions based upon the customary leasing commission applicableto the same geographic location of the respective property.  In the event that we contract directly with anon-affiliated third-party property manager in respect of a property, we willpay BH Property Management an oversight fee equal to 0.5% of gross revenues ofthe property managed.  In no event willwe pay both a property management fee and an oversight fee to BH PropertyManagement with respect to any particular property.  We incurred and expensed property managementfees or oversight fees totaling $1.2 million and $1.5 million in the ninemonths ended September 30, 2010 and 2009, respectively.  For each of the nine months ended September 30,2010 and 2009, we incurred less than $0.1 million of construction managementfees payable to BH Property Management.

 

Wepay Behringer Opportunity Advisors I an annual asset management fee of 0.75% ofthe aggregate asset value of acquired real estate.  The fee is payable monthly in an amount equalto one-twelfth of 0.75% of the aggregate asset value as of the last day of thepreceding month.  For the nine monthsended September 30, 2010, we expensed $4.5 million of asset managementfees.  In August 2010, BehringerOpportunity Advisors I deferred until March 31, 2011 our obligation to payall asset management fees accruing during the months of May 2010 through October 2010and all debt financing fees and administrative service expense reimbursementsaccruing during the months of July 2010 through October 2010 totaling$2.1 million.  Further, in August 2010,BH Property Management deferred until March 31, 2011 our obligation to payproperty management oversight fees accruing during the months of July 2010through October 2010 totaling $0.1 million.  For the nine months ended September 30,2009, we expensed $4.1 million of asset management fees and capitalized lessthan $0.1 million of asset management fees to real estate.

 

We will reimburse Behringer Opportunity Advisors I or its affiliatesfor all expenses paid or incurred by them in connection with the services theyprovide to us, including direct expenses and the costs of salaries and benefitsof persons employed by those entities and performing services for us, subjectto the limitation that we will not reimburse for any amount by which ouradvisor’s operating expenses (including the asset management fee) at the end ofthe four fiscal quarters immediately preceding the date reimbursement is soughtexceeds the greater of:  (1) 2% ofour average invested assets or (2) 25% of our net income for that fourquarter period other than any additions to reserves for depreciation, bad debtsor other similar non-cash reserves and any gain from the sale of our assets forthat period.  Notwithstanding thepreceding sentence, we may reimburse the advisor for expenses in excess of thislimitation if a majority of our independent directors determines that suchexcess expenses are justified based on unusual and non-recurring factors.  For the nine months ended September 30,2010 and 2009, we incurred and expensed costs for administrative servicestotaling $1.4 million and $1.3 million, respectively.

 

AtSeptember 30, 2010, we had a payable to our advisor and its affiliates of$2.9 million.  This balance consistsprimarily of asset management fees and administrative service expenses payableto Behringer Opportunity Advisors I, 

 

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**BehringerHarvard Opportunity REIT I, Inc.**

**Notes toConsolidated Financial Statements**

**(Unaudited)**

 

managementfees payable to BH Property Management, and other miscellaneous payables.  This payable is partially offset by areceivable from our advisor and its affiliates of $0.1 million, which isincluded in receivables from related parties at September 30, 2010.

 

We are dependent on Behringer Opportunity Advisors I and BH PropertyManagement for certain services that are essential to us, including assetacquisition and disposition decisions, property management and leasingservices, and other general administrative responsibilities.  In the event that these companies were unableto provide us with the respective services, we would be required to obtain suchservices from other sources.

 

**16.      Stock-Based Compensation**

 

TheBehringer Harvard Opportunity REIT I, Inc. Amended and Restated 2004Incentive Award Plan (“Incentive Award Plan”) was approved by our board ofdirectors on July 19, 2005 and by our stockholders on July 25, 2005,and provides for equity awards to our directors and consultants and toemployees, directors, and consultants of our affiliates.  In November 2008, the board of directorsapproved an amendment to the grantees’ stock option agreements for all awardsgranted prior to December 31, 2007, setting forth a revised vesting andexpiration schedule.  Accordingly, alloptions granted prior to December 31, 2007 that were previouslyoutstanding and fully vested are subject to the revised vesting and expirationschedule as follows:  25% becomeexercisable in each of the calendar years 2010 and 2011 with the remaining 50%exercisable in the calendar year 2012. Any vested awards not exercised in the calendar year specified areforfeited and no longer exercisable.  Wedid not recognize any incremental compensation cost resulting from thesemodifications.

 

OnJune 22, 2009, we issued options to purchase 5,000 shares of our commonstock at $8.17 per share to each of our three independent directors pursuant tothe Incentive Award Plan.  On July 24,2008, we issued options to purchase 5,000 shares of our common stock at $9.50per share to each of our three independent directors pursuant to the IncentiveAward Plan.  The options issued in 2009became exercisable one year after the date of grant.  As of September 30, 2010, options topurchase 69,583 shares of stock were outstanding, at a weighted averageexercise price per share of $8.99.  Ofthese outstanding shares, 39,896 are fully vested, at a weighted averageexercise price per share of $8.90.  Theremaining contractual life of the outstanding options is 3.1 years.  Compensation expense associated with ourIncentive Award Plan was not material for the nine months ended September 30,2010 or 2009.

 

**17.      Supplemental Cash FlowInformation**

 

Supplemental cash flow information is summarized below.

 
| ** **                                                                                          | ** ** | **Nine months ended September 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                                                          | ** ** | **2010**                                                | ** ** | **2009** | ** ** |
| **Supplemental disclosure:**                                                                        |       |                                                    |       |   |   |
| Interest paid, net of amounts capitalized                                                           |       | $                                                       | 9,487      |   | $ | 10,522 |   |
|                                                                                                |       |                                                    |       |   |   |
| **Non-cash investing activities:**                                                                  |       |                                                    |       |   |   |
| Property and equipment additions and purchases of  real estate in accrued liabilities               |       | $                                                       | 42         |   | $ | 140 |   |
| Capital expenditures for real estate under development  in accounts payable and accrued liabilities |       | $                                                       | 2,422      |   | $ | 1,123 |   |
| Amortization of deferred financing fees in  properties under development                            |       | $                                                       | 56         |   | $ | 218 |   |
|                                                                                                |       |                                                    |       |   |   |
| **Non-cash financing activities:**                                                                  |       |                                                    |       |   |   |
| Common stock issued in distribution reinvestment  plan                                              |       | $                                                       | 4,745      |   | $ | 6,996 |   |

 

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**BehringerHarvard Opportunity REIT I, Inc.**

**Notes toConsolidated Financial Statements**

**(Unaudited)**

 

**18.****                  ****DiscontinuedOperations**

 

During the nine months ended September 30, 2010, pursuant to adeed-in-lieu of foreclosure, we transferred ownership of our property,Ferncroft Corporate Center, to the lender associated with this property.  The results of this property is classified asdiscontinued operations in the accompanying consolidated statements ofoperations and other comprehensive loss for the three and nine months ended September 30,2010 and 2009 and summarized in the following table:

 
| ** **                        | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|-----------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                        | ** ** | **2010**                                             | ** ** | **2009**                                            | ** ** | **2010** | ** ** | **2009** | ** ** |
|                              |       |                                                 |       |                                                |       |   |   |   |   |
| **Revenues**                      |       |                                                 |       |                                                |       |   |   |   |   |
| Rental revenue                    |       | $                                                    | 498        |                                                | $          | 1,548 |   | $ | 2,185 |   | $ | 4,701 |   |
|                              |       |                                                 |       |                                                |       |   |   |   |   |
| **Expenses**                      |       |                                                 |       |                                                |       |   |   |   |   |
| Property operating expenses       |       | 394                                                  |       | 633                                                 |       | 1,623 |   | 1,803 |   |
| Bad debt expense                  |       | 1                                                    |       | 131                                                 |       | 1 |   | 131 |   |
| Interest expense                  |       | 160                                                  |       | 303                                                 |       | 755 |   | 898 |   |
| Real estate taxes                 |       | 43                                                   |       | 77                                                  |       | 216 |   | 250 |   |
| Impairment charge                 |       | —                                               |       | —                                              |       | 4,230 |   | — |   |
| Property management fees          |       | 15                                                   |       | 59                                                  |       | 102 |   | 197 |   |
| Asset management fees             |       | 33                                                   |       | 50                                                  |       | 135 |   | 152 |   |
| Depreciation and amortization     |       | 199                                                  |       | 589                                                 |       | 794 |   | 2,407 |   |
| Total expenses                    |       | 845                                                  |       | 1,842                                               |       | 7,856 |   | 5,838 |   |
|                              |       |                                                 |       |                                                |       |   |   |   |   |
| Other income (expense)            |       | (1                                                   | )          | 1                                                   |       | (2 | ) | 1 |   |
| Loss on debt extinguishment       |       | (2,253                                               | )          | —                                              |       | (2,253 | ) | — |   |
|                              |       |                                                 |       |                                                |       |   |   |   |   |
| Loss from discontinued operations |       | $                                                    | (2,601     | )                                                   | $          | (293 | ) | $ | (7,926 | ) | $ | (1,136 | ) |

 

**19.****                  ****SubsequentEvents**

 

*Stock-Based Compensation*

 

OnOctober 18, 2010, we issued options to purchase 5,000 shares of our commonstock at $8.03 per share to each of our three independent directors pursuant tothe Incentive Award Plan.  The optionsissued become exercisable one year after the date of grant.

 

*GrandMarc at the Corner*

 

OnOctober 22, 2010, we sold our 50% equity interest in the GrandMarc at theCorner, a student housing complex at the University of Virginia inCharlottesville, Virginia, to an unaffiliated third party.  The aggregate sale price for the GrandMarc atthe Corner was $45.5 million.  As of thedate of the sale, we no longer have any continuing involvement in the GrandMarcat the Corner.

 

*Chase Park Plaza*

 

On November 15, 2007,we entered into separate, secured loans with Bank of America, as leadadministrative agent and lender, and other financial institutions, related toour Chase Park Plaza Hotel and The Private Residences properties, located inSt. Louis, Missouri (collectively, “Chase Park Plaza”) to borrow up to anaggregate of $145 million for the redevelopment and construction of Chase ParkPlaza and to repay a $55 million loan assumed at the acquisition of Chase ParkPlaza.  The loans are secured by ChasePark Plaza.  We have a 95% ownershipinterest in Chase Park Plaza and have unconditionally guaranteed 50% of theChase Park Plaza loans.  The loanagreements and related loan documents are collectively referred to as the LoanAgreement.

 

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**BehringerHarvard Opportunity REIT I, Inc.**

**Notes toConsolidated Financial Statements**

**(Unaudited)**

 

Pursuantto the terms of the Loan Agreement, the Chase Park Plaza loans matured on November 15,2010.  We have been in negotiations withthe lender to restructure and extend the loans. However, we have not reached an agreement with the lender to restructureor extend the loans as of the maturity date resulting in an event of defaultunder the Loan Agreement.  We arecurrently in communication with the lender to waive the event of default andcontinue negotiations to restructure the loans’ terms.  However, there are no assurances that we willbe successful in our negotiations with the lender.  Accordingly, pursuant to the terms of theLoan Agreement, we are subject to: (i) an immediate increase in ourfinancial obligation to the lender in connection with the interest rateincreasing to a higher default rate; (ii) the lender foreclosing on ChasePark Plaza; and/or (iii) the lender may pursue their rights under theguaranty against us.

 

*****

 

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**Item 2.                    Management’s Discussion andAnalysis of Financial Condition and Results of Operations.**

 

The following discussion andanalysis should be read in conjunction with the accompanying financialstatements of the Company and the notes thereto:

 

**Forward-LookingStatements**

 

Certainstatements in this Quarterly Report on Form 10-Q constitute “forward-lookingstatements” within the meaning of Section 27A of the Securities Act of1933, as amended (the “Securities Act”) and Section 21E of the SecuritiesExchange Act of 1934, as amended (the “Exchange Act”).  These forward-looking statements includediscussion and analysis of the financial condition of Behringer HarvardOpportunity REIT I, Inc. and our subsidiaries (which may be referred toherein as the “Company,” “REIT,” “we,” “us,” or “our”), including our abilityto rent space on favorable terms, to address our debt maturities and to fundour liquidity requirements, the value of our assets, our anticipated capitalexpenditures, the amount and timing of anticipated future cash distributions toour stockholders, the estimated per share value of our common stock and othermatters.  Words such as “may,” “anticipates,”“expects,” “intends,” “plans,” “believes,” “seeks,” “estimates,” “would,” “could,”“should” and variations of these words and similar expressions are intended toidentify forward-looking statements.

 

Theseforward-looking statements are not historical facts but reflect the intent,belief or current expectations of our management based on their knowledge andunderstanding of the business and industry, the economy and other futureconditions.  These statements are notguarantees of future performance, and we caution stockholders not to placeundue reliance on forward-looking statements. Actual results may differ materially from those expressed or forecastedin the forward-looking statements due to a variety of risks, uncertainties andother factors, including but not limited to the factors listed and describedunder Item 1A, “Risk Factors” in our Annual Report on Form 10-K filed withthe Securities and Exchange Commission on March 19, 2010 and the factorsdescribed below:

 

·                  market and economic challenges experienced bythe U.S. economy or real estate industry as a whole and the local economicconditions in the markets in which our properties are located;

 

·                  the availability of cash flow from operatingactivities for distributions and capital expenditures;

 

·                  a decrease in the level of participationunder our distribution reinvestment plan;

 

·                  our level of debt and the terms andlimitations imposed on us by our debt agreements;

 

·                  the availability of credit generally, and anyfailure to refinance or extend our debt as it comes due or a failure to satisfythe conditions and requirements of that debt;

 

·                  the need to invest additional equity inconnection with debt refinancings as a result of reduced asset values andrequirements to reduce overall leverage;

 

·                  future increases in interest rates;

 

·                  our ability to raise capital in the future byissuing additional equity or debt securities, selling our assets or otherwise;

 

·                  impairment charges;

 

·                  our ability to retain our executive officersand other key personnel of our advisor, our property manager and theiraffiliates;

 

·                  conflicts of interest arising out of ourrelationships with our advisor and its affiliates;

 

·                  unfavorable changes in laws or regulationsimpacting our business or our assets; and

 

·                  factors that could affect our ability toqualify as a real estate investment trust.

 

Forward-lookingstatements in this Quarterly Report on Form 10-Q reflect our management’sview only as of the date of this Report, and may ultimately prove to beincorrect or false.  We undertake noobligation to update or revise forward-looking statements to reflect changedassumptions, the occurrence of unanticipated events or changes to futureoperating results.  We intend for theseforward-looking statements to be covered by the applicable safe harborprovisions created by Section 27A of the Securities Act and Section 21Eof the Exchange Act.

 

**Cautionary Note**

 

Therepresentations, warranties, and covenants made by us in any agreement filed asan exhibit to this report on Form 10-Q are made solely for the benefit ofthe parties to the agreement, including, in some cases, for the purpose of 

 

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allocatingrisk among the parties to the agreement, and should not be deemed to berepresentations, warranties or covenants to or with any other parties.  Moreover, these representations, warrantiesor covenants should not be relied upon as accurately describing or reflectingthe current state of our affairs.

 

**ExecutiveOverview**

 

Weare a Maryland corporation that was formed in November 2004 to invest inand operate commercial real estate or real-estate related assets located in oroutside the United States on an opportunistic basis.  We conduct substantially all of our businessthrough our operating partnership and its subsidiaries. We are organized andqualify as a real-estate investment trust (“REIT”) for federal income taxpurposes.

 

We are externally managed and advised by Behringer Harvard OpportunityAdvisors I, LLC (“Behringer Opportunity Advisors I”), a Texas limited liabilitycompany formed in June 2007. Behringer Opportunity Advisors I is responsible for managing ourday-to-day affairs and for identifying and making acquisitions and investmentson our behalf.

 

Asof September 30, 2010, we had invested in 22 assets including ten whollyowned properties and six consolidated properties through investments in joint ventures.  In addition, we are the mezzanine lender forone multifamily property.  We also havenoncontrolling, unconsolidated ownership interests in four properties and oneinvestment in a joint venture consisting of 22 properties that are accountedfor using the equity method.  Ourinvestment properties are located in Arizona, California, Colorado, Minnesota,Missouri, Nevada, Texas, Virginia, the Commonwealth of The Bahamas, London,England, the Czech Republic, Poland, Hungary, and Slovakia.  During the nine months ended September 30,2010, pursuant to a deed-in-lieu of foreclosure, we transferred ownership ofFerncroft Corporate Center, located in Middleton, Massachusetts, to the lenderassociated with this property.

 

*MarketOutlook*

 

Beginningin 2008, the U.S. and global economies experienced a significant downturn.  This downturn included disruptions in thebroader financial and credit markets, declining consumer confidence, and anincrease in unemployment rates.  Theseconditions have contributed to weakened market conditions.  Due to the struggling U.S. and globaleconomies, overall demand across most real estate sectors including office,hospitality, and retail remains low due to losses in the financial and professionalservices industries and a U.S. unemployment rate of 10% throughout much of thesecond half of 2009.  We believe thatcorresponding rental rates will also remain weak at least through 2010.  The national vacancy percentage for officespace increased from 14.5% in the fourth quarter of 2008 to 19.6% in the secondquarter of 2010.  Vacancies are expectedto peak at around 19.6% in 2010. Further, we believe that tenant defaults and bankruptcies are likely toincrease in the short-term.  To date, wehave not experienced any significant tenant defaults resulting in the loss ofmaterial rental income.

 

Thehospitality industry is beginning to see early signs of a recoveringeconomy.  Smith Travel Research indicatesthat the national overall occupancy rate for hospitality properties in theUnited States rose from 50.6% in the fourth quarter of 2009 to 58.9% in thethird quarter of 2010.  The nationaloverall Average Daily Rate (“ADR”) has also risen, from $95.79 in the fourthquarter of 2009 to $97.89 in the third quarter of 2010.  This positive growth in the hospitalityindustry is expected to continue.

 

Inthe multifamily real estate sector, a limited new supply of multifamily assetsis expected in the near future.  Sincehigh quality multifamily developments can take 18 months to 36 months to entitle,obtain necessary permits, and construct, we believe there will be an imbalancein supply and demand fundamentals for at least the next couple of years.  As the economy improves, we expect renterdemand and effective rents to increase in multifamily communities.  Particularly after 2010, we expectmultifamily rental rates to begin to return to their pre-recession levels.

 

Wehave several projects in various stages of development including Rio Saladolocated in Phoenix, Arizona and The Lodge & Spa at Cordillera locatedin Edwards, Colorado.  Due in large partto the struggling U.S. and global economies, we have decided to defer furthersubstantive development activities on these projects for the near term.

 

Whileit is unclear as to when the overall economy will recover, we do not expectconditions to improve significantly in the near future.  Management expects that the currentvolatility in the capital markets will continue, at least in the short-term.  This volatility has significantly impactedthe availability of credit for borrowers. These market conditions make it more difficult to refinance assets whentheir mortgages mature as well as impact our ability to access bank capital forleasing, tenant improvements, and other capital needs of our properties.  Consequently, we may seek alternative sourcesof financing to achieve our investment objectives, including using the proceedsfrom the sale of our properties, reducing or eliminating our quarterlydistributions, and further limiting or suspending our share redemption program.

 

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*Strategic Asset Sales*

 

Webelieve it makes economic sense to sell properties in today’s market in certaininstances, such as when the value of the in-place cash flows from existingtenants is stable, predictable and attractive to potential buyers, when theproperty has limited or no equity with a near-term debt maturity, or when theequity in a property can be redeployed in the portfolio in order to achievebetter returns or strategic goals.

 

Ourmanagement has begun to review strategies to execute the original business planfor the REIT and create additional liquidity for the Company and itsstockholders by identifying several distinct sub-portfolios:  a near-term disposition portfolio, a mid-termdisposition portfolio, and a long-term disposition portfolio.  The near-term disposition portfolio comprisedof six stabilized properties that offer the best opportunity for disposition in2011 based on the current stability of their tenancy combined with limitedlease rollover during 2011 — 2013 and one property with a near-term debtmaturity that would require additional capital. Consequently, we anticipate these properties will be disposed of during2011.  The mid-term disposition portfoliois comprised of three stabilized properties in markets that would benefit fromanticipated rental increases and improving local markets before sale and nineproperties that are in various stages of working towards stabilization for aneventual disposition, which may require additional time to lease up vacancy,retain a key tenant, re-investment to create value, or the sale of condominiumunits or land parcels.  We anticipatecompleting these strategies in the 2011 — 2013 timeframe.  The long-term liquidation portfolio iscomprised of three development projects and a final exit is contingent upon astabilized economy and resurgent demand for the respective product types.  It is possible that management will investenough additional capital in two of these sites to make them attractive tomarket to other developers rather than complete the original development plan.  If so, a disposition of these three assets isexpected to occur by or before 2014.  Dueto the nature of these various portfolios, we believe that distributions to ourshareholders will occur in a phased manner and that most or all of the netproceeds from sales occurring in late 2010 or 2011 will be used to provideliquidity to refinance maturing debt, cover operating expenses, and makeenhancements to portfolio properties in cases where additional investment makessense for maximizing total stockholder value. However, there can be no assurance that future dispositions will occur,or, if they occur, that they will help us to achieve our objectives.

 

**Liquidity and Capital Resources**

 

Our principal demands forfunds for the next twelve months and beyond will be for the payment of costsassociated with the lease-up of available space at our operating properties(including commissions, tenant improvements, and capital improvements), forcertain ongoing costs at our development properties, for the payment ofoperating expenses and distributions, and for the payment of interest andprincipal on our outstanding indebtedness. Generally, cash needs for items other than costs associated with thelease-up of available space at our operating properties (including commissions,tenant improvements, and capital improvements) and ongoing costs at ourdevelopment properties are expected to be met from operations andborrowings.   In August 2010,Behringer Opportunity Advisors I deferred until March 31, 2011 ourobligation to pay all asset management fees accruing during the months of May 2010through October 2010 and all debt financing fees and expensereimbursements accruing during the months of July 2010 through October 2010.  Also in August 2010, BH PropertyManagement deferred until March 31, 2011 our obligation to pay propertymanagement oversight fees accruing during the months of July 2010 through October 2010.

 

We expect to fund ourshort-term liquidity requirements by using short-term borrowings and cash flowfrom the operations of our current investments.  For both our short-termand long-term liquidity requirements, other potential sources of capital mayinclude proceeds from secured or unsecured debt financing, assetdispositions, reduction or elimination of the amount of distributions paid,decreases in the amount of nonessential capital expenditures, deferral of feespaid to Behringer Harvard Opportunity Advisors I, further limitation on thepayment of redemptions, and undistributed funds from operations.  Ifnecessary, we may use financings or other sources of capital in the event ofunforeseen significant capital expenditures.

 

OnOctober 22, 2010, we sold our 50% equity interest in the GrandMarc at theCorner, a student housing complex at the University of Virginia inCharlottesville, Virginia, to an unaffiliated third party.  The aggregate sale price for the GrandMarc atthe Corner was $45.5 million.  Ourportion of the proceeds, following the pay off of the outstanding third-partysenior loan and after selling costs, was approximately $8.8 million, which willbe used to fund ongoing development costs at our Frisco Square property andother operating needs.

 

Asdiscussed in more detail in “Strategic Asset Sales” above, there can be noassurance that future dispositions will occur, or, if they occur, that theywill help us to achieve our objectives. In addition, we may seek to raise capital by contributing one or more ofour existing assets to a joint venture with a third party.  Investments in joint ventures may, undercertain circumstances, involve risks not present when a third party is notinvolved.  Our ability to successfullyidentify, negotiate, and complete joint venture transactions on acceptableterms or at all is highly uncertain in the current economic environment.

 

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*Royal Island*

 

OnSeptember 14, 2010, we entered into a forbearance agreement with the RoyalIsland borrower pursuant to which, among other things, the borrower agreed notto contest or oppose any foreclosure, exercise of power of sale, or similaraction we may seek in order to protect our investment in Royal Island.  Further, the borrower agreed to fully cooperateto expedite the proceedings should we take such a course of action.

 

*Debt Financings*

 

Oneof our principal long-term liquidity requirements includes the repayment ofmaturing debt, including borrowings under our senior secured credit facilitydiscussed below.  The following tableprovides information with respect to the contractual maturities and scheduled principalrepayments of our indebtedness as of September 30, 2010.  The table does not represent any extensionoptions (amounts in thousands).

 
| ** **                                                                                       | ** ** | **Payments Due by Period**                       | ** ** |
|--------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------|------------|
| ** **                                                                                       | ** ** | **October 1, 2010 -December 31, 2010** | ** ** | **2011-2012** | ** ** | **2013-2014** | ** ** | **After 2014** | ** ** | **Total** | ** ** |
| Principal payments - fixed rate debt                                                             |       | $                                                               | 145        |   | $ | 623 |   | $ | 702 |   | $ | 18,883 |   | $ | 20,353 |   |
| Interest payments - fixed rate debt                                                              |       | 584                                                             |       | 2,292 |   | 2,214 |   | 1,166 |   | 6,256 |   |
| Principal payments - variable rate debt                                                          |       | 87,095                                                          |       | 213,676 |   | 25,000 |   | — |   | 325,771 |   |
| Interest payments - variable rate debt (based on  rates in effect as of September 30, 2010) |       | 2,072                                                           |       | 8,735 |   | 727 |   | — |   | 11,534 |   |
|                                                                                             |       |                                                            |       |   |   |   |   |   |   |   |   |
| Total                                                                                            |       | $                                                               | 89,896     |   | $ | 225,326 |   | $ | 28,643 |   | $ | 20,049 |   | $ | 363,914 |   |

 

Thetable below provides information regarding our notes payable with scheduledmaturities in the twelve months following September 30, 2010, along withextension options, if available. Available extension options that are associated with the notes payablelisted below are subject to certain conditions as required under the respectiveloan agreements (amounts in thousands).

 
| **Description**                 | ** ** | **Balance at  September 30,  2010** | ** ** | **Maturity  Date** | ** ** | **Extension  Options** | ** **           |
|---------------------------------|------------|-----------------------------------------------|------------|--------------------|------------|------------------------|----------------------|
| Chase Park Plaza Hotel          |       | $                                             | 77,474     |               | 11/15/10   |                   | Two one-year options |   |
| Chase - The Private Residences  |       | 9,132                                         |       | 11/15/10           |       | Two one-year options   |                 |
| Senior Secured Credit Facility  |       | 70,082                                        |       | 02/13/11           |       | Two one-year options   |                 |
| Becket House - RBS              |       | 18,497                                        |       | 03/09/11           |       | None                   |                 |
| Crossroads                      |       | 25,316                                        |       | 06/30/11           |       | Two one-year options   |                 |
| Frisco Square I, LLC (Land)     |       | 23,218                                        |       | 07/28/11           |       | One one-year option    |                 |
| Frisco Square II, LLC           |       | 7,801                                         |       | 07/28/11           |       | Two one-year options   |                 |
| Frisco Square III, LLC          |       | 8,515                                         |       | 07/28/11           |       | Two one-year options   |                 |
| Frisco Square IV, LLC           |       | 14,569                                        |       | 07/28/11           |       | Two one-year options   |                 |
|                            |       |                                          |       |               |       |                   |                 |
| Total due in next twelve months |       | $                                             | 254,604    |               |       |                   |                 |   |
|                            |       |                                          |       |               |       |                   |                 |

 

With respect to our debt duein the next twelve months, we are working with our lenders to either extend thematurity dates of the loans or refinance the loans under different terms.  We currently expect to use funds generated byour operating properties, additional borrowings, and proceeds from thedisposition of properties to continue making our 

 

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scheduled debt servicepayments until the maturity dates of the loans are extended, the loans arerefinanced, or the outstanding balance of the loans are completely paidoff.  However, there is no guarantee thatwe will be able to refinance our borrowings with more or less favorable terms orextend the maturity dates of such loans. In addition, the continued economic downturn and lack of availablecredit could delay or inhibit our ability to dispose of our properties in anorderly manner, or cause us to have to dispose of our properties for a lowerthan anticipated return.

 

Our notes payable decreasedto $347 million at September 30, 2010 from $429.8 million at December 31,2009 primarily as a result of the deconsolidation of Alexan Black Mountain,effective January 1, 2010 (see Note 8 to our consolidated financialstatements) and the deed-in-lieu of foreclosure related to Ferncroft CorporateCenter.  Each of our loans is secured byone or more of our properties.  AtSeptember 30, 2010, our notes payable interest rates ranged from 2% to8.8%, with a weighted average interest rate of 3.4%.  Generally, our notes payable mature atapproximately two to ten years from origination and require payments ofinterest only for approximately two to five years, with all principal andinterest due at maturity. Notes payable associated with our Northborough andFrisco Square investments require monthly payments of both principal andinterest.  At September 30, 2010,our notes payable had maturity dates that range from November 2010 to January 2016.

 

Thecommercial real estate debt markets have been experiencing and continue toexperience volatility as a result of certain factors, including the tighteningof underwriting standards by lenders and credit rating agencies.  Credit spreads for major sources of capitalhave widened significantly as investors have demanded a higher riskpremium.  This is resulting in lendersincreasing the cost for debt financing. Current economic conditions, as well as few unmortgaged assets, negativelyimpact our ability to finance capital needs through borrowings.  Current market conditions also make it moredifficult to refinance assets when their mortgages mature.  In general, in the current market lendershave increased the amount of equity required to support either new or existingborrowings.  Consequently, there isgreater uncertainty regarding our ability to access the credit markets in orderto attract financing on reasonable terms.

 

Asthe overall cost of borrowings increase, either by increases in the index ratesor by increases in lender spreads, we will need to factor such increases intothe economics of our developments and property contributions.  This may result in our investment operationsgenerating lower overall economic returns and a reduced level of cash flow, whichcould potentially impact our ability to make distributions to our stockholdersat current levels.  In addition, therecent dislocations in the debt markets have reduced the amount of capital thatis available to finance real estate, which, in turn: (i) leads to adecline in real estate values generally; (ii) slows real estatetransaction activity; (iii) reduces the loan to value upon which lendersare willing to extend debt; and, (iv) results in difficulty in refinancingdebt as it becomes due, all of which may reasonably be expected to have amaterial adverse impact on the value of real estate investments and therevenues, income or cash flow from the acquisition and operations of realproperties and mortgage loans.  Inaddition, the current state of the debt markets has negatively impacted theability to raise equity capital.

 

Ifdebt financing is not available on acceptable terms and conditions, we may notbe able to refinance maturing debt or obtain financing for investments.  Domestic and international financial marketshave been experiencing and continue to experience unusual volatility anduncertainty.  If this volatility anduncertainty persists, our ability to borrow monies, on acceptable terms andconditions, to finance the purchase of, or other activities related to, realestate assets will be significantly impacted. If we are unable to borrow monies on acceptable terms and conditions, wemay find it difficult, costly or impossible to refinance indebtedness uponmaturity.  If interest rates are higherwhen the properties are refinanced, our cash flow from operating activitieswill be reduced.  In addition, in thecurrent market, lenders have increased the amount of equity required to supporteither new or existing borrowings.

 

*Santa Clara Tech Center*

 

TheSanta Clara Tech Center property consists of three buildings:  the 700, 750, and 800 buildings.  The mortgage and mezzanine loans(collectively, the “Original Loans”) associated with the Santa Clara TechCenter matured on June 9, 2010.  Asof the maturity date, due to ongoing negotiations with an unaffiliated thirdparty (the “Santa Clara JV Partner”) to create the joint ventures discussedbelow, we had not yet reached an agreement with the lender to extend the termsof the Original Loans and accordingly, we were granted a forbearance by thelender through August 5, 2010.

 

OnAugust 5, 2010, we reached agreements to sell a 50% interest in the SantaClara Tech Center to the Santa Clara JV Partner, to create two joint ventureswith the Santa Clara JV Partner to own the Santa Clara Tech Center, and tosever and replace the Original Loans with new loans from the Santa Clara lenderas describe below.

 

Further,on August 5, 2010, we entered into the following arrangements:

 

·                  We entered into an agreement with the SantaClara JV Partner to sell a 50% interest in the Santa Clara Tech Center propertyfor $8.8 million in cash;

 

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·                  We entered into two joint ventures with theSanta Clara JV Partner so that one joint venture holds the 700 and 750buildings (the “700/750 Joint Venture”) separately from the joint venture thatholds the 800 building (the “800 Joint Venture”).  We contributed our remaining 50% interest inthe Santa Clara Tech Center along with an aggregate $8.8 million of cash inexchange for 50% interests in each of the two new joint ventures.  The Santa Clara JV Partner also contributedan aggregate $8.8 million of cash and their 50% interest in the Santa ClaraTech Center in exchange for their respective 50% interests.   In addition, the Santa Clara JV Partneracquired preferred equity interests in the joint ventures for an aggregate $7.5million in cash, which was used to pay down the Original Loans’ outstandingbalance discussed below;

 

·                  The agreements associated with the OriginalLoans were severed and replaced by new loan agreements with the same lender bybifurcating the Original Loans into two new loans (the “Replacement Loans”)such that the balance of the Replacement Loans at inception associated with the700 and 750 buildings totaled $25 million and the balance associated with the800 building totaled $20.5 million;

 

·                  The new joint ventures paid down the OriginalLoans’ balance by an aggregate $7 million, such that the balances of theReplacement Loans at inception were an aggregate of $45.5 million;

 

·                  The maturity date of the Replacement Loans isJune 9, 2013;

 

·                  The Replacement Loans require payment ofinterest only until maturity at a rate equal to:

 

·                  Replacement mortgage loans —either (i) the greater of 1% or the 30-day LIBOR, plus 4.75% (the “LIBOROption”), or (ii) the prime rate plus the difference between the LIBOROption and the prime rate; and

 

·                  Replacement mezzanine loans —either (i) the greater of 1% or the 30-day LIBOR, plus 8.5% (the “MezzanineLIBOR Option”), or (ii) the prime rate plus the difference between theMezzanine LIBOR Option and the prime rate;

 

·                  There is no penalty for prepayment of theReplacement Loans, subject to certain conditions; and

 

·                  The capital contributed to the 700/750 JointVenture and 800 Joint Venture will be used to construct and develop the vacantspace in the 800 building as data center pods. Accordingly, cash contributions received into the 700/750 Joint Venturewere subsequently contributed to the 800 Joint Venture.

 

The700/750 Joint Venture agreement provides the Santa Clara JV Partner with a putoption that could require us to re-acquire the Santa Clara JV Partners’ 50%interest in the 700/750 Joint Venture at a fixed price upon satisfaction ofcertain conditions.  Under GAAP, thecondition of retaining the substantial risk or rewards of ownership such as aput option precludes us from recognizing the sale of the 700 and 750 buildingsto the Santa Clara JV Partner. Accordingly, we will continue to reflect the assets and liabilities ofthe 700 and 750 buildings in our consolidated balance sheet as if a sale hadnot occurred.  Further, we haverecognized the $6 million cash contribution received from the Santa Clara JVPartner for their respective 50% interest in the 700/750 Joint Venture as adeposit in accrued and other liabilities in our consolidated balance sheet at September 30,2010 pending termination or cancellation of the put option or until the sale isconsidered consummated under GAAP.  The800 Joint Venture agreement does not contain a put option provision.

 

*Becket House*

 

Ourloan agreements generally stipulate that we comply with certain reporting andfinancial covenants.  These covenantsinclude, among other things, notifying the lender of any change in managementand maintaining minimum debt service coverage ratios.  As a result of the difficult economicconditions negatively impacting both occupancy and rental rates at the BecketHouse, which caused lease renewals and new leases to be executed atsubstantially lower rates per square foot, we were unable to meet certainfinancial covenants under the Becket House loan agreement as of September 30,2010.  In addition, in 2009 and 2008, werecognized impairment charges related to our leasehold interest in Becket Houseof $9.9 million and $6 million, respectively. Failure to meet the loan covenants under the loan agreement constitutesa technical default and, absent a waiver or modification of the loan agreement,the lender may accelerate maturity with any unpaid interest and principalimmediately due and payable.  At September 30,2010, the outstanding principal balance of the Becket House loan was $18.5million.  We are currently innegotiations with the lender to waive the event of noncompliance or modify theloan agreement.  However, there are noassurances that we will be successful in our negotiations with the lender. TheBecket House loan is non-recourse to us.  In addition, we are evaluating alternative sources of financing forBecket House including on-going discussions with an unaffiliated third party toprovide additional equity capital and restructure the existing joint venture.

 

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*Credit Facility*

 

OnFebruary 13, 2008, we entered into a senior secured revolving credit facility(the “Credit Agreement”) providing for up to $75 million of secured borrowingswith Bank of America, as lender and administrative agent, and other lendinginstitutions that become a party to the Credit Agreement.  The credit facility is secured by a firstlien on all real property assets in a collateral pool consisting of five whollyowned properties.  Loans under the creditfacility bear interest at an annual rate that is equal to a combination of (i) theLIBOR plus an applicable margin that, depending upon the debt service coverageratio, may vary from 1.5% to 1.7%, or (ii) the prime rate plus anapplicable margin that, depending upon the debt service coverage ratio, mayvary from 0% to 0.2%.  The creditfacility matures on February 13, 2011. We have two options to extend the maturity date for a period of twelvemonths each upon meeting certain conditions per the Credit Agreement.

 

Wehave unconditionally guaranteed payment of the senior secured revolving creditfacility.  The availability of creditunder the senior secured credit facility is limited by the terms of the CreditAgreement.  As of September 30,2010, the maximum availability and outstanding balance under the senior securedcredit facility was $70.1 million.  Theproceeds of the senior secured credit facility have been used to fund ongoingcosts at our development and operating properties and for general corporatepurposes.

 

Ourability to fund our liquidity requirements are expected to come from the cashand cash equivalents on the consolidated balance sheet totaling $3.5 million asof September 30, 2010, additional amounts that may become available underour senior secured credit facility, and proceeds from the disposition of ourproperties.  As necessary, we may seekalternative sources of financing including using the proceeds from the sale ofour properties and temporarily reducing or eliminating our quarterlydistribution to achieve our investment objectives.

 

Asof September 30, 2010, restricted cash on the consolidated balance sheetof $3.1 million includes amounts set aside as interest reserves totaling $1.1million.  The remaining balance of $2million includes amounts set aside related to certain operating properties fortenant improvement and commission reserves, tax reserves, maintenance andcapital expenditures reserves, and other amounts as may be required by ourlenders.

 

*Joint Venture Indebtedness*

 

Wehave noncontrolling, unconsolidated ownership investments in four propertiesand one investment in a joint venture consisting of 22 properties.  Our effective ownership percentages rangefrom 30% to 50%.  We exercise significantinfluence over, but do not control, these entities and therefore they arepresently accounted for using the equity method of accounting.  As of September 30, 2010, the aggregatedebt held by unrelated parties, including both ours and our partners’ share,incurred by these ventures was approximately $177.8 million.

 

Thetable below summarizes the outstanding debt of these properties as of September 30,2010 (amounts in thousands).

 
| ** **                                   | ** ** | **Venture**   | ** ** | **Interest Rate**            | ** ** | ** **   | ** ** | ** **            | ** **           |
|----------------------------------------------|------------|---------------|------------|-----------------------------------|------------|--------------|------------|-----------------------|----------------------|
| ** **                                   | ** ** | **Ownership** | ** ** | **(as of**                   | ** ** | **Carrying** | ** ** | **Maturity**          | ** **           |
| **Properties**                               | ** ** | **%**         | ** ** | **September 30, 2010)** | ** ** | **Amount**   | ** ** | **Date**              | ** **           |
|                                         |       |          |       |                              |       |         |       |                  |                 |
| GrandMarc at the Corner                      |       | 50            | %          | 5.07                              | %          | $            | 26,963     |                  | January 1, 2020 |   |
| GrandMarc at Westberry Place                 |       | 50            | %          | 4.99                              | %          | 37,594       |       | January 1, 2020  |                 |
| Santa Clara 800 Joint  Venture mortgage loan |       | 50            | %          | 5.75                              | %          | 10,000       |       | June 9, 2013     |                 |
| Santa Clara 800 Joint Venture mezzanine loan |       | 50            | %          | 9.50                              | %          | 10,500       |       | June 9, 2013     |                 |
| Central Europe Joint Venture                 |       | 47            | %          | 2.43                              | %(1)       | 92,761       |       | March 1, 2012(2) |                 |
| Total                                        |       |          |       |                              |       | $            | 177,818    |                  |                 |   |

 

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(1)Representsthe weighted average interest rate of the various notes payable secured by the22 properties in the Central Europe Joint Venture.

(2)Representsthe weighted average maturity date of the various notes payable secured by the22 properties in the Central Europe Joint Venture.

 

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**Resultsof Operations**

 

Asof September 30, 2010, we had invested in 22 assets including ten whollyowned properties and six consolidated properties through investments in jointventures.  In addition, we are themezzanine lender for one multifamily property. We also have noncontrolling, unconsolidated ownership interests in fourproperties and one investment in a joint venture consisting of 22 propertiesthat are accounted for using the equity method. Our investment properties are located in Arizona, California, Colorado,Minnesota, Missouri, Nevada, Texas, Virginia, the Commonwealth of The Bahamas,London, England, the Czech Republic, Poland, Hungary, and Slovakia.

 

Asa result of new accounting guidance regarding the accounting and disclosurerequirements for the consolidation of variable interest entities, on January 1,2010, we deconsolidated the assets and liabilities of Alexan Black Mountain andTanglewood at Voss along with the associated revenue and expenses.

 

*Three months ended September 30,2010 as compared to three months ended September 30, 2009*

 
| ** **                    | ** ** | **Three months ended September 30,** | ** ** | **Increase (Decrease)** | ** ** |
|-------------------------------|------------|----------------------------------------------------------|------------|------------------------------|------------|
| ** **                    | ** ** | **2010**                                                 | ** ** | **2009**                     | ** ** | **Amount** | ** ** | **Percent** | ** ** |
| Revenue:                      |       |                                                     |       |                         |       |   |   |   |   |
| Rental revenue                |       | $                                                        | 11,468     |                         | $          | 14,400 |   | $ | (2,932 | ) | -20 | % |
| Hotel revenue                 |       | 1,720                                                    |       | 1,513                        |       | 207 |   | 14 | % |
| Condominium sales             |       | 664                                                      |       | 1,964                        |       | (1,300 | ) | -66 | % |
| Total revenues                |       | $                                                        | 13,852     |                         | $          | 17,877 |   | $ | (4,025 | ) | -23 | % |
|                          |       |                                                     |       |                         |       |   |   |   |   |
| Expenses:                     |       |                                                     |       |                         |       |   |   |   |   |
| Property operating expenses   |       | $                                                        | 4,909      |                         | $          | 6,223 |   | $ | (1,314 | ) | -21 | % |
| Bad debt expense              |       | 89                                                       |       | 10,146                       |       | (10,057 | ) | -99 | % |
| Cost of condominium sales     |       | 773                                                      |       | 1,983                        |       | (1,210 | ) | -61 | % |
| Interest expense              |       | 3,932                                                    |       | 4,112                        |       | (180 | ) | -4 | % |
| Real estate taxes             |       | 1,588                                                    |       | 1,609                        |       | (21 | ) | -1 | % |
| Impairment charge             |       | 21,033                                                   |       | 7,109                        |       | 13,924 |   | 196 | % |
| Property management fees      |       | 589                                                      |       | 553                          |       | 36 |   | 7 | % |
| Asset management fees         |       | 1,448                                                    |       | 1,336                        |       | 112 |   | 8 | % |
| General and administrative    |       | 1,605                                                    |       | 1,406                        |       | 199 |   | 14 | % |
| Depreciation and amortization |       | 5,588                                                    |       | 6,274                        |       | (686 | ) | -11 | % |
| Total expenses                |       | $                                                        | 41,554     |                         | $          | 40,751 |   | $ | 803 |   | 2 | % |

 

**Continuing Operations**

 

*Revenues.*  Our totalrevenues decreased by $4 million to $13.9 million for the three months ended September 30,2010 as compared to $17.9 million for the three months ended September 30,2009.  The change in revenues isprimarily due to:

 

·                  a decrease in rental revenue of $2.9 millionto $11.5 million for the three months ended September 30, 2010.  The decrease in rental revenue is primarilydue to $1.4 million related to the deconsolidation of Tanglewood at Voss(through September 30, 2010) and Alexan Black Mountain, a decrease inrevenue related to the Chase Park Plaza lease of $1.1 million, and a decreasein revenue from Becket House of $0.8 million. We expect rental revenue to be flat in 2010 due to slowing lease-up ofavailable space at our operating properties and moderating rental rates onrollover of existing leases in the current weak economy;

 

·                  hotel revenues for the three months ended September 30,2010 totaled $1.7 million as compared to $1.5 million for the three monthsended September 30, 2009, and consisted of revenues generated by theoperations of The Lodge & Spa at Cordillera.  The increase in hotel revenues is primarilydue to an increase in occupancy from 42.8% for 2009 to 65% for 2010; and

 

·                  condominium sales of $0.7 million for thethree months ended September 30, 2010 as compared to $2 million for thethree months ended September 30, 2009. We closed on the sale of one condominium unit at The Private Residencesat The Chase Park Plaza during the three months ended September 30, 2010as compared to two condominium units during the three months ended September 30,2009.

 

*Property Operating Expenses.*  Property operating expenses for the threemonths ended September 30, 2010 were $4.9 million as compared to $6.2million for the three months ended September 30, 2009, and were comprisedof operating expenses from our consolidated properties.  The decrease in property operating expenseswas primarily due to $0.6 million

 

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related to reduced servicecharges on Becket House consistent with reduced occupancy and $0.8 millionrelated to the deconsolidation of the Tanglewood at Voss (through September 30,2010) and Alexan Black Mountain properties.

 

*Cost of Condominium Sales. *Cost of condominium sales,relating to the sale of condominium units at The Private Residences at TheChase Park Plaza, for the three months ended September 30, 2010 were $0.8million as compared to $2 million for the three months ended September 30,2009.  The decrease is due to the sale ofone condominium unit for the three months ended September 30, 2010 ascompared to the sales of two condominium units for the three months ended September 30,2009.

 

*Interest Expense.* Interest expense for the three months ended September 30, 2010 was$3.9 million as compared to $4.1 million for the three months ended September 30,2009 and was primarily due to the decrease in notes payable balances related tothe deconsolidation of Tanglewood at Voss (through September 30, 2010) andAlexan Black Mountain and a paydown of $8.7 million on the principal of thenote related to Chase Park Plaza in December 2009.  Our total notes payable at September 30,2010 was $347 million as compared to $441.6 million at September 30, 2009.

 

*Real Estate Taxes.*Real estate taxes, net ofamounts capitalized, for the three months ended September 30, 2010 and September 30,2009 were $1.6 million and were comprised of real estate taxes from each of ourconsolidated properties.

 

*Impairment charge. *We recognizedimpairment charges totaling $21 million related to Regency Center, Crossroads,The Private Residences — Chase Park Plaza, and to our 30.38% unconsolidatedjoint venture interest in Royal Island for the three months ended September 30,2010.  We recognized a $7.1 millionnon-cash impairment charge for the three months ended September 30, 2009,related to our leasehold interest, Becket House.

 

*Property Management Fees. *Property management fees forthe three months ended September 30, 2010 and September 30, 2009 were$0.6 million and were comprised of fees incurred by our consolidatedproperties.  We expect decreases inproperty management fees in the future as we sell our properties.

 

*Asset Management Fees. *Asset management fees forthe three months ended September 30, 2010 totaled $1.4 million as comparedto $1.3 million for the three months ended September 30, 2009 and werecomprised of fees incurred by our consolidated properties.  We expect asset management fees to decreasein the future as well sell our properties.

 

*General and Administrative Expenses.* General and administrative expenses for thethree months ended September 30, 2010 totaled $1.6 million, as compared to$1.4 million for the three months ended September 30, 2009 and werecomprised of corporate general and administrative expenses, including directors’and officers’ insurance premiums, auditing fees, legal fees, and otheradministrative expenses.

 

*Depreciation and Amortization Expense. *Depreciation and amortization expense for the three months endedSeptember 30, 2010 was $5.6 million as compared to $6.3 million forthe three months ended September 30, 2009 and was comprised of depreciationand amortization of our consolidated properties.  The decrease in depreciation and amortizationexpense was primarily due to the deconsolidation of the Tanglewood at Voss(through September 30, 2010) and Alexan Black Mountain properties.

 

*Gain on sale of real estate*.  Gain on sale of real estate for the threemonths ended September 30, 2010 was $3.9 million and related to the saleto an unaffiliated third party of a 50% interest in one of the three buildings(the 800 building) that comprises the Santa Clara Tech Center in August 2010.  As we have a continuing involvement with theSanta Clara Tech Center buildings, the sale of a 50% interest is not considereddiscontinued operations.  We had no gainon sale of real estate for the three months ended September 30, 2009.

 

*Loss on troubled debt restructuring*. Loss on troubled debtrestructuring for the three months ended September 30, 2010 was $5 millionand related to obtaining the fee simple interest in the Tanglewood at Vossproperty including the assumption of the outstanding senior note payable infull satisfaction of our Tanglewood at Voss mezzanine loan receivable balanceplus accrued interest totaling $18.3 million. We had no loss on troubled debt restructuring for the three months endedSeptember 30, 2009.

 

**Discontinued Operations**

 

*Loss from Discontinued Operations. *During the three months ended September 30, 2010, pursuant to adeed-in-lieu of foreclosure, we transferred ownership of Ferncroft CorporateCenter to the lender associated with the property.  The loss from discontinued operations for thethree months ended September 30, 2010 was $2.6 million as compared to $0.3million for the three months ended September 30, 2009.  The loss from discontinued operations for thethree months ended September 30, 2010, includes an approximately $2.3million loss on extinguishment of debt.

 

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*Nine months ended September 30,2010 as compared to Nine months ended September 30, 2009*

 
| ** **                            | ** ** | **Nine months ended September 30,** | ** ** | **Increase (Decrease)** | ** ** |
|---------------------------------------|------------|---------------------------------------------------------|------------|------------------------------|------------|
| ** **                            | ** ** | **2010**                                                | ** ** | **2009**                     | ** ** | **Amount** | ** ** | **Percent** | ** ** |
| Revenue:                              |       |                                                    |       |                         |       |   |   |   |   |
| Rental revenue                        |       | $                                                       | 34,325     |                         | $          | 42,828 |   | $ | (8,503 | ) | -20 | % |
| Hotel revenue                         |       | 3,769                                                   |       | 3,011                        |       | 758 |   | 25 | % |
| Condominium sales                     |       | 26,228                                                  |       | 13,893                       |       | 12,335 |   | 89 | % |
| Interest income from notes receivable |       | 6,434                                                   |       | —                       |       | 6,434 |   | n/a |   |
| Total revenues                        |       | $                                                       | 70,756     |                         | $          | 59,732 |   | $ | 11,024 |   | 18 | % |
|                                  |       |                                                    |       |                         |       |   |   |   |   |
| Expenses:                             |       |                                                    |       |                         |       |   |   |   |   |
| Property operating expenses           |       | $                                                       | 14,398     |                         | $          | 18,266 |   | $ | (3,868 | ) | -21 | % |
| Bad debt expense                      |       | 366                                                     |       | 10,489                       |       | (10,123 | ) | -97 | % |
| Cost of condominium sales             |       | 26,710                                                  |       | 14,003                       |       | 12,707 |   | 91 | % |
| Interest expense                      |       | 10,570                                                  |       | 11,708                       |       | (1,138 | ) | -10 | % |
| Real estate taxes                     |       | 5,174                                                   |       | 5,871                        |       | (697 | ) | -12 | % |
| Impairment charge                     |       | 21,033                                                  |       | 9,841                        |       | 11,192 |   | 114 | % |
| Provision for loan losses             |       | 7,136                                                   |       | —                       |       | 7,136 |   | n/a |   |
| Property management fees              |       | 1,587                                                   |       | 1,615                        |       | (28 | ) | -2 | % |
| Asset management fees                 |       | 4,450                                                   |       | 4,014                        |       | 436 |   | 11 | % |
| General and administrative            |       | 4,206                                                   |       | 4,389                        |       | (183 | ) | -4 | % |
| Depreciation and amortization         |       | 16,576                                                  |       | 19,470                       |       | (2,894 | ) | -15 | % |
| Total expenses                        |       | $                                                       | 112,206    |                         | $          | 99,666 |   | $ | 12,540 |   | 13 | % |

 

**Continuing Operations**

 

*Revenues.*  Our totalrevenues increased by $11 million to $70.8 million for the nine months ended September 30,2010 as compared to $59.7 million for the nine months ended September 30,2009.  The change in revenues isprimarily due to:

 

·                  a decrease in rental revenue of $8.5 millionto $34.3 million for the nine months ended September 30, 2010.  The decrease in rental revenue is primarilydue to $3.7 million related to the deconsolidation of Tanglewood at Voss(through September 30, 2010) and Alexan Black Mountain, a decrease inrevenue related to the Chase Park Plaza lease of $3.3 million, and a decreasein revenue from Becket House of $2 million. We expect rental revenue to be flat in 2010 due to slowing lease-up ofavailable space at our operating properties and moderating rental rates onrollover of existing leases in the current weak economy;

 

·                  hotel revenues for the nine months ended September 30,2010 totaled $3.8 million as compared to $3 million for the nine months ended September 30,2009, and consisted of revenues generated by the operations of The Lodge &Spa at Cordillera.  The increase in hotelrevenues is primarily due to an increase in occupancy from 29.3% for 2009 to55.7% for 2010;

 

·                  condominium sales of $26.2 million for thenine months ended September 30, 2010 as compared to $13.9 million for thenine months ended September 30, 2009. We closed on the sale of 13 condominium units at an average price of $2million each at The Private Residences at The Chase Park Plaza during the ninemonths ended September 30, 2010.  Weclosed on the sale of 19 condominium units at an average price of $0.7 millioneach at The Private Residences at The Chase Park Plaza during the nine monthsended September 30, 2009; and

 

·                  interest income from notes receivable of $6.4million for the nine months ended September 30, 2010 as compared to nointerest income from notes receivable for the nine months ended September 30,2009.  This increase is primarily due tothe $5.5 million of interest received from the Royal Island borrowers and $0.9million earned on the Tanglewood at Voss mezzanine loan.

 

*Property Operating Expenses.*  Property operating expenses for the ninemonths ended September 30, 2010 were $14.4 million as compared to $18.3million for the nine months ended September 30, 2009, and were comprisedof operating expenses from our consolidated properties.  The decrease in property operating expenseswas primarily due to $1.6 million related to reduced service charges on BecketHouse consistent with reduced occupancy and $2 million related to thedeconsolidation of the Tanglewood at Voss (through September 30, 2010) andAlexan Black Mountain properties.

 

*Cost of Condominium Sales. *Cost of condominium sales,relating to the sale of condominium units at The Private Residences at TheChase Park Plaza, for the nine months ended September 30, 2010 were $26.7million as compared to $14 

 

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million for the nine monthsended September 30, 2009.  We closedon the sale of 13 condominium units at an average cost of $2.1 million each atThe Private Residences at The Chase Park Plaza during the nine months ended September 30,2010.  We closed on the sale of 19condominium units at an average cost of $0.7 million each at The PrivateResidences at The Chase Park Plaza during the nine months ended September 30,2009.

 

*Interest Expense.* Interest expense for the nine months ended September 30, 2010 was$10.6 million as compared to $11.7 million for the nine months ended September 30,2009 and was primarily due to the decrease in notes payable balances related tothe deconsolidation of Tanglewood at Voss (through September 30, 2010) andAlexan Black Mountain and a paydown of $8.7 million on the principal of thenote related to Chase Park Plaza in December 2009.  Our total notes payable at September 30,2010 was $347 million as compared to $441.6 million at September 30, 2009.

 

*Real Estate Taxes.*Real estate taxes, net ofamounts capitalized, for the nine months ended September 30, 2010 were$5.2 million as compared to $5.9 million for the nine months ended September 30,2009 and were comprised of real estate taxes from each of our consolidatedproperties.  The decrease in real estatetaxes is primarily due to the deconsolidation of the Tanglewood at Voss(through September 30, 2010) and Alexan Black Mountain properties.  We expect increases in real estate taxes inthe future as available space at our operating properties is leased-up.

 

*Impairment charge.*We recognized impairmentcharges totaling $21 million related to Regency Center, Crossroads, The PrivateResidences — Chase Park Plaza, and to our 30.38% unconsolidated joint ventureinterest in Royal Island for the nine months ended September 30,2010.  For the nine months ended September 30,2009, we recognized an impairment charge of $9.8 million related to ourleasehold interest, Becket House.

 

*Provision for loan losses.*  During the first quarter of 2010, we recordeda $7.1 million provision for loan losses to reflect our current estimate ofpotential loan loss.  The provision forloan losses relates to the Alexan Black Mountain mezzanine loan.  There were no such provisions or reservesrecorded for the first, second, or third quarters of 2009 as we did notconsolidate this asset.

 

*Property Management Fees. *Property management fees forthe nine months ended September 30, 2010 and 2009 were $1.6 million andwere comprised of fees incurred by our consolidated properties.  We expect decreases in property managementfees in the future as we sell our properties.

 

*Asset Management Fees. *Asset management fees forthe nine months ended September 30, 2010 totaled $4.5 million as comparedto $4 million for the nine months ended September 30, 2009 and werecomprised of fees incurred by our consolidated properties.  We expect asset management fees to decreasein the future as we sell properties.

 

*General and Administrative Expenses.* General and administrative expenses for thenine months ended September 30, 2010 were $4.2 million as compared to $4.4million for the nine months ended September 30, 2009 and were comprised ofcorporate general and administrative expenses, including directors’ andofficers’ insurance premiums, auditing fees, legal fees, and otheradministrative expenses.

 

*Depreciation and Amortization Expense. *Depreciation and amortization expense for the nine months endedSeptember 30, 2010 was $16.6 million as compared to $19.5 million forthe nine months ended September 30, 2009 and was comprised of depreciationand amortization of our consolidated properties.  The decrease in depreciation and amortizationexpense was primarily due a decrease in depreciation and amortization expenseof $2.4 million related to the deconsolidation of the Tanglewood at Voss(through September 30, 2010) and Alexan Black Mountain properties.

 

*Gain on sale of real estate.*  Gain on sale of real estate for the ninemonths ended September 30, 2010 was $3.9 million and related to the saleto an unaffiliated third party of a 50% interest in one of the three buildings(the 800 building) that comprises the Santa Clara Tech Center in August 2010.  As we have a continuing involvement with theSanta Clara Tech Center buildings, the sale of a 50% interest is not considereddiscontinued operations.  We had no gainon sale of real estate for the nine months ended September 30, 2009.

 

*Loss on troubled debt restructuring.* Loss on troubled debtrestructuring for the nine months ended September 30, 2010 was $5 millionand related to obtaining the fee simple interest in the Tanglewood at Vossproperty including the assumption of the outstanding senior note payable infull satisfaction of our Tanglewood at Voss mezzanine loan receivable balanceplus accrued interest totaling $18.3 million. We had no loss on troubled debt restructuring for the nine months ended September 30,2009.

 

**Discontinued Operations**

 

*Loss from Discontinued Operations. *During the nine months ended September 30, 2010, pursuant to adeed-in-lieu of foreclosure, we transferred ownership of Ferncroft CorporateCenter to the lender associated with the property.  The loss from discontinued operations for thenine months ended September 30, 2010 was $7.9 million as compared to aloss of $1.1 million for the nine months ended September 30, 2009.  The loss from discontinued operations for thenine months ended 

 

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September 30,2010 includes a $2.3 million loss on extinguishment of debt and a $4.2 millionimpairment charge recognized in the first quarter of 2010.

 

**CashFlow Analysis**

 

Cashflows provided by operating activities for the nine months ended September 30,2010 were $15.1 million and were comprised of the change in condominiuminventory of $20 million, a provision for loan losses of $7.1 million, non-cashimpairment charges related to Ferncroft Corporate Center, Regency Center,Crossroads, The Private Residences — Chase Park Plaza, and Royal Island of $25.3million, and depreciation and amortization expense of $15.3 million; offset bythe net loss of $54.7 million and a gain on sale of real estate related to theSanta Clara 800 building of $3.9 million.

 

Cashflows provided by operating activities for the nine months ended September 30,2009 were $3.5 million and were comprised of the change in condominiuminventory of $2 million, bad debt expense of $10.6 million related to ChasePark Plaza, a non-cash impairment charge of $9.8 million related to BecketHouse, amortization of deferred financing fees of $2.4 million, equity inlosses of unconsolidated joint ventures of $2.6 million, changes in accrued andother liabilities of $3.7 million, changes in payables to related parties of$2.1 million, and depreciation and amortization expense of $18.5 million;offset by the net loss of $43.7 million and a change in accounts receivable of$3.5 million.

 

Cashflows used in investing activities for the nine months ended September 30,2010 were $11.8 million and primarily represent investment in notes receivableof $3.8 million, investments in unconsolidated joint ventures of $2.9 million,and capital expenditures for real estate under development of $7 million;offset by proceeds from the sale of a 50% interest in the Santa Clara 800building of $2.8 million.  Cash flowsused in investing activities for the nine months ended September 30, 2009were $30.2 million and primarily represent capital expenditures for real estateunder development, including capital expenditures of consolidated borrowerstotaling $10.5 million, investment in notes receivable of $6.5 million andadditions of property and equipment of $7.1 million.

 

Cashflows used in financing activities for the nine months ended September 30,2010 were $9.9 million and were comprised primarily of payments on notespayable of $26.6 million, offset by net borrowings on our senior secured revolvingcredit facility of $7.5 million, proceeds from notes payable of $7.2 million,and proceeds from the deposit received under the agreement to sell a 50%interest in the Santa Clara 700 and 750 buildings of $6 million.  Cash flows provided by financing activitiesfor the nine months ended September 30, 2009 were $21.9 million and werecomprised primarily of net borrowings on our senior secured revolving creditfacility of $15.4 million and proceeds from notes payable of $18.8 million,offset by payments on notes payable of $12.2 million.

 

**Fundsfrom Operations and Modified Funds from Operations**

 

Funds from operations (“FFO”) is a non-GAAP financial measure that iswidely recognized as a measure of REIT operating performance.  We use FFO, defined by the NationalAssociation of Real Estate Investment Trusts as net income (loss), computed inaccordance with GAAP, excluding extraordinary items, as defined by GAAP, andgains (or losses) from sales of property, plus depreciation and amortization onreal estate assets, and after adjustments for unconsolidated partnerships,joint ventures, subsidiaries, and noncontrolling interests as one measure toevaluate our operating performance.  Inaddition to FFO, we use modified funds from operations (“Modified Funds from Operations”or “MFFO”), which excludes from FFO acquisition-related costs, impairmentcharges including provisions for loan losses, losses on troubled debtrestructurings, gains and losses from the early extinguishment of debt, gainsand losses from deconsolidation to the equity method of accounting, andadjustments to fair value for derivatives not qualifying for hedge accounting,to further evaluate our operating performance.

 

Historicalcost accounting for real estate assets in accordance with GAAP implicitlyassumes that the value of real estate diminishes predictably over time.  Since real estate values have historicallyrisen or fallen with market conditions, many industry investors and analystshave considered the presentation of operating results for real estate companiesthat use historical cost accounting alone to be insufficient.  As a result, our management believes that theuse of FFO and MFFO, together with the required GAAP presentations, provide amore complete understanding of our performance.

 

Webelieve that FFO is helpful to investors and our management as a measure ofoperating performance because it excludes depreciation and amortization, gainsand losses from property dispositions, and extraordinary items, and as aresult, when compared year over year, reflects the impact on operations fromtrends in occupancy rates, rental rates, operating costs, general andadministrative expenses, and interest costs, which is not immediately apparentfrom net income.  We believe that MFFO ishelpful to our investors and our management as a measure of operatingperformance because it excludes costs that management considers more reflectiveof investing activities and other non-operating items included in FFO.  By providing FFO and MFFO, we present informationthat assists investors in aligning their analysis with management’s analysis oflong-term, core operating activities.  Webelieve fluctuations in MFFO are indicative of changes in operating activitiesand provide comparability in evaluating our performance over time and ascompared to other real estate companies that may not have acquisitionactivities or derivatives or be affected by impairments.

 

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Asexplained below, management’s evaluation of our operating performance excludesthe items considered in the calculation of MFFO based on the following economicconsiderations:

 

·                  Acquisition-related costs.  In evaluating investments in real estate,including both business combinations and investments accounted for under theequity method of accounting, management’s investment models and analysisdifferentiate costs to acquire the investment from the operations derived fromthe investment.  Prior to 2009,acquisition costs for these types of investments were capitalized; however,beginning in 2009 acquisition costs related to business combinations areexpensed.  We believe by excludingexpensed acquisition costs, MFFO provides useful supplemental information thatis comparable for each type of our real estate investments and is consistentwith management’s analysis of the investing and operating performance of ourproperties.

 

·                  Impairment charges and provision for loanlosses.  An impairment charge representsa downward adjustment to the carrying amount of a long-lived asset to reflectthe current valuation of the asset even when the asset is intended to be heldlong-term.  Such adjustment, whenproperly recognized under GAAP, may lag the underlying consequences related torental rates, occupancy and other operating performance trends.  The valuation is also based, in part, on theimpact of current market fluctuations and estimates of future capitalrequirements and long-term operating performance that may not be directlyattributable to current operating performance. As required by GAAP, we evaluate notes receivable forcollectability.  Provision for loanlosses represents a downward adjustment to the carrying amounts of notesreceivable in the current period. Because MFFO excludes impairment charges and provision for loan losses,management believes MFFO provides useful supplemental information by focusingon the changes in our operating fundamentals rather than changes that mayreflect only anticipated losses.

 

·                  Elimination of gains and losses from theearly extinguishment of debt and losses on troubled debt restructuring. A gainor loss on the early extinguishment of debt and losses on troubled debtrestructuring represents the difference between the fair value of a fullysettled debt obligation and the net carrying amount of the debt.  The valuation of the fully settled debtobligation is based, in part, on the impact of current market fluctuations aswell as estimates of long-term operating performance that may not be directlyattributable to current operating performance. Because MFFO excludes such gains and losses, management believes MFFOprovides useful supplemental information by focusing on the changes in ourcurrent operating fundamentals.

 

·                  Elimination of gains and losses fromdeconsolidation to the equity method of accounting. A gain or loss from thedeconsolidation to the equity method of accounting represents the differencebetween the aggregate of the fair value of any consideration received, the fairvalue of any noncontrolling investment retained by us, and the carrying amountof any noncontrolling interest in the former consolidated entity, and thecarrying amount of the former consolidated entity’s assets andliabilities.  The estimate of fair valueis based, in part, on the impact of current market fluctuations and estimatesof future capital requirements and long-term operating performance that may notbe directly attributable to current operating performance and may lag theunderlying consequences related to rental rates, occupancy, and other operatingperformance trends.  Because MFFOexcludes such gains and losses, management believes MFFO provides useful supplementalinformation by focusing on the changes in our current operating fundamentals.

 

·                  Adjustments to fair value for derivatives notqualifying for hedge accounting. Management uses derivatives in the management of our debt and interestrate exposure.  We do not intend tospeculate in these interest rate derivatives and accordingly period-to-periodchanges in derivative valuations are not primary factors in management’sdecision-making process.  We believe byexcluding the gains or losses from these derivatives, MFFO provides usefulsupplemental information on the realized economic impact of the hedgesindependent of short-term market fluctuations.

 

FFOor MFFO should not be considered an alternative to net income (loss) or anindication of our liquidity.  Neither isindicative of funds available to fund our cash needs, including our ability tomake distributions, and each should be reviewed in connection with other GAAPmeasurements.  Our FFO and MFFO may notbe comparable to presentations by other REITs.

 

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Ourcalculation of FFO and MFFO for the three and nine months ended September 30,2010 and 2009 is presented below (amounts in thousands, except per shareamounts):

 
| ** **                                                                 | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|----------------------------------------------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                                 | ** ** | **2010**                                                 | ** ** | **2009**                                                | ** ** | **2010** | ** ** | **2009** | ** ** |
|                                                                       |       |                                                     |       |                                                    |       |   |   |   |   |
| Net loss                                                                   |       | $                                                        | (34,337    | )                                                       | $          | (24,240 | ) | $ | (54,704 | ) | $ | (43,743 | ) |
| Net loss attributable to noncontrolling interest                           |       | 499                                                      |       | 3,791                                                   |       | 1,104 |   | 8,868 |   |
| Adjustments for:                                                           |       |                                                     |       |                                                    |       |   |   |   |   |
| Real estate depreciation and amortization from  consolidated properties(1) |       | 5,787                                                    |       | 6,863                                                   |       | 17,370 |   | 21,877 |   |
| Pro rata share of unconsolidated JV depreciation  and amortization (2)     |       | 1,165                                                    |       | 1,182                                                   |       | 3,436 |   | 3,603 |   |
| Noncontrolling interest depreciation &  amortization(3)           |       | (124                                                     | )          | (987                                                    | )          | (385 | ) | (3,009 | ) |
| Gain on sale of real estate                                                |       | (3,935                                                   | )          | —                                                  |       | (3,935 | ) | — |   |
|                                                                       |       |                                                     |       |                                                    |       |   |   |   |   |
| Funds from operations (FFO)                                                |       | $                                                        | (30,945    | )                                                       | $          | (13,391 | ) | $ | (37,114 | ) | $ | (12,404 | ) |
|                                                                       |       |                                                     |       |                                                    |       |   |   |   |   |
| Other Adjustments:                                                         |       |                                                     |       |                                                    |       |   |   |   |   |
| Losses from asset impairments (including  discontinued operations)         |       | 21,033                                                   |       | 7,109                                                   |       | 25,263 |   | 9,841 |   |
| Noncontrolling interest share of impairment  charge(4)                     |       | (239                                                     | )          | (1,422                                                  | )          | (239 | ) | (1,968 | ) |
| Provision for loan losses                                                  |       | —                                                   |       | —                                                  |       | 7,136 |   | — |   |
| Fair value adjustments to derivatives                                      |       | (680                                                     | )          | (293                                                    | )          | (1,975 | ) | (1,047 | ) |
| Noncontrolling interest share of fair value  adjustments to derivatives(4) |       | 34                                                       |       | 15                                                      |       | 99 |   | 52 |   |
| Loss on troubled debt restructuring                                        |       | 5,036                                                    |       | —                                                  |       | 5,036 |   | — |   |
| Loss on early extinguishment of debt(5)                                    |       | 2,253                                                    |       | —                                                  |       | 2,253 |   | — |   |
| Acquisition expenses                                                       |       | 122                                                      |       | —                                                  |       | 122 |   | — |   |
|                                                                       |       |                                                     |       |                                                    |       |   |   |   |   |
| MFFO                                                                       |       | $                                                        | (3,386     | )                                                       | $          | (7,982 | ) | $ | 581 |   | $ | (5,526 | ) |
|                                                                       |       |                                                     |       |                                                    |       |   |   |   |   |
| GAAP weighted average shares:                                              |       |                                                     |       |                                                    |       |   |   |   |   |
| Basic and diluted                                                          |       | 56,261                                                   |       | 55,431                                                  |       | 56,127 |   | 55,226 |   |
|                                                                       |       |                                                     |       |                                                    |       |   |   |   |   |
| MFFO per share                                                             |       | $                                                        | (0.06      | )                                                       | $          | (0.14 | ) | $ | 0.01 |   | $ | (0.10 | ) |

 

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(1) Reflects the depreciation and amortization of continuingoperations as well as discontinued operations.

 

(2) This represents the depreciation and amortization expense ofour share of depreciation and amortization expense of the properties which weaccount for under the equity method of accounting.

 

(3) This reflects the noncontrolling interest adjustment for thethird-party partners’ proportionate share of the real-estate depreciation andamortization.

 

(4) This reflects the noncontrolling interest adjustment for thethird-party partners’ proportionate share of impairment charges and fair value adjustmentsto derivatives.

 

(5) Loss on extinguishment of debt is included in the loss fromdiscontinued operations on the accompanying statement of operations and othercomprehensive loss for the three and nine months ended September 30, 2010.

 

Providedbelow is additional information related to selected non-cash items included innet loss above, which may be helpful in assessing our operating results.

 

·                  Straight-linerental revenue of $0.2 million and $2 million was recognized for the three andnine months ended September 30, 2010, respectively.  Straight-line rental revenue of $0.5 millionand $1.6 million was recognized for the three and nine months ended September 30,2009, respectively.

 

·                  Amortization ofintangible lease assets and liabilities was recognized as a net increase torental revenues of $0.8 million and $2.2 million for the three and nine monthsended September 30, 2010, respectively. Amortization of intangible lease assets and liabilities was recognizedas a net increase to rental revenues of $1.2 million and $3.6 million for thethree and nine months ended September 30, 2009, respectively.

 

·                  Amortization ofintangible property tax abatement assets was recognized as an increase to realestate tax expense of less than $0.1 million and $0.2 million for the three andnine months ended September 30, 2010, respectively.  Amortization of intangible property taxabatement assets was recognized as an increase to real estate tax expense of$0.1 million and $0.3 million for the three and nine months ended September 30,2009, respectively.

 

·                  Amortization ofdeferred financing costs of $0.7 million and $2.1 million was recognized asinterest expense for mortgages and notes payable for the three and nine monthsended September 30, 2010, respectively; and $0.2 million and $0.6 millionwas recognized as a reduction of interest income for the three and nine monthsended September 30, 2010, respectively. Amortization of deferred financing costs of $0.8 million and $2.4million was recognized as interest expense for mortgages and notes payable for thethree and nine months ended September 30, 2009, respectively; and $0.2million and $0.6 million was recognized as a reduction of interest income forthe three and nine months ended September 30, 2009, respectively.

 

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Inaddition, cash flows generated from FFO may be used to fund all or a portion ofcertain capitalizable items that are excluded from FFO, such as capitalexpenditures and payments of principal on debt, each of which may impactthe amount of cash available for distribution to our stockholders.

 

Asnoted above, we believe FFO and MFFO are helpful to investors and ourmanagement as a measure of operating performance.  FFO and MFFO are not indicative of our cashavailable to fund distributions since other uses of cash, such as capitalexpenditures at our properties and principal payments of debt, are not deductedwhen calculating FFO and MFFO.

 

**Distributions**

 

Distributionsare authorized at the discretion of our board of directors based on itsanalysis of our performance over the previous period, expectations ofperformance for future periods, including actual and anticipated operating cashflow, changes in market capitalization rates for investments suitable for ourportfolio, capital expenditure needs, general financial condition, and otherfactors that our board deems relevant. The board’s decision will be influenced, in substantial part, by itsobligation to ensure that we maintain our status as a REIT.  In light of the pervasive and fundamentaldisruptions in the global financial and real estate markets, we cannot provideassurance that we will be able to achieve expected cash flows necessary tocontinue to pay distributions at any particular level, or at all.  Our board may determine to reduce our currentdistribution rate or cease paying distributions in order to conserve cash.

 

Cashamounts distributed to stockholders during the nine months ended September 30,2010 was $2.3 million.  For the ninemonths ended September 30, 2010, cash flows provided by operatingactivities was $15.1 million. Accordingly, for the nine months ended September 30, 2010, cashflow from operations exceeded cash amounts distributed to stockholders by $12.8million.  Cash amounts distributed tostockholders during the nine months ended September 30, 2009 were $2.6million.  For the nine months ended September 30,2009, cash flows provided by operating activities were $3.5 million.  Accordingly, for the nine months ended September 30,2009, cash flow from operations exceeded cash amounts distributed tostockholders by $0.9 million.

 

Thefollowing are the distributions paid and declared for the three and nine monthsended September 30, 2010 and 2009.

 
| ** **     | ** ** | ** **                  | ** ** | ** **        | ** ** | ** **       | ** ** | **Total**    | ** ** | **Declared**       | ** ** |
|----------------|------------|-----------------------------|------------|-------------------|------------|------------------|------------|--------------|------------|--------------------|------------|
| ** **     | ** ** | **Distributions Paid** | ** ** | **Distributions** | ** ** | **Distribution** | ** ** |
| **2010**       | ** ** | **Cash**                    | ** ** | **Reinvested**    | ** ** | **Total**        | ** ** | **Declared** | ** ** | **Per Share** | ** ** |
| Third Quarter  |       | $                           | 474        |              | $          | 930              |       | $            | 1,404      |               | $          | 1,406 |   | $ | 0.025 |   |
| Second Quarter |       | 460                         |       | 943               |       | 1,403            |       | 1,406        |       | 0.025              |       |
| First Quarter  |       | 1,316                       |       | 2,872             |       | 4,188            |       | 1,405        |       | 0.025              |       |
|           |       | $                           | 2,250      |              | $          | 4,745            |       | $            | 6,995      |               | $          | 4,217 |   | $ | 0.075 |   |

 
| ** **     | ** ** | ** **                  | ** ** | ** **        | ** ** | ** **       | ** ** | **Total**    | ** ** | **Declared**       | ** ** |
|----------------|------------|-----------------------------|------------|-------------------|------------|------------------|------------|--------------|------------|--------------------|------------|
| ** **     | ** ** | **Distributions Paid** | ** ** | **Distributions** | ** ** | **Distribution** | ** ** |
| **2009**       | ** ** | **Cash**                    | ** ** | **Reinvested**    | ** ** | **Total**        | ** ** | **Declared** | ** ** | **Per Share** | ** ** |
| Third Quarter  |       | $                           | 1,192      |              | $          | 2,947            |       | $            | 4,139      |               | 4,140      |   | 0.075 |   |
| Second Quarter |       | 372                         |       | 1,032             |       | 1,404            |       | —       |       | —             |       |
| First Quarter  |       | 1,047                       |       | 3,017             |       | 4,064            |       | 4,070        |       | 0.075              |       |
|           |       | $                           | 2,611      |              | $          | 6,996            |       | $            | 9,607      |               | $          | 8,210 |   | $ | 0.150 |   |
|                |            |                             |            |                   |            |                  |            |              |            |                    |            |  |  |  |  |  |

 

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(1) The distribution declared for the fourth quarter 2009 wasdeclared on January 8, 2010.

(2) Prior to April 1, 2009, distributions were declared inadvance based upon a daily rate of $0.0008219 per share and paid monthly by the16th day of the following month. Beginning with the second quarter of 2009, our board determined to declaredistributions quarterly in arrears.  As aresult, the distributions paid during the second quarter of 2009 related to distributionsdeclared for March 2009. Distributions paid with respect to the second quarter of 2009 were paidduring the third quarter.

 

OnApril 2, 2009, our Board of Directors voted to declare distributions on aquarterly basis rather than a monthly basis, thus generating significantadministrative cost savings to our shareholders, and to determine and payfuture distributions in arrears rather than in advance of the period to whichthey apply.  On October 18, 2010,our Board authorized a quarterly distribution in the amount of $0.025 per shareof common stock, which is equivalent to an annual distribution of 1% assuming a$10 price per share, payable to the common stockholders of record at the closeof business on September 30, 2010. The distribution will be paid on or before November 16, 2010.

 

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Operatingperformance cannot be accurately predicted due to numerous factors, includingthe financial performance of our investments in the current real estateenvironment, the types and mix of investments in our portfolio and theaccounting treatment of our investments in accordance with our accountingpolicies.  Asa result, future distributions declared and paid may continue to exceed cashflow from operating activities.

 

**Share Redemption Plan**

 

Ourboard of directors has authorized a share redemption program for stockholderswho have held their shares for more than one year.  On March 30, 2009, our board ofdirectors suspended, until further notice, redemptions other than thosesubmitted in respect of a stockholder’s death, qualifying disability orconfinement to a long-term care facility. On May 11, 2009 and November 9, 2009, our board of directorsapproved certain amendments to the program related to the per share redemptionprice.  In the third quarter ended September 30,2010, we redeemed 51,658 shares of common stock.

 

**Critical Accounting Policies and Estimates**

 

Management’sdiscussion and analysis of financial condition and results of operations arebased upon our consolidated financial statements, which have been prepared inaccordance with GAAP.  The preparation ofthese financial statements requires our management to make estimates andassumptions that affect the reported amounts of assets, liabilities, revenuesand expenses, and related disclosure of contingent assets and liabilities.  We evaluate these estimates, includinginvestment impairment, on a regular basis. These estimates will be based on management’s historical industryexperience and on various other assumptions that are believed to be reasonableunder the circumstances.  Actual resultsmay differ from these estimates.

 

Below is a discussion of theaccounting policies that we consider will be critical in that they may requirecomplex judgment in their application or require estimates about matters thatare inherently uncertain.

 

***Principles of Consolidation and Basis ofPresentation***

 

Ourconsolidated financial statements include our accounts and the accounts ofother subsidiaries over which we have control. All inter-company transactions, balances, and profits have beeneliminated in consolidation.  Interestsin entities acquired will be evaluated based on applicable GAAP, which includesthe requirement to consolidate entities deemed to be variable interest entities(“VIE”) in which we are the primary beneficiary.  If the interest in the entity is determinednot to be a VIE, then the entities will be evaluated for consolidation based onlegal form, economic substance, and the extent to which we have control and/orsubstantive participating rights under the respective ownership agreement.

 

Thereare judgments and estimates involved in determining if an entity in which wehave made an investment is a VIE and, if so, whether we are the primarybeneficiary.  The entity is evaluated todetermine if it is a VIE by, among other things, calculating the percentage ofequity being risked compared to the total equity of the entity.  Determining expected future losses involvesassumptions of various possibilities of the results of future operations of theentity, assigning a probability to each possibility and using a discount rateto determine the net present value of those future losses.  A change in the judgments, assumptions, andestimates outlined above could result in consolidating an entity that shouldnot be consolidated or accounting for an investment using the equity methodthat should in fact be consolidated, the effects of which could be material toour financial statements.

 

***Real Estate***

 

Upon the acquisition of real estate properties, we recognize the assetsacquired, the liabilities assumed, and any noncontrolling interest as of theacquisition date, measured at their fair values.  The acquisition date is the date on which weobtain control of the real estate property. These assets acquired and liabilities assumed may consist of buildings,any assumed debt, identified intangible assets and asset retirementobligations.  Identified intangibleassets generally consist of the above-market and below-market leases, in-placeleases, in-place tenant improvements and tenant relationships.  Goodwill is recognized as of the acquisitiondate and measured as the aggregate fair value of the consideration transferredand any noncontrolling interests in the acquiree over the fair value ofidentifiable net assets acquired. Likewise, a bargain purchase gain is recognized in current earnings whenthe aggregate fair value of the consideration transferred and anynoncontrolling interests in the acquiree is less than the fair value of theidentifiable net assets acquired. Acquisition-related costs are expensed in the period incurred.

 

Initialvaluations are subject to change until our information is finalized, which isno later than twelve months from the acquisition date.

 

Thefair value of any tangible assets acquired, expected to consist of land, landimprovements, buildings, building improvements, and furniture, fixtures andequipment, is determined by valuing the property as if it were vacant, and the “as-if-vacant”value is then allocated to the tangible assets. Land values are derived from appraisals, and building and landimprovements values are calculated as replacement cost less depreciation ormanagement’s estimates of the relative fair value 

 

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ofthese assets using discounted cash flow analyses or similar methods.  Furniture, fixtures, and equipment values aredetermined based on current reproduction or replacement cost less depreciationand other estimated allowances based on physical, functional, or economicfactors.  The value of buildings isdepreciated over the estimated useful lives ranging from 25 years for commercialoffice property to 39 years for hotel/mixed-use property using thestraight-line method.  Land improvementsare depreciated over the estimated useful life of 15 years, and furniture,fixtures, and equipment are depreciated over estimated useful lives rangingfrom five to seven years using the straight-line method.

 

Wedetermine the value of above-market and below-market in-place leases foracquired properties based on the present value (using an interest rate thatreflects the risks associated with the leases acquired) of the differencebetween (i) the contractual amounts to be paid pursuant to the in-placeleases and (ii) management’s estimate of current market lease rates forthe corresponding in-place leases, measured over a period equal to (a) theremaining noncancelable lease term for above-market leases, or (b) theremaining noncancelable lease term plus any fixed rate renewal options forbelow-market leases.  We record the fairvalue of above-market and below-market leases as intangible assets orintangible liabilities, respectively, and amortize them as an adjustment torental income over the determined lease term.

 

Thetotal value of identified real estate intangible assets that we may acquire inthe future is further allocated to in-place lease values and tenantrelationships based on our evaluation of the specific characteristics of eachtenant’s lease and our overall relationship with that respective tenant.  The aggregate value of in-place leasesacquired and tenant relationships is determined by applying a fair value model.  The estimates of fair value of in-placeleases include an estimate of carrying costs during the expected lease-upperiods for the respective spaces considering current market conditions.  In estimating fair value of in-place leases,we consider items such as real estate taxes, insurance and other operatingexpenses as well as lost rental revenue during the expected lease-up period andcarrying costs that would have otherwise been incurred had the leases not beenin place, including tenant improvements and commissions.  The estimates of the fair value of tenantrelationships also include costs to execute similar leases including leasingcommissions, legal costs and tenant improvements as well as an estimate of thelikelihood of renewal as determined by management on a tenant-by-tenant basis.

 

Weamortize the value of in-place leases acquired in the future to expense overthe term of the respective leases.  Thevalue of tenant relationship intangibles is amortized to expense over theinitial term and any anticipated renewal periods, but in no event does theamortization period for intangible assets exceed the remaining depreciable lifeof the building.  Should a tenantterminate their lease, the unamortized portion of the in-place lease value andtenant relationship intangibles would be charged to expense.

 

Otherintangible assets include the value of identified hotel trade names andin-place property tax abatements.  Thesefair values are based on management’s estimates of the relative fair value ofthese assets using discounted cash flow analyses or similar methods.  The value of the trade names is amortizedover its respective estimated useful life of 20 years using the straight-linemethod and the value of the in-place property tax abatement is amortized over itsestimated term of 10 years using the straight-line method.

 

Wedetermine the fair value of assumed debt by calculating the net present valueof the scheduled mortgage payments using interest rates for debt with similarterms and remaining maturities that management believes we could obtain.  Any difference between the fair value andstated value of the assumed debt is recorded as a discount or premium andamortized over the remaining life of the loan.

 

***Investment Impairments***

 

Forreal estate we consolidate, we monitor events and changes in circumstancesindicating that the carrying amounts of the real estate assets may not berecoverable.  When such events or changesin circumstances are present, we assess potential impairment by comparingestimated future undiscounted operating cash flows expected to be generatedover the life of the asset and from its eventual disposition to the carryingamount of the asset.  In the event thatthe carrying amount exceeds the estimated future undiscounted operating cash flows,we recognize an impairment loss to adjust the carrying amount of the asset toestimated fair value.  We considerprojected future undiscounted cash flows, trends, strategic decisions regardingfuture development plans, and other factors in our assessment of whetherimpairment conditions exist.  While webelieve our estimates of future cash flows are reasonable, differentassumptions regarding such factors as market rents, economies, and occupanciescould significantly affect these estimates.

 

Duringthe third quarter of 2010, we evaluated certain real estate properties forimpairment as a result of changes in expected holding periods.   Accordingly, we recognized an impairmentcharge totaling $1.8 million related to our Regency Center property for the ninemonths ended September 30, 2010.  Asa result of general weakness in market rental rates and vacancies at ourCrossroads property, we recognized an $8.1 million impairment charge for thenine months ended September 30, 2010.

 

Duringthe first quarter of 2010, we evaluated Ferncroft Corporate Center forimpairment and, accordingly, recognized a $4.2 million impairment charge forthe three months ended March 31, 2010, which is included in the loss from 

 

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discontinuedoperations in the accompanying statement of operations and other comprehensiveloss for the nine months ended September 30, 2010.  On August 17, 2010, pursuant to adeed-in-lieu of foreclosure, we transferred ownership of Ferncroft CorporateCenter to the lender associated with the property and, accordingly, recognizeda loss on the extinguishment of debt of $2.3 million, which is included in theloss from discontinued operations in the accompanying consolidated statement ofoperations and other comprehensive loss for the three and nine months ended September 30,2010.

 

Wealso evaluate our investments in unconsolidated joint ventures at eachreporting date.  If we believe there isan other than temporary decline in market value we will record an impairmentcharge based on these evaluations.  Weassess potential impairment by comparing our portion of estimated futureundiscounted operating cash flows expected to be generated by the joint ventureover the life of the joint venture’s assets to the carrying amount of the jointventure.  In the event that the carryingamount exceeds our portion of estimated future undiscounted operating cashflows, we recognize an impairment loss to adjust the carrying amount of thejoint venture to its estimated fair value.

 

Dueto uncertainties surrounding the timing of development activities at RoyalIsland, we recognized an impairment charge related to our unconsolidated 30.38%investment in Royal Island totaling $6.3 million for the three and nine monthsended September 30, 2010.

 

Wealso evaluate our investments in notes receivable as of each reportingdate.  If we believe that it is probablewe will not collect all principal and interest in accordance with the terms ofthe loans, we consider the loan impaired. When evaluating loans for potential impairment, we compare the carryingamount of the loans to the present value of future cash flows discounted at theloan’s effective interest rate, or, if a loan is collateral dependent, to theestimated fair value of the related collateral net of any senior loans.  For impaired loans, a provision is made forloan losses to adjust the reserve for loan losses.  The reserve for loan losses is a valuationallowance that reflects our current estimate of loan losses as of the balancesheet date.  The reserve is adjustedthrough the provision for loan losses account on our consolidated statement ofoperations.

 

Inthe first quarter of 2010, we recorded a reserve for loan losses totaling $11.1million related to our mezzanine loan associated with Alexan Black Mountain,including $7.1 million recognized as a provision to loan losses on ourconsolidated statement of operations and comprehensive loss, for the threemonths ended March 31, 2010, and the remaining $4 million as a cumulativeeffect adjustment to the opening balance of accumulated distributions and netloss in our consolidated statement of equity for the nine months ended September 30,2010.  There was no such provision orreserve recorded for the three months ended September 30, 2010.

 

Inevaluating our investments for impairment, management may use appraisals andmake estimates and assumptions, including, but not limited to, the projecteddate of disposition of the properties, the estimated future cash flows of theproperties during our ownership, and the projected sales price of each of theproperties.  A change in these estimatesand assumptions could result in understating or overstating the book value ofour investments, which could be material to our financial statements.  The value of our properties held fordevelopment depends on market conditions, including estimates of the projectstart date as well as estimates of future demand for the property type underdevelopment.  We have analyzed trends andother information related to each potential development and incorporated thisinformation as well as our current outlook into the assumptions we use in ourimpairment analyses.  Due to the judgmentand assumptions applied in the estimation process with respect to impairments,including the fact that limited market information regarding the value ofcomparable land exists at this time, it is possible actual results could differsubstantially from those estimated.

 

Otherthan the impairment charge discussed above, we believe the carrying value ofour operating real estate assets, properties under development, investments inunconsolidated joint ventures, and notes receivable is currentlyrecoverable.  However, if marketconditions worsen beyond our current expectations, or if our assumptionsregarding expected future cash flows from the use and eventual disposition ofour assets decrease or our expected hold periods decrease, or if changes in ourdevelopment strategy significantly affect any key assumptions used in our fairvalue calculations, we may need to take additional charges in future periodsfor impairments related to existing assets. Any such non-cash charges would have an adverse effect on ourconsolidated financial position and results of operations.

 

***Condominium Inventory***

 

Condominiuminventory is stated at the lower of cost or fair market value.  In addition to land acquisition costs, landdevelopment costs, and construction costs, costs include interest and realestate taxes, which are capitalized during the period beginning with thecommencement of development and ending with the completion of construction.

 

Forcondominium inventory, at each reporting date, management compares theestimated fair value less costs to sell to the carrying value.  An adjustment is recorded to the extent thatthe fair value less costs to sell is less than the carrying value.  We determine the estimated fair value ofcondominiums based on comparable sales in the normal course of business underexisting and anticipated market conditions. This evaluation takes into consideration estimated future sellingprices, costs incurred to date, estimated additional future costs, andmanagement’s plans for the property.

 

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Thenationwide downturn in the housing and related condominium market that beganduring 2007 and has continued through 2010 has resulted in lower than expectedsales volume and reduced selling prices, among other effects.  As a result of our evaluations, we recognizeda non-cash charge of $4.8 million during the nine months endedSeptember 30, 2010 to reduce the carrying value of condominiums at ThePrivate Residences — Chase Park Plaza, which is classified as an impairmentcharge in the accompanying consolidated statement of operations.  There were no impairment charges related toour condominium inventory for the nine months ended September 30,2009.  In the event that marketconditions continue to decline in the future or the current difficult marketconditions extend beyond our expectations, additional adjustments may benecessary in the future.

 

**Item 3.            Quantitative and Qualitative Disclosures About MarketRisk.**

 

*Interest Rate Risk*

 

Wemay be exposed to interest rate changes primarily as a result of long-term debtused to acquire properties and make loans and other permitted investments.  Our management’s objectives, with regard tointerest rate risks, are to limit the impact of interest rate changes onearnings and cash flows and to lower overall borrowing costs.  To achieve these objectives, we will borrowprimarily at fixed rates or variable rates with the lowest margins availableand in some cases, with the ability to convert variable rates to fixedrates.  With regard to variable ratefinancing, we will assess interest rate cash flow risk by continuallyidentifying and monitoring changes in interest rate exposures that mayadversely impact expected future cash flows and by evaluating hedgingopportunities.  We may enter intoderivative financial instruments such as options, forwards, interest rateswaps, caps, or floors to mitigate our interest rate risk on a related financialinstrument or to effectively lock the interest rate portion of our variablerate debt.  Of our $347 million in notespayable at September 30, 2010, $325.8 million represented debt subject tovariable interest rates.  If our variableinterest rates increased 100 basis points, we estimate that total annualinterest cost, including interest expensed, interest capitalized, and theeffects of the interest rate caps and swaps, would increase by $0.9 million.

 

AtSeptember 30, 2010, interest rate swaps classified as liabilities werereported at their combined fair values of $0.6 million in other liabilities at September 30,2010.  A 100 basis point decrease ininterest rates would result in a less than $0.1 million net decrease in thefair value of our interest rate caps and swaps. A 100 basis point increase in interest rates would result in a $0.2million net increase in the fair value of our interest rate caps and swaps.

 

**Item 4.    Controls andProcedures.**

 

*Evaluation of Disclosure Controls and Procedures*

 

Asrequired by Rule 13a-15(b) and Rule 15d-15(b) under theExchange Act, our management, including our Chief Executive Officer and ChiefFinancial Officer, evaluated, as of September 30, 2010, the effectivenessof our disclosure controls and procedures as defined in Exchange ActRule 13a-15(e) and Rule 15d-15(e). Based on that evaluation, ourChief Executive Officer and Chief Financial Officer concluded that ourdisclosure controls and procedures were effective as of September 30,2010, to provide reasonable assurance that information required to be disclosedby us in this report is recorded, processed, summarized and reported within thetime periods specified by the rules and forms of the Exchange Act and isaccumulated and communicated to our management, including our Chief ExecutiveOfficer and Chief Financial Officer, as appropriate to allow timely decisionsregarding required disclosures.

 

Webelieve, however, that a controls system, no matter how well designed andoperated, cannot provide absolute assurance that the objectives of the controlssystems are met, and no evaluation of controls can provide absolute assurancethat all control issues and instances of fraud or error, if any, within acompany have been detected.

 

*Changes in Internal Control over Financial Reporting*

 

Therehas been no change in internal control over financial reporting that occurredduring the quarter ended September 30, 2010 that has materially affected,or is reasonably likely to materially affect, our internal control overfinancial reporting.

 

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**PART II**

 

**OTHER INFORMATION**

 

**Item 1.            Legal Proceedings.**

 

Duringthe period covered by this quarterly report, there were no material developmentsrelated to the legal proceedings related to the Skokoses disclosed in ourquarterly report for the period ended March 31, 2010.

 

**Item 1A.         Risk Factors.**

 

Therehave been no material changes from the risk factors set forth in our AnnualReport on Form 10-K for the year ended December 31, 2009.

 

**Item 2.            Unregistered Sales of Equity Securities**

 

**PublicOffering of Common Stock**

 

During the period covered bythis quarterly report, we did not sell any equity securities that were notregistered under the Securities Act of 1933.

 

**ShareRedemption Program**

 

Ourboard of directors has adopted a share redemption program that permitsstockholders to sell their shares back to us after they have held them for atleast one year, subject to the significant conditions and limitations of theprogram.  Our board of directors canamend the provisions of our share redemption program without the approval ofour stockholders.  The terms on which weredeem shares may differ between redemptions upon a stockholder’s death, “qualifyingdisability” (as defined in the share redemption program) or confinement to along-term care facility (collectively referred to herein as “ExceptionalRedemptions”) and all other redemptions (referred to herein as “OrdinaryRedemptions”).  On March 30, 2009,our board of directors voted to accept all redemption requests submitted duringthe first quarter of 2009 from stockholders who submitted requests forExceptional Redemptions.  However, theboard determined to not accept and suspend until further notice redemptionsother than Exceptional Redemptions.  Thepurchase price for shares redeemed under the redemption program is set forthbelow.

 

Inthe case of Ordinary Redemptions, the purchase price per share will equal 90%of (i) the most recently disclosed estimated value per share (the “Valuation”)as determined in accordance with our valuation policy (the “Valuation Policy”),less (ii) the aggregate distributions per share of any net sale proceedsfrom the sale of one or more of our assets, or other special distributions sodesignated by our board of directors, distributed to stockholders after theValuation was determined (the “Valuation Adjustment”); provided, however, thatthe purchase price per share shall not exceed: (1) prior to the firstvaluation conducted by the board of directors, or a committee thereof (the “InitialBoard Valuation”), under the Valuation Policy, 90% of (i) average priceper share the original purchaser or purchasers of shares paid to us for all ofhis or her shares (as adjusted for any stock dividends, combinations, splits,recapitalizations and the like with respect to our common stock) (the “OriginalShare Price”) less (ii) the aggregate distributions per share of any netsale proceeds from the sale of one or more of our assets, or other specialdistributions so designated by the board of directors, distributed tostockholders prior to the redemption date (the “Special Distributions”); or (2) onor after the Initial Board Valuation, the Original Share Price less any SpecialDistributions.

 

Inthe case of Exceptional Redemptions, the purchase price per share will be equalto: (1) prior to the Initial Board Valuation, the Original Share Priceless any Special Distributions; or (2) on or after the Initial BoardValuation, the most recently disclosed Valuation less any Valuation Adjustment,provided, however, that the purchase price per share may not exceed theOriginal Share Price less any Special Distributions.

 

Notwithstandingthe redemption prices set forth above, our board of directors may determine,whether pursuant to formulae or processes approved or set by our board ofdirectors, the redemption price of the shares, which may differ betweenOrdinary Redemptions and Exceptional Redemptions; provided, however, that wemust provide at least 30 days’ notice to stockholders before applying this newprice determined by our board of directors.

 

Anyshares approved for redemption will be redeemed on a periodic basis asdetermined from time to time by our board of directors, and no less frequentlythan annually. We will not redeem, during any twelve-month period, more than 5%of the weighted average number of shares outstanding during the twelve-monthperiod immediately prior to the date of redemption. Generally, the cashavailable for redemption on any particular date will be limited to the proceedsfrom the DRP during the period consisting of the preceding four fiscal quartersfor which financial statements are available, less any cash already used forredemptions during the same period, plus, if we had positive operating cashflow during such preceding four fiscal quarters, 1% of all operating cash flowduring such preceding four fiscal quarters. The redemption limitations apply to all redemptions, whether Ordinary orExceptional Redemptions.

 

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OnJanuary 8, 2010, our board of directors established a new estimated pershare value of $8.03 pursuant to the Valuation Policy, adjusted from theprevious per share value of $8.17.  Thus,in accordance with the share redemption program as amended and restated, as of January 15,2010, the per share redemption price for Exceptional Redemptions will be thelesser of (a) $8.03, which is the valuation disclosed above, less theValuation Adjustment, and (b) the average price per share that investorpaid for his shares less any Special Distributions.

 

Forall other ordinary redemptions, the per share redemption price will be thelesser of (1) $7.23, which is 90% of the valuation disclosed above, lessany Valuation Adjustment and (2) 90% of the average price per share thatthe investor paid for his shares less any Special Distributions.  However,as previously disclosed, we have suspended redemptions other than ExceptionalRedemptions until further notice.

 

Duringthe third quarter ended September 30, 2010, we redeemed shares as follows:

 
| **2010**  | ** ** | **Total Number of  Shares Redeemed** | ** ** | **Average Price  Paid Per Share** | ** ** | **Total Number of  Shares Purchased  as Part of  Publicly  Announced Plans  or Programs** | ** ** | **Maximum  Number of Shares  That May Be  Purchased Under  the Plans or  Programs** | ** ** |
|-----------|------------|-----------------------------------------------------|------------|--------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------|------------|
| July      |       | —                                              |       | $                                                | —     |                                                                                                                         | —     |                                                                                                                   |       |   |
| August    |       | 51,658                                              |       | $                                                | 8.03       |                                                                                                                         | 51,658     |                                                                                                                   |       | (1) |
| September |       | —                                              |       | $                                                | —     |                                                                                                                         | —     |                                                                                                                   |       |   |
|      |       |                                                |       |                                             |       |                                                                                                                         |       |                                                                                                                   |       |
|      |       | 51,658                                              |       | $                                                | 8.03       |                                                                                                                         | 51,658     |                                                                                                                   |       | (1) |

 

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(1) A description of the maximum number of shares that may bepurchased under our redemption program is included in the narrative precedingthis table.

 

**Item 3.            Defaults Upon Senior Securities.**

 

OnNovember 15, 2007, we entered into separate, secured loans with Bank ofAmerica, as lead administrative agent and lender, and other financialinstitutions, related to our Chase Park Plaza Hotel and The Private Residencesproperties, located in St. Louis, Missouri (collectively, “Chase Park Plaza”)to borrow up to an aggregate of $145 million for the redevelopment andconstruction of the Chase Park Plaza properties and to repay a $55 million loanassumed at the acquisition of Chase Park Plaza. The loans are secured by Chase Park Plaza.  We have a 95% ownership interest in Chase ParkPlaza and have unconditionally guaranteed the Chase Park Plaza loans.  The loan agreements and related loandocuments are collectively referred to as the Loan Agreement.

 

Pursuantto the terms of the Loan Agreement, the Chase Park Plaza loans matured on November 15,2010.  We have been in negotiations withthe lender to restructure and extend the loans. However, we have not reached anagreement with the lender to restructure or extend the loans as of the maturitydate resulting in an event of default under the Loan Agreement.  We are currently in communication with thelender to waive the event of default and continue negotiations to restructurethe loans’ terms.  However, there are noassurances that we will be successful in our negotiations with the lender.  Accordingly, pursuant to the terms of theLoan Agreement, we are subject to: (i) an immediate increase in ourfinancial obligation to the lender in connection with the interest rateincreasing to a higher default rate; (ii) the lender foreclosing on ChasePark Plaza; and/or (iii) the lender may pursue their rights under theguaranty against us.

 

**Item 4.            (Removed and Reserved)**

 

**Item 5.            Other Information.**

 

None.

 

**Item 6.            Exhibits.**

 

Theexhibits filed in response to Item 601 of Regulation S-K are listed on the Exhibit Indexattached hereto.

 

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**SIGNATURE**

 

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

 

 
|                           | **Behringer Harvard Opportunity REIT I, Inc.** |
|--------------------------------|-----------------------------------------------------|
|                           |                                                |
|                           |                                                |
| Dated:  November 15, 2010 | By:                                                 | /s/  Gary S. Bresky |
|                           | Gary  S. Bresky                                     |
|                           | Chief Financial Officer                             |
|                           | (Principal Financial  Officer)                      |

 

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**Index to Exhibits**

 
| **Exhibit Number** | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                           |
|-------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                    |       |                                                                                                                                                                                                                                                                                                                                                                                      |
| 3.1                     |       | Second  Articles of Amendment and Restatement of the Registrant (previously filed in  and incorporated by reference to Form 8-K, filed on July 29, 2008)                                                                                                                                                                                                                        |
|                    |       |                                                                                                                                                                                                                                                                                                                                                                                      |
| 3.2                     |       | Amended  and Restated Bylaws of the Registrant (previously filed in and incorporated  by reference to Form 8-K filed on March 11, 2010)                                                                                                                                                                                                                                         |
|                    |       |                                                                                                                                                                                                                                                                                                                                                                                      |
| 4.1                     |       | Third  Amended and Restated Distribution Reinvestment Plan (previously filed in and  incorporated by reference to Form 10-Q filed on November 13, 2009)                                                                                                                                                                                                                         |
|                    |       |                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.1                    |       | Letter  Agreement, dated July 19, 2010, between Behringer Harvard Opportunity  REIT I, Inc. and Behringer Harvard Opportunity Advisors I, LLC  (previously filed in and incorporated by reference to Form 8-K filed on  July 22, 2010)                                                                                                                                |
|                    |       |                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.2                    |       | Letter  Agreement, dated August 9, 2010, between Behringer Harvard Opportunity  REIT I, Inc. and Behringer Harvard Opportunity Advisors I, LLC  (previously filed and incorporated by reference to Form 10-Q filed on  August 12, 2010)                                                                                                                               |
|                    |       |                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.3                    |       | Letter  Agreement, dated August 9, 2010, between Behringer Harvard Opportunity  REIT I, Inc., HPT Management Services, LLC, Behringer Harvard Real  Estate Services, LLC, Behringer Harvard Opportunity Management Services, LLC,  and Behringer Harvard Opportunity OP I, LP (previously filed and incorporated  by reference to Form 10-Q filed on August 12, 2010) |
|                    |       |                                                                                                                                                                                                                                                                                                                                                                                      |
| 31.1*                   |       | Rule 13a-14(a)/15d-14(a) Certification                                                                                                                                                                                                                                                                                                                                          |
|                    |       |                                                                                                                                                                                                                                                                                                                                                                                      |
| 31.2*                   |       | Rule 13a-14(a)/15d-14(a) Certification                                                                                                                                                                                                                                                                                                                                          |
|                    |       |                                                                                                                                                                                                                                                                                                                                                                                      |
| 32.1*(1)                |       | Section 1350  Certifications                                                                                                                                                                                                                                                                                                                                                         |
|                    |       |                                                                                                                                                                                                                                                                                                                                                                                      |
| 99.1                    |       | Third  Amended and Restated Share Redemption Program (previously filed and  incorporated by reference to Form 10-Q filed on November 13, 2009)                                                                                                                                                                                                                                  |
|                    |       |                                                                                                                                                                                                                                                                                                                                                                                      |
| 99.2                    |       | Amended  and Restated Policy for Estimation of Common Stock Value (previously filed  and incorporated by reference to form 8-K filed on June 22, 2009)                                                                                                                                                                                                                               |

 

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*filedherewith

 

(1)   In accordance with Item 601(b)(32) ofRegulation S-K, this Exhibit is not deemed “filed” for purposes of Section 18of the Exchange Act or otherwise subject to the liabilities of thatsection.  Such certifications will not bedeemed incorporated by reference into any filing under the Securities Act orthe Exchange Act, except to the extent that the registrant specificallyincorporates it by reference.

 

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