#### **UNITED STATESSECURITIES AND EXCHANGE COMMISSION****Washington,D.C. 20549**

**FORM 10-K**
| **ý**                                           | **ANNUAL REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**     |
|------------------------------------------------------|----------------------------------------------------------------------------------------------------|
| **For the fiscal year ended December 31, 2006** |
| **or**                                               |
| **o**                                                | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d)|OF THE SECURITIES EXCHANGE ACT OF 1934** |

 

**For the transitionperiod from          to**

**Commission FileNo. 1-32248**

**GRAMERCY CAPITAL CORP.**(Exact name ofregistrant as specified in its charter)

| **Maryland**                                                           |   | **06-1722127**                                 |
|------------------------------------------------------------------------|--------|------------------------------------------------|
| (State or other jurisdiction  incorporation or organization)           |   | (I.R.S. Employer of  Identification No.)       |
| **420 Lexington Avenue, New York,  NY****10170**                       |
| (Address of principal executive offices - zip code)                    |
| **(212) 297-1000**                                                     |
| (Registrant’s telephone number, including area code)              |
| SECURITIES REGISTERED  PURSUANT TO SECTION 12(b) OF THE ACT: |
| **Title of Each Class**                                                |   | **Name of Each Exchange on Which  Registered** |
| Common Stock, $.001 Par Value                                          |   | New York Stock Exchange                        |

 

SECURITIES REGISTERED PURSUANT TOSECTION 12(g) OF THE ACT: **None**

Indicate by check mark if the registrant is awell-known seasoned issuer, as defined in Rule 405 of the Securities Act.Yes o No x.

Indicate by check mark if the registrant is not requiredto file reports pursuant to Section 13 or Section 15(d) of theAct. Yes o No x.

Indicate by check mark whether the registrant(1) has filed all reports required to be filed by Section 13 or15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days. Yes x No o.

Indicate by check mark if disclosure of delinquentfilers pursuant to Item 405 of Regulation S-K is not contained herein, and willnot be contained, to the best of the registrant’s knowledge, in definitiveproxy or information statements incorporated by reference in Part III ofthis Form 10-K or any amendment to this Form 10-K. o

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

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

As of February 28, 2007, there were 26,034,056shares of the Registrant’s common stock outstanding. The aggregate market valueof common stock held by non-affiliates of the registrant (18,529,560 shares) atJune 30, 2006, was $479,915,604. The aggregate market value was calculatedby using the closing price of the common stock as of that date on the New YorkStock Exchange, which was $25.90 per share.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of theregistrant’s Proxy Statement for the 2007 Annual Stockholders’ Meeting to beheld May 24, 2007 and to be filed within 120 days after the close ofthe Registrant’s fiscal year are incorporated by reference into Part IIIof this Annual Report on Form 10-K.

 

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**GRAMERCY CAPITALCORP.FORM 10-KTABLE OF CONTENTS**

**10-K PART ANDITEM NO.**
| **PART I**   | ** ** | **Page**                                                                                                          |
|-------------------|------------|-------------------------------------------------------------------------------------------------------------------|
| 1.                |       | Business                                                                                                          |   |   | 1 |   |
| 1A.               |       | Risk Factors                                                                                                      |   |   | 18 |   |
| 1B.               |       | Unresolved Staff Comments                                                                                         |   |   | 42 |   |
| 2.                |       | Properties                                                                                                        |   |   | 42 |   |
| 3.                |       | Legal Proceedings                                                                                                 |   |   | 42 |   |
| 4.                |       | Submission of Matters to a Vote of Security Holders                                                               |   |   | 42 |   |
| **PART II**  |       |                                                                                                              |   |   |
| 5.                |       | Market for Registrant’s Common Equity and Related  Stockholders Matters                                      |   |   | 43 |   |
| 6.                |       | Selected  Financial Data                                                                                          |   |   | 44 |   |
| 7.                |       | Management’s Discussion and Analysis of Financial  Condition and Results of Operations                       |   |   | 47 |   |
| 7A.               |       | Quantitative and Qualitative Disclosures about Market  Risk                                                       |   |   | 71 |   |
| 8.                |       | Financial Statements and Supplemental Data                                                                        |   |   | 75 |   |
| 9.                |       | Changes in and Disagreements with Accountants on  Accounting and Financial Disclosure                             |   |   | 117 |   |
| 9A.               |       | Controls and Procedures                                                                                           |   |   | 117 |   |
| 9B.               |       | Other  Information                                                                                                |   |   | 117 |   |
| **PART III** |       |                                                                                                              |   |   |
| 10.               |       | Directors, Executive Officers and Corporate Governance  of the Registrant                                         |   |   | 118 |   |
| 11.               |       | Executive Compensation                                                                                            |   |   | 118 |   |
| 12.               |       | Security Ownership of Certain Beneficial Owners and  Management and Related Stockholder Matters    |   |   | 118 |   |
| 13.               |       | Certain Relationships and Related Transactions and  Director Independence                                         |   |   | 118 |   |
| 14.               |       | Principal Accounting Fees and Services                                                                            |   |   | 118 |   |
| **PART IV**  |       |                                                                                                              |   |   |
| 15.               |       | Exhibits, Financial Statements, Schedules and Reports  on Form 8-K                                           |   |   | 119 |   |
|              |       | SIGNATURES                                                                                                        |   |   | 123 |   |

 

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**PART I**

**ITEM 1.  BUSINESS**

**General**

Gramercy Capital Corp.(the “Company” or “Gramercy”) is a commercial real estate specialty financecompany that focuses on the direct origination and acquisition of whole loans,subordinate interests in whole loans, mezzanine loans, preferred equity, andnet lease investments involving commercial properties throughout the UnitedStates. When evaluating transactions, we assess our risk-adjusted return andtarget transactions with yields that seek to provide excess returns for therisks being taken. We have elected to be taxed as a real estate investmenttrust, or REIT, under the Internal Revenue Code and generally will not besubject to federal income taxes to the extent we distribute our income to ourstockholders.

Gramercy was formed in April 2004as a Maryland corporation and we completed our initial public offering in August 2004.Substantially all of Gramercy’s operations are conducted through GKK CapitalLP, a Delaware limited partnership, or our Operating Partnership. Gramercy, asthe sole general partner of, and currently the holder of 100% of the common units of, our Operating Partnership, hasresponsibility and discretion in the management and control of our OperatingPartnership, and the limited partners of our Operating Partnership, in suchcapacity, have no authority to transact business for, or participate in themanagement activities of, our Operating Partnership. Accordingly, weconsolidate the accounts of our Operating Partnership.

We are externally managedand advised by GKK Manager LLC, or our Manager, a majority-owned subsidiary ofSL Green Realty Corp. (NYSE: SLG), or SL Green. At December 31, 2006, SLGreen also owned approximately 25% of the outstanding shares of our commonstock.

As of December 31,2006, we held loans and other lending investments of approximately $2.2 billionnet of fees, discounts, and unfunded commitments with an average spread toLIBOR of 384 basis points for our floating rate investments, and an averageyield of 10.04% for our fixed rate investments. As of December 31, 2006,we also held interests in four credit tenant lease, or CTL, investmentscomprised of a 49.75% tenancy-in-common, or TIC, interest in 55 Corporate Drivein Bridgewater, New Jersey, and three joint venture investments.

Our corporate offices arelocated in midtown Manhattan at 420 Lexington Avenue, New York, New York 10170.We do not currently have any employees, nor do we anticipate hiring anyemployees in the near term. Our executive officers are all employed by our Manageror SL Green. We can be contacted at (212) 297-1000. We maintain awebsite at *www.gramercycapitalcorp.com*.On our website, you can obtain, free of charge, a copy of our annual report on Form 10-K,quarterly reports on Form 10-Q, current reports on Form 8-K,and amendments to those reports filed or furnished pursuant to Section 13(a) or15(d) of the Securities Exchange Act of 1934, as amended, as soon aspracticable after we file such material electronically with, or furnish it to,the Securities and Exchange Commission. We have also made available on ourwebsite our audit committee charter, compensation committee charter, nominatingand corporate governance committee charter, code of business conduct and ethicsand corporate governance principles.

Unless the contextrequires otherwise, all references to “we,” “our,” and “us” in this annualreport means Gramercy Capital Corp., a Maryland corporation, and one or more ofits subsidiaries, including GKK Capital LP, a Delaware limited partnership.

**Corporate Structure**

**Substantiallyall of our assets are held by, and all of our operations are conducted through,our Operating Partnership. We are the sole general partner and sole owner ofthe Class A limited partner interests of our Operating Partnership. At December 31,2006, the majority of the Class B limited partnership interests were ownedby our Manager and SL Green Operating Partnership, L.P. Interests**

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**werealso held by certain officers and employees of SL Green Realty Corp., includingsome of whom are our executive officers, which interests are subject toperformance thresholds. To provide an incentive to enhance the value of ourcommon stock, the holders of the Class B limited partner interests of ourOperating Partnership are entitled to an incentive return equal to 25% of theamount by which funds from operations, or FFO, plus certain accounting gainsand losses (as defined in the partnership agreement of our OperatingPartnership which was amended and restated in April 2006) exceed theproduct of our weighted average stockholders equity (as defined in the amendedand restated partnership agreement of our Operating Partnership) multiplied by9.5% (divided by 4 to adjust for quarterly calculations).**

As of December 31,2006, the majority of the interests in our Manager were held by SL GreenOperating Partnership, L.P. Interests were also held by certain officers andemployees of SL Green Realty Corp., some of whom are our executive officers,which interests are subject to performance thresholds. We pay to our Manager abase management fee equal to one and three-quarters of one percent (1.75%) ofour stockholders’ equity (as defined in the amended and restated managementagreement with our Manager) inclusive of the trust preferred securities issuedin May 2005, August 2005 and January 2006. In addition, we areobligated to reimburse our Manager for its costs incurred under an assetservicing agreement between our Manager and an affiliate of SL Green OperatingPartnership, L.P. and a separate outsourcing agreement between our Manager andSL Green Operating Partnership, L.P. The asset servicing agreement, which wasamended and restated in April 2006, provides for an annual fee payable toSL Green Operating Partnership, L.P. by us of 0.05% of the book value of allcredit tenant lease assets and non-investment grade bonds and 0.15% of the bookvalue of all other assets. The asset servicing fee is reduced by SL GreenOperating Partnership, L.P. for fees paid directly to outside servicers by us. Theoutsourcing agreement currently provides for an annual fee payable by us, whichfee is currently $1.3 million per year, increasing 3% annually over the prioryear on the anniversary date of the outsourcing agreement in August ofeach year. The asset servicing and outsourcing agreements allow us to leveragethe experience, resources and relationships SL Green has established.

Our collateralized debtobligations, or CDOs, were closed in July 2005 and August 2006. TheCDO that closed in 2005 was issued through two indirect subsidiaries, GramercyReal Estate CDO 2005-1 Ltd., or the 2005 Issuer, and Gramercy RealEstate CDO 2005-1 LLC, or the 2005 Co-Issuer. The CDO that closed in 2006was also issued through two indirect subsidiaries, Gramercy Real EstateCDO 2006-1 Ltd., or the 2006 Issuer, and Gramercy Real Estate CDO2006-1 LLC, or the 2006 Co-Issuer. The 2005 Issuer, 2006 Issuer, 2005Co-Issuer and 2006 Co-Issuer are subsidiaries of our private REIT, GramercyInvestment Trust. Our Operating Partnership holds all shares of common stockand controls all of the management and operations of the private REIT. At December 31,2006, the private REIT and all subsidiaries of the private REIT wereconsolidated into our financial results.

In connection with the closingof our first CDO in July 2005, the Issuer, Gramercy Real Estate CDO 2005-1Ltd., entered into a collateral management agreement with our Manager. Pursuantto the collateral management agreement, our Manager has agreed to providecertain advisory and administrative services in relation to the collateral debtsecurities and other eligible investments securing the CDO notes. Thecollateral management agreement provides for a senior collateral managementfee, payable quarterly in accordance with the priority of payments as set forthin the indenture, equal to 0.15% per annum of the net outstanding portfoliobalance, and a subordinate collateral management fee, payable quarterly inaccordance with the priority of payments as set forth in the indenture, equalto 0.25% per annum of the net outstanding portfolio balance. Net outstandingportfolio balance is the sum of the (i) aggregate principal balance of thecollateral debt securities, excluding defaulted securities, (ii) aggregateprincipal balance of all principal proceeds held as cash and eligibleinvestments in certain accounts, and (iii) with respect to the defaultedsecurities, the calculation amount of such defaulted securities. Ascompensation for the performance of its obligations as collateral manager underthe first CDO, our Board of Directors has allocated to our Manager thesubordinate collateral management fee paid on securities not held by us. At 

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December 31,2006, we owned all of the non-investment grade bonds, preferred equity and equityin both CDOs. The seniorcollateral management fee and balance of the subordinate collateral managementfee is allocated to us.

Collateral manager feespaid on our CDO that closed in August 2006 are governed by the amended andrestated management agreement as a “transitional managed” CDO, as defined inthe amended and restated management agreement, consisting primarily of debtinvestments secured by non-stabilized real estate. The amended and restatedmanagement agreement provides that in connection with formations ofcollateralized debt obligations or other securitization vehicles after theexecution of the amended and restated management agreement, if a collateralmanager is retained, our Manager or an affiliate will be the collateral managerand will receive the following fees:  (i) 0.25% per annum of the bookvalue of the assets owned for “transitional managed” CDOs, (ii) 0.15% perannum of the book value of the assets owned for “non-transitional managed”CDOs, (iii) 0.10% per annum of the book value of the assets owned forstatic CDOs that own primarily non-investment grade bonds, and (iv) 0.05%per annum of the book value of the assets owned for static CDOs that ownprimarily investment grade bonds; limited in each instance by the fees that arepaid to the collateral manager. The balance of the fees paid by the CDOs forcollateral management services are paid to us.

**Business and Growth Strategies**

We invest in a diversifiedportfolio of real estate loans and securities, including permanent loans, bridgeloans, subordinate interests in whole loans, mezzanine loans, distressed debt,mortgage-backed securities, or MBS, preferred equity, and net lease investmentsinvolving commercial properties throughout the United States. When evaluatingtransactions, we assess our risk-adjusted return and target transactions withyields that seek to provide excess returns for the risks being taken.

We generate incomeprincipally from the spread between the yields on our assets and the cost ofour borrowing and hedging activities. We leverage our investments to enhancereturns to stockholders equity. We finance, or may finance in the future,assets through a variety of techniques, including repurchase agreements,secured and unsecured credit facilities, CDOs, unsecured junior subordinatedcorporate debt, issuances of commercial mortgage-backed securities, or CMBS,and other structured financings. In addition, we match fund interest rates withlike-kind debt (i.e., fixed-rate assets are financed with fixed-rate debt, andfloating rate assets are financed with floating rate debt), through the use ofhedges such as interest rate swaps, caps, or through a combination of thesestrategies. This allows us to reduce the impact of changing interest rates onour cash flow and earnings. We actively manage our positions, using our credit,structuring and asset management skills to enhance returns. We intend to growour business using prudent levels of debt financing, syndication of loaninterests and structured financing when feasible, rather than relying solely onequity capital, in order to increase earnings per share.

Our ability to manage thereal estate risk underwritten by our Manager is a critical component of oursuccess. We actively manage and maintain the credit quality of our portfolio byusing our management team’s expertise in structuring and repositioninginvestments to improve the quality and yield on managed investments. Wheninvesting in higher leverage transactions, we use guidelines and standardsdeveloped and employed by senior management of our Manager and SL Green,including rigorous underwriting of collateral performance and valuation, areview of the creditworthiness of the equity investors, additional forms ofcollateral and strategies to effect repayment. If defaults occur, we willemploy SL Green’s strong asset management skills to mitigate the severityof any losses and seek to optimize the recovery from assets in the event thatwe foreclose upon them. In New York, Washington, D.C. and elsewhere asappropriate, SL Green will manage these assets and has the right topurchase properties in metropolitan New York and Washington, D.C. that weacquire in foreclosure. In other geographic markets, we often use long-standingrelationships of senior management or SL Green with local operators orinvestors to enhance our ability to underwrite transactions or mitigatedefaults when making or managing investments.

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We seek to control thenegotiation and structure of the debt transactions in which we invest, whichenhances our ability to mitigate our losses, to control the negotiation anddrafting of loan documents that afford us appropriate rights and control overour collateral, and to have the right to control the debt that is senior to ourposition. We believe that this level of control allows us to achieve attractiverisk-adjusted returns within a real estate debt capital structure. We generallyavoid investments where we cannot secure adequate control rights, unless webelieve the default risk is very low. Our flexibility to invest in all or anypart of a debt capital structure enables us to participate in many transactionsand to retain only the investments that meet our investment parameters.

We believe that ourability to provide a wide range of financing products and our ability tocustomize financing structures to meet borrowers’ needs differentiates us fromour competitors. We can provide real estate financing solutions throughout theentire capital structure from the most senior capital positions through subordinateinterests to equity participations. Our senior management team has substantialexperience in responding to unique borrower needs by crafting financialproducts that are tailored to meet the business plan of a property owner.

We focus on certain typesof investments where we believe we have a competitive advantage and that offerappropriate risk adjusted returns. For properties that we believe have stablevalues or where we have specific asset management capabilities to mitigatelosses, we will target higher leverage investments. If we conclude that aproperty to be financed will have more volatile values or cash flows under avariety of market conditions, we target a less leveraged investment. In suchtransactions we may seek a second-loss position. We also target the originationof larger financings, including whole loans, to afford us the opportunity tosyndicate and securitize our investments, create retained instruments withabove-market returns, and realize gains on the sale of these positions. Weoriginate investments in direct transactions with borrowers, we co-originatewith or acquire existing assets from third parties, primarily financialinstitutions, and we occasionally co-invest with SL Green and itsaffiliates.

Our targeted investmentsinclude the following:

***Permanent Loans******—We*** originatefixed-rate permanent whole loans with terms of up to 15 years.  We may separate certain of these loans intotranches, which can be securitized and resold. When we do so, we occasionallyretain that component of the permanent loan that we believe has the mostadvantageous risk-adjusted returns. The retained interest can be the seniorinterest, a subordinate interest, a mezzanine loan or a preferred equityinterest created in connection with such permanent loan origination. We expectthe stated maturity of our permanent loan investments to range from five yearsto 15 years. We may sell these investments prior to maturity.

***Bridge Loans******—We*** offerfloating rate bridge whole loans to borrowers who are seeking debt capital witha final term to maturity of not more than five years to be used in theacquisition, construction or redevelopment of a property. Typically, theborrower has identified a property in a favorable market that it believes to bepoorly managed or undervalued. Bridge financing enables the borrower to employshort-term financing while improving the operating performance and physicalaspects of the property and avoid burdening it with restrictive long-term debt.The bridge loans we originate are predominantly secured by first mortgage lienson the property and are expected to provide interest rates ranging from 125 to400 basis points over applicable index rate indexes. We expect the statedmaturity of our bridge loans to range from two years to five years, and wefrequently hold these investments to maturity.

We believe our bridgeloans will lead to additional financing opportunities in the future, as bridgefacilities are often a first step toward permanent financing or a sale of theunderlying real estate. We generally view securitization as a financing ratherthan a trading activity. We have, and will continue to, pool together smallerbridge loans and retain the resulting non-investment grade interests (andinterest-only certificates, if any) resulting from these securitizations, whichto-date have taken the 

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form of CDOs. To increaseour volume, enhance financing efficiencies, and expand our national presence,we may seek joint ventures, mergers or other arrangements with regional orproduct-specific loan originators.

***SubordinateInterests in Whole Loans******—We*** purchasefrom third parties, and may retain from whole loans we originate andco-originate and securitize or sell, subordinate interests in whole loans.Subordinate interests are participation interests in mortgage notes or loanssecured by a lien subordinated to a senior interest in the same loan. Thesubordination is generally evidenced by a co-lender or participation agreementbetween the holders of the related senior interest and the subordinateinterest. In some instances, the subordinate interest lender may additionallyrequire a security interest in the stock or partnership interests of theborrower as part of the transaction. When we originate whole loans, we maydivide them, frequently securitizing or selling the senior interest and keepinga subordinate interest for investment. We believe the subordinate interestmarket will continue to grow with the expansion of the commercial mortgagesecuritization market.

Subordinate interests inwhole loans typically bear interest at a rate of 200 to 600 basis points overthe applicable interest rate index and have loan-to-value ratios between 65%and 85%. Subordinate interest lenders have the same obligations, collateral andborrower as the senior interest lender, but typically are subordinated inrecovery upon a default. Subordinate interests in whole loans share certaincredit characteristics with second mortgages, in that both are subject togreater credit risk with respect to the underlying mortgage collateral than thecorresponding senior interest.

Subordinate interestscreated from bridge loans generally will have terms matching those of the wholeloan of which they are a part, typically two to five years. Subordinateinterests created from whole loans generally will have terms of five years tofifteen years. We expect to hold subordinate interests in whole loans to theirmaturity.

When we acquiresubordinate interests in whole loans from third parties, we may earn income onthe investment, in addition to the interest payable on the subordinate piece,in the form of fees charged to the borrower under that note (currentlyapproximately 0.25% to 1% of the note amount) or by receiving principalpayments in excess of the discounted price (below par value) we paid to acquirethe note. When we originate subordinate interests out of whole loans and thensell the senior interest, we allocate our basis in the whole loan among the two(or more) components to reflect the fair market value of the new instruments.We may realize a profit on sale if our allocated value is below the sale price.Our ownership of a subordinate interest with controlling class rights, whichtypically means we have the ability to determine when, and in what manner, toexercise the rights and remedies afforded the holder of the senior interest,may, in the event the financing fails to perform according to its terms, causeus to elect to pursue our remedies as owner of the subordinate interest, whichmay include foreclosure on, or modification of, the note. In some cases,usually restricted to situations where the appraised value of the collateralfor the debt falls below agreed levels relative to the total outstanding debt,the owner of the senior interest may be able to foreclose or modify the noteagainst our wishes as holder of the subordinate interest. As a result, oureconomic and business interests may diverge from the interests of the holdersof the senior interest. These divergent interests among the holders of eachinvestment may result in conflicts of interest.

***Mezzanine Loans******—We*** originatemezzanine loans that are senior to the borrower’s equity in, and subordinate toa mortgage loan on, a property. These loans are secured by pledges of ownershipinterests, typically in whole but occasionally in part (but usually witheffective sole control over all the ownership interests), in entities thatdirectly or indirectly own the real property. In addition, we may require othercollateral to secure mezzanine loans, including letters of credit, personalguarantees, or collateral unrelated to the property.

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We typically structure ourmezzanine loans to receive a stated coupon (benchmarked usually against LIBOR,or occasionally against a Treasury index or a swap index). We may in certain,select instances structure our mezzanine loans to receive a stated coupon plusa percentage of gross revenues and a percentage of the increase in the fairmarket value of the property securing the loan, payable upon maturity,refinancing or sale of the property. 

These investmentstypically have terms from two to ten years and typically bear interest ata rate of 400 to 800 basis points over the applicable interest rate index. Sometransactions entail the issuance of more than one tranche or class of mezzaninedebt. Mezzanine loans usually have loan-to-value ratios between 65% and 90%. Mezzanineloans frequently have maturities that match the maturity of the relatedmortgage loan but may have shorter or longer terms. We expect to hold theseinvestments to maturity.

***Distressed Debt******—We*****may also invest in distressed debt, most often sub- andnon-performing real estate loans acquired from financial institutions. We makethese investments when we believe our underwriting, credit, financing and assetmanagement experience enable us to generate above-average risk-adjusted returnsby resolving these distressed loans expeditiously through refinancings, negotiatedrepayments with borrowers or foreclosure and subsequent sale of the underlyingproperty. A sub-performing loan is a loan with a very high loan-to-value ratio,with a low debt service coverage ratio, and which is likely to default atmaturity because the property securing the loan cannot support a refinancing ofthe loan’s entire unpaid principal balance. A non-performing loan is a loanthat is in default of its covenants, is past due in interest payments, or ispast its final maturity date and has not been repaid. Sub- and non-performingloans are typically purchased at a discount to the note balance. Our investmentreturn results from a combination of current cash flow from the note orunderlying property, plus any eventual recovery of loan principal.

We expect the maturity ofour distressed debt investments to range from several months to up to tenyears. Such investments will usually be held until resolution, which may entaila bankruptcy and foreclosure process, which can require months or years tocomplete.

***Mortgage-BackedSecurities******—We***occasionallyacquire mortgage MBS that are created when commercial or residential loans arepooled and securitized. These securities may be issued by government sponsoredagencies or other entities, and may or may not be rated investment grade byrating agencies. We may also originate MBS from pools of commercial loans weassemble, in which event we expect to retain the more junior interests.

CMBS are secured by orevidenced by ownership interests in a single commercial mortgage loan or a poolof mortgage loans secured by commercial properties. Residential mortgage-backedsecurities, or RMBS, are backed by pools of home mortgages. We expect amajority of our mortgage-backed securities investments to be rated by at leastone rating agency.

CMBS are generallypass-through certificates that represent beneficial ownership interests incommon law trusts whose assets consist of defined portfolios of one or morecommercial mortgage loans. They are typically issued in multiple trancheswhereby the more senior classes are entitled to priority distributions from thetrust’s income to make specified interest and principal payments on suchtranches. Losses and other shortfalls from expected amounts to be received onthe mortgage pool are borne by the most subordinate classes, which receivepayments only after the more senior classes have received all principal and/orinterest to which they are entitled.

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The credit quality of MBS depends on the creditquality of the underlying mortgage loans, which is a function of factors suchas:

·                 theprincipal amount of loans relative to the value of the related properties;

·                 themortgage loan terms (e.g. amortization);

·                 marketassessment and geographic location;

·                 constructionquality and economic utility of the property; and

·                 thecreditworthiness of the borrowers.

To date, we have focusednot on new issues but on “Story Securities” available in the secondary marketwhere we are able to analyze and underwrite the underlying assets. “StorySecurities” are seasoned securities with identifiable credit risks (such aslarge defaulted or sub-performing loans or a negative development with respectto the sponsor of a large loan) that we believe may require complex financialanalysis to fully understand the issues and which fixed income money managerscannot efficiently underwrite, or which make them unattractive to a significantnumber of fixed income investors. We seek capital appreciation, in addition tointerest income, by buying these securities at yields that are greater thansecurities with comparable risk and selling them when the credit risk improves.

We expect the statedmaturity of our MBS investments to range from several months to up to 15 yearsfor CMBS, and up to 40 years for RMBS. Such securities do not have statedmaturities but rather receive principal payments from the underlyinginvestments. We expect to hold CMBS to maturity and may sell RMBS prior tomaturity.

***Preferred Equity******—We***originatepreferred equity investments in entities that directly or indirectly owncommercial real estate. Preferred equity is not secured, but holders havepriority relative to common equity holders on cash flow distributions andproceeds from capital events. In addition, preferred holders can often enhance theirposition and protect their equity position with covenants that limit the entity’sactivities and grant us the exclusive right to control the property after anevent of default. Occasionally, the first mortgage on a property prohibitsadditional liens and a preferred equity structure provides an attractivefinancing alternative. With preferred equity investments, we may become aspecial limited partner or member in the ownership entity and may be entitledto take certain actions, or cause a liquidation, upon a default. Preferredequity typically is more highly leveraged, with loan-to-value ratios of 85% tomore than 90%. We expect our preferred equity to have mandatory redemptiondates (that is, maturity dates) that range from three years to five years, andwe expect to hold these investments to maturity.

***Other RealEstate-Related Investments******—We***may alsomake investments in other types of commercial or multi-family real estateassets. These may include acquisitions of real property and debt issued byREITs or other real estate companies. We have authority to issue our commonstock or other equity or debt securities in exchange for assets. Subject togross income and asset tests necessary for REIT qualification, we may alsoinvest in securities of other REITs, or other entities engaged in real estateactivities or securities of other issuers, including for the purpose ofexercising control over such entities.

Some of these investments may be equity interests inproperties with no stated maturity or redemption date, or long-term leaseholdinterests with expiration dates as long as 40 years beyond the date of ourinvestment. We expect to hold these investments for between several months andup to ten years, depending upon the risk profile of the investment and ourinvestment rationale. The timing of our sale of these investments, or of theirrepayment, will frequently be tied to certain events involving the underlyingproperty, such as leases to new tenants or a refinancing on superior terms.

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The aggregatecarrying values, allocated by product type and weighted average coupons of ourloans and other lending investments as of December 31, 2006 and December 31,2005 were as follows: 

| ** **                                          | ** ** | ** **                     | ** ** | ** **                                   | ** ** | ** **                               | ** ** | ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** | **Floating Rate:** | ** ** |
|-----------------------------------------------------|------------|--------------------------------|------------|----------------------------------------------|------------|------------------------------------------|------------|---------------------------------------------|------------|------------|------------|------------|------------|-------------------------|------------|
| ** **                                          | ** ** | **Carrying Value(1)**     | ** ** | **Allocation by  Investment Type** | ** ** | **Fixed Rate:  Average Yield** | ** ** | **Average Spread over  LIBOR(2)** | ** ** |
| ** **                                          | ** ** | **2006**                       | ** ** | **2005**                                     | ** ** | **2006**                                 | ** ** | **2005**                                    | ** ** | **2006**   | ** ** | **2005**   | ** ** | **2006**                | ** ** | **2005** | ** ** |
| ** **                                          | ** ** | **($ in thousands)** | ** ** | ** **                                   | ** ** | ** **                               | ** ** | ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** | ** **              | ** ** |
| Whole loans, floating rate                          |       | $                              | 1,372,316  |                                         | $          | 561,388                                  |       |                                        | 63         | %          |       |       | 46         | %                       |       | — |   | — |   | 327 bps |   | 325 bps |   |
| Whole loans, fixed rate                             |       | 42,376                         |       | 94,448                                       |       |                                     | 2          | %                                           |       |       | 8          | %          |       | 11.69                   | %          | 10.67 | % | — |   | — |   |
| Subordinate interests in whole loans, floating rate |       | 236,308                        |       | 362,983                                      |       |                                     | 11         | %                                           |       |       | 30         | %          |       | —                  |       | — |   | 445 bps |   | 443 bps |   |
| Subordinate interests in whole loans, fixed rate    |       | 48,769                         |       | 37,104                                       |       |                                     | 2          | %                                           |       |       | 3          | %          |       | 8.54                    | %          | 8.80 | % | — |   | — |   |
| Mezzanine loans, floating rate                      |       | 226,675                        |       | 82,793                                       |       |                                     | 10         | %                                           |       |       | 7          | %          |       | —                  |       | — |   | 665 bps |   | 858 bps |   |
| Mezzanine loans, fixed rate                         |       | 216,216                        |       | 43,352                                       |       |                                     | 10         | %                                           |       |       | 4          | %          |       | 9.92                    | %          | 8.51 | % | — |   | — |   |
| Preferred equity, floating rate                     |       | —                         |       | 11,795                                       |       |                                     | —     |                                        |       |       | 1          | %          |       | —                  |       | — |   | 900 bps |   | 900 bps |   |
| Preferred equity, fixed rate                        |       | 44,224                         |       | 11,882                                       |       |                                     | 2          | %                                           |       |       | 1          | %          |       | 10.68                   | %          | 10.27 | % | — |   | — |   |
| Total / Weighted  average                           |       | $                              | 2,186,884  |                                         | $          | 1,205,745                                |       |                                        | 100        | %          |       |       | 100        | %                       |       | 10.04 | % | 9.78 | % | 384 bps |   | 417 bps |   |

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

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

We monitor our portfolio periodically and prior toeach acquisition to confirm that we continue to qualify for the exemption fromregistration provided by Section 3(c)(5)(C) and 3(c)(6) of theInvestment Company Act of 1940, as amended, or the Investment Company Act. Qualifyingfor the Section 3(c)(5)(C) exemption requires that at least 55% ofour portfolio be comprised of “qualifying assets,” and a total of at least 80%of our portfolio be comprised of “real estate-related assets,” a categorythat includes qualifying assets.

We generally expect mortgage loans, whole pool MBS,our CTLs and certain distressed debt securities to be qualifying assets. Thetreatment of distressed debt securities as qualifying assets is based on thecharacteristics of the particular type of loan, including its foreclosurerights. Junior (first loss) interests in MBS pools may constitute qualifyingassets under Section 3(c)(5)(C), provided that we have the unilateralright to foreclose, directly or indirectly, on the mortgages in the pool andthat we may act as the controlling class or directing holder of the pool.Similarly, subordinate interests in whole loans may constitute qualifyingassets under Section 3(c)(5)(C), provided that we have the unilateralright to foreclose, directly or indirectly, on the mortgage and that we may actas the controlling class or directing holder of the note. We generally do nottreat mezzanine loans and preferred equity investments as qualifying assets. Inaddition to making investments in qualifying assets, we also make investmentsso that at least 80% of our portfolio is comprised of real estate-relatedassets. We expect that all of these classes of investments will be consideredreal estate-related assets under the Investment Company Act for purposes of the80% investment threshold. Qualification for the 3(c)(5)(C) and 3(c)(6) exemptionswill limit our ability to make certain investments. To the extent that thestaff of the Securities and Exchange Commission, or the SEC, provides morespecific guidance regarding the treatment of assets as qualifying assets orreal estate-related assets, we may be required to adjust our investmentstrategy accordingly. Any additional guidance from the staff of the SEC couldprovide additional flexibility to us, or it could further inhibit our abilityto pursue the investment strategy we have chosen.

On occasion, we utilize a special servicer, which insome instances may be an affiliate of us or may be the rated special serviceraffiliate of SL Green, to manage, modify and resolve loans and other investmentsthat fail to perform under the terms of the loan agreement, note, indenture, orother governing documents. 

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We will typicallynegotiate for the right to appoint a special servicer as part of theorigination or purchase of an investment. Special servicers are most frequentlyemployed in connection with whole loans, subordinate interests in whole loansand first-loss classes of CMBS. The rights of the special servicer, which aretypically subject to a servicing standard that requires the special servicer topursue remedies that maximize the recovery of investment principal, typicallyinclude, among other things, the right to foreclose upon the loan collateralafter an event of default.

Our rights, including foreclosure rights we hold, arefound in the agreements among the lenders or holders of notes, such asintercreditor or participation agreements. Where we hold unilateral foreclosurerights, those rights generally become exercisable upon the occurrence of anevent of default, such as nonpayment of the debt. In certain circumstances wemay lose our foreclosure rights. For example, where the appraised value of thecollateral for the debt falls below agreed levels relative to the totaloutstanding debt, we may lose our foreclosure rights, which are then exercisableby the holder of more senior debt. Generally, we do not expect SL Green or itsaffiliates to hold these types of senior debt where we hold a more juniorinstrument. If we were to lose our foreclosure rights, the Investment CompanyAct status of the particular investment could change.

While we intend to holdour investments to maturity, we may sell an investment prior to its statedmaturity for reasons of risk management, liquidity, changing investmentobjectives, or regulatory requirements.

**Financing Strategy**

We use debt financing in various forms in an effort toincrease the size of our portfolio and potential returns to our stockholders.Access to low-cost capital is crucial to our business, since we earn incomebased on the spread between the yield on our investments and the cost of ourborrowings.

Our financing strategy focuses on the use ofmatch-funded financing structures. This means that we seek to match thematurities of our financial obligations with the maturities of our investmentsto minimize the risk that we have to refinance our liabilities prior to thematurities of our assets, and to reduce the impact of changing interest rateson our cash flow and earnings. In addition, we match fund interest rates withlike-kind debt (i.e., fixed-rate assets are financed with fixed-rate debt, andfloating rate assets are financed with floating rate debt), through the use ofhedges such as interest rate swaps, caps, or through a combination of thesestrategies. This allows us to reduce the impact on our cash flow and earningsof changing interest rates. At December 31, 2006, approximately 84% of ourinvestments, when measured by carrying value, were floating rate instrumentsbased on LIBOR. The remaining 16% of our investments carried fixed rates ofinterest, although we have entered into swap contracts that convertsubstantially all of the floating rate financing expenses against these assetsto fixed rate expenses to eliminate basis risk. Our investments had a weightedaverage remaining term to initial maturity of 2.1 years.

We use short-term financing in the form of ourrepurchase agreements, unsecured revolving credit facilities and bridgefinancings in conjunction with or prior to the implementation of longer-termmatch-funded financing. At December 31, 2006, we had approximately $277.4million outstanding under our repurchase facilities with Wachovia CapitalMarkets, LLC, or Wachovia, and Goldman Sachs Mortgage Company, or Goldman. Anevent of default can be triggered on our repurchase facilities if, among otherthings, GKK Manager LLC is terminated as our Manager.

For longer-term funding, we utilize securitizationstructures, including CDOs, as well as other match-funded financing structures.CDOs are multiple class debt securities, or bonds, secured by pools of assets,such as MBS, bridge loans, permanent loans, subordinate interests in wholeloans, mezzanine loans and REIT debt. In a CDO the assets are pledged to atrustee for the benefit of the holders of the bonds. The bonds may be rated byone or more rating agencies. One or more classes of the bonds are marketed to awide variety of fixed income investors, which enables the CDO sponsor toachieve a relatively low cost of 

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long-term financing. Webelieve that CDOs are a suitable long-term financing vehicle for ourinvestments because they will enable us to maintain our strategy of fundingsubstantially all of our assets and related liabilities using the same, orsimilar, LIBOR benchmark, lock-in a long-term cost of funds tied to LIBOR, andreduce the risk that we have to refinance our liabilities prior to thematurities of our investments. On July 14, 2005, we issued $1.0 billion ofCDOs, and on August 24, 2006 we issued an additional $1.0 billion of CDOs.The CDO issued in 2005 consists of $810.5 million of investment grade notes,$84.5 million of non-investment grade notes, and $105 million of preferredshares. The CDO issued in 2006 consists of $903.75 million of investment gradenotes, $38.75 million of non-investment grade notes, and $57.5 million ofpreferred shares. We retained all non-investment grade securities, thepreferred shares and the common shares in the 2005 Issuer and the 2006 Issuer.

We use different levels of leverage depending on thespecific risk-return characteristics of each investment type. Usually, thelevel of financial leverage employed varies inversely with the loan-to-valueratio of the underlying debt investment being financed. For example, wegenerally use more leverage with whole loans than mezzanine loans. Weanticipate our overall leverage will be 70% to 85% of the carrying value of ourassets; but our actual leverage depends on our mix of assets. As of December 31,2006, our leverage as a percentage of total balance sheet assets was 76%,excluding the trust preferred securities, which are discussed in more detailbelow. The average advance rate against investment assets pledged under ourrepurchase facilities with Wachovia and Goldman was 70%.

Our charter and bylaws do not limit the amount ofindebtedness we can incur. Our current policy is to leverage up to 80% of thecarrying value of our assets. Our board of directors has discretion to deviatefrom or change our indebtedness policy at any time. However, we seek tomaintain an adequate capital base to protect against various businessenvironments in which our financing and hedging costs might exceed the interestincome from our investments. These conditions could occur, for example, due tocredit losses or when, due to interest rate fluctuations, interest income onour investment lags behind interest rate increases on our borrowings, which arepredominantly variable rate. We use leverage for the sole purpose of financingour portfolio and not for the purpose of speculating on changes in interest rates.

In addition, wecontinuously evaluate other sources of long-term debt and hybrid debt/equitycapital, including perpetual preferred equity and trust preferred equity, whichmay be available to us on competitive market pricing and terms.

**Origination, Underwritingand Asset Management**

Our Manager andSL Green provide all of our critical investment selection, assetmanagement, servicing and portfolio management and reporting functions fromloan origination to disposition. Our origination and underwriting is based oncareful review and preparation, and generally proceeds as follows:

·       Allinvestments are analyzed for consistency with investment parameters developedby our Manager and adopted by our board of directors;

·       Alltransactions considered for funding are presented at a weekly pipeline meetingattended by our Manager’s senior executive officers; and

·       Allfinancing applications, conditional commitments and submissions to the creditcommittee must be approved by a managing director of our Manager.

The affirmative vote of all members of a creditcommittee consisting of all senior officers of our Manager plus our chiefexecutive officer is necessary to approve all transactions over$3 million. Our chief investment officer may approve investments of lessthan $3 million. The investment committee of our board of directors mustunanimously approve all transactions involving investments of (i) $35 millionor more with respect to whole loans, (ii) $30 million or more withrespect to subordinate interests in whole loans, and (iii) $20 millionor over with respect to mezzanine loans, preferred equity, and CTLs. The full 

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board of directors mustapprove investments (i) over $75 million with respect to whole loans,(ii) over $65 million with respect to subordinate interests in wholeloans, (iii) over $55 million with respect to mezzanine loans, and (iv) over$50 million with respect to preferred equity and CTLs. Our Manager willhave full discretion to make investments on our behalf under (i) $35 millionwith respect to whole loans, (ii) $30 million with respect tosubordinate interests in whole loans, and (iii) $20 million withrespect to mezzanine loans, preferred equity and CTLs. Approval limits arebased on the investment amount less any origination fees, discounts or otherup-front fees we receive in connection with the investment.

The stages of theinvestment process are described in more detail below.

***Origination***

Our Manager is primarilyresponsible for originating all of our assets. Our Manager utilizes an extensivenational network of relationships with property owners, developers, mortgageloan brokers, commercial and investment banks and institutional investors. Thisnetwork has been developed by the senior managers of our Manager and seniorexecutives of SL Green over almost 20 years. We originate investments in directtransactions with borrowers, we co-originate with or acquire existing assetsfrom third parties, primarily financial institutions, and we may occasionallyco-invest with SL Green and its affiliates. We continue to grow ournational platform through the creation of strategic partnerships, expansion ofour origination teams, and our offices in New York, New York and Los Angeles,California. Once potential investment opportunities have been identified, ourManager determines which financing products best meet the borrower’s needs. OurManager works to optimize pricing and structure and create a favorabletransaction for us while meeting our borrower’s needs. After identifying asuitable structure, our Manager works with the borrower to prepare a loanapplication and an initial review of the investment before committingunderwriting resources. Once a loan is identified as suitable, it isunderwritten by our Manager’s team of experienced underwriters.

***Underwriting***

Once a potentialinvestment has been identified, our Manager’s underwriters performcomprehensive financial, structural, operational and legal due diligence toassess the risks of the investment. Our Manager’s underwriters analyze the loanapplication package and conduct follow-up due diligence on each borrower aspart of the underwriting process. Our Manager’s underwriters generally reviewthe following criteria as part of the underwriting process:

·       thehistoric, in-place and projected property revenues and expenses;

·       thepotential for near-term revenue growth and opportunity for expense reductionand increased operating efficiencies;

·       onhigher leverage loans secured by leased properties, accountants may be engagedto audit operating expense recovery income;

·       theproperty’s location and its attributes;

·       thevaluation of the property based upon financial projections prepared by ourManager’s underwriters and confirmed by an independent “as is” and/or “asstabilized” appraisal;

·       marketassessment, including, review of tenant lease files, surveys of property salesand leasing comparables based on conversations with local property owners,leasing brokers, investment sales brokers and other local market participants,and an analysis of area economic and demographic trends, and a review of anacceptable mortgagee’s title policy;

·       marketrents, and in the case of certain high-leverage loans, leasing projections formajor vacant spaces and near-term vacancies, frequently prepared by commercialleasing brokers with local 

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knowledge, and confirmedby discussion with other owners (often our borrowers) of competitive commercialproperties in the same sub-market;

·       structuraland environmental review of the property, including review of engineering andenvironmental reports and a site inspection, to determine future maintenanceand capital expenditure requirements;

·       therequirements for any reserves, including those for immediate repairs orrehabilitation, replacement reserves, tenant improvement and leasing commissioncosts, real estate taxes and property, casualty and liability insurance;

·       the“Underwritten Net Cash Flow” for a property, which is a set of calculations andadjustments prepared for the underwriting process to assist in evaluating aproperty’s cash flows. The Underwritten Net Cash Flow is generally theestimated stabilized annual revenue derived from the use and operation of theproperty (consisting primarily of rental income and reimbursement of expenseswhere applicable) after an allowance for vacancies, concessions and creditlosses, less estimated stabilized annual expenses;

·       creditquality of the borrower through background checks and review of financialstrength and real estate operating experience; and

·       theloan documents, to ensure that we have the necessary protections, rights andremedies.

Key factors that areconsidered in credit decisions include, but are not limited to, debt servicecoverage, loan-to-value ratios and property and financial operatingperformance. Consideration is also given to other factors such as theexperience, financial strength, reputation, and investment track record of theborrower, additional forms of collateral and identified likely strategies toeffect repayment. Our Manager will continue to refine its underwriting criteriabased upon actual loan portfolio experience and as market conditions andinvestor requirements evolve. Once diligence is completed and our Manager hasreviewed the Underwritten Net Cash Flow, sponsorship and the deal structure,our Manager determines the level in the capital structure at which aninvestment will be made, the pricing for such an investment, and the requiredlegal and structural protections.

***Servicing and Asset Management***

SL Green servicessubstantially all of our assets through a sub-contract with our Manager. Theloan servicing platform is designed to provide timely, responsive customerservice as well as accurate and timely information for account follow-up,financial reporting, collateral and portfolio risk management and managementreview. In addition, the servicing operations include enforcement of the loandocuments and standard asset management functions, including monitoring ofproperty performance and condition and market analysis. The asset managementgroup monitors the investments to identify any potential underperformance ofthe asset and work with the borrower to remedy the situation in an expeditiousmanner in order to mitigate any effects of underperformance. The asset manageris responsible for understanding the borrower’s business plan with respect toeach collateral property and monitoring performance measured against that plan.We differentiate ourselves by leveraging our Manager’s real estate knowledgeand proactive approach to asset management by providing approvals andprocessing requests on a timely and efficient basis. We believe that assetmanagement is a vital component of the borrower-lender relationship because itenables us to be responsive, timely, anticipate changes to a borrower’sfinancing requirements, and generally develop a strong relationship that leadsto repeat business.

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**Operating Policies**

***Investment and Borrowing Guidelines***

We operate pursuantto the following general guidelines for our investments and borrowings:

·       noinvestments are made that would cause us to fail to qualify as a REIT;

·       noinvestments are made that would cause us to be regulated as an investmentcompany under the Investment Company Act;

·       substantiallyall assets are financed through securitization, syndication and securedborrowings, and assets intended for inclusion in traditional securitizationtransactions will be hedged against movements in the applicable swap yieldthrough customary techniques;

·       hedgingis generally done through the bank providing the related repurchase facility onmarket terms, or through other dealers. We engage an outside advisory firm toassist in executing and monitoring hedges, advising management on theappropriateness of such hedges, and establishing the appropriate tax andaccounting treatment of our hedges; and

·       wewill not co-invest with SL Green or any of its affiliates unless the termsof such transaction are approved by a majority of our independent directors.

These investmentguidelines may be changed by our board of directors without the approval of ourstockholders.

**OriginationAgreement**

We have anorigination agreement with SL Green pursuant to which SL Green andany of its subsidiairies will not originate, acquire or participate in fixedincome investments in the United States, subject to certain conditions andexclusions described below. Fixed income investments include debt obligationsor interests in debt obligations bearing a fixed-rate of return andcollateralized by real property or interests in real property. SL Green hasalso agreed not to acquire, originate or participate in preferred equityinvestments which bear a fixed rate of return related primarily to realproeprty or interests in real property in the United States, unless we havedetermined not to pursue that opportunity.

Under theagreement, SL Green has the following rights:

(a)          to retain any fixedincome investments and/or preferred equity investments it owned or committed toown as of April 19, 2006 and any fixed income investments and/or preferredequity investments owned or committed to be owned, as of the date of a businesscombination, change of control or other similar transaction, by companies thatare acquired by SL Green or with the respect to which SL Green engagesin such a transaction, provided, however, that SL Green shall not acquirecompanies or businesses engaged primarily in Gramercy’s primary business activities;

(b)         to originate, acquire orparticipate in fixed income investments and/or preferred equity investments inconnection with the sale, recapitalization or restructuring (howevercharacterized) of any fixed income investment, preferred equity investment orinterest in real property which SL Green owns at any given time;

(c)          to originate, acquire orparticipate in fixed income and/or preferred equity investments that provide arate of return tied to the or measured by cash flow, appreciation or both ofthe underlying real property or interests in real property;

(d)         to originate, acquire or participatein any distressed debt, where there is a payment default, an acceleration,bankruptcy or foreclosure, when a default is highly likely because theloan-to-value 

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ratio is over 100% or whenthe debt service exceeds the available cash flow from the underlying collateralor of the borrower both on a current and projected basis; and

(e)   to modify,amend, supplement, extend, refinance or restructure any portion of theinvestments in item (a), (b), (c) or (d) above including, but not limited to,changes in principal, additional investment, rate of return, maturity orredemption date, lien priority, collateral, return priority, guarantor and/orborrower.

We have agreed thatwe will not:

·       acquirereal property or interests in real property located in metropolitan New Yorkand Washington, D.C. (except by foreclosure or similar conveyance resultingfrom a fixed income investment);

·       originate,acquire or participate in any investments described in (c) above ordistressed debt, in each case where more than 75% of the value of theunderlying collateral is real property or interests in real property located inmetropolitan New York or Washington, D.C.; and

·       originate,acquire or participate in any investments described in item (b) or (e) above.

We have also agreed that, when we acquire direct orindirect ownership interests in property in metropolitan New York or WashingtonD.C. by foreclosure or similar conveyance, SL Green will have the right topurchase the property at a price equal to our unpaid asset balance on the datewe foreclosed or acquired the asset, plus unpaid interest at the last statedcontract (non-default) rate and, to the extent payable by the borrower underthe initial documentation evidencing the property, legal costs incurred by usdirectly related to the conveyance and the fee, if any, due upon the repaymentor prepayment of the investment which is commonly referred to as an “exit fee”(but not including default interest, late charges, prepayment penalties,extension fees or other premiums of any kind) through the date of SL Green’spurchase. We refer to this amount as “Par Value.” If we seek to sell the assetand receive a bona fide third party offer to acquire the asset for cash that wedesire to accept, SL Green may purchase the asset at the lower of the ParValue or the third party’s offer price. If the asset is not sold within oneyear, SL Green has the right to purchase the property at its appraisedvalue. The appraised value will be determined as follows: we will select anappraiser and SL Green will select an appraiser, who will each appraisethe property. These two appraisers jointly will select a third appraiser, whowill then choose one of the two appraisals as the final appraised value. Theserights may make it more difficult to sell such assets because third parties maynot want to incur the expense and effort to bid on assets when they perceivethat SL Green may acquire them at the lower of the same terms proposed bythe third party or Par Value. As a result, we may not receive the same value onthe sale of such assets as we might receive from an independent third partysubmitting an offer through a competitive bidding process.

SL Green has a right of first offer to acquireany distressed debt which we decide to sell.

If any time SL Green plans to sell to a third partyany fixed income investment or preferred equity investment, we will have theright to purchase the offered investment within 10 business days on the termsand conditions offered by the third party. If SL Green is required toobtain any other party’s consent in connection with the sale of any investment,our right of first offer will be subject to such consent. If we choose not toexercise our right to purchase the offered investment, SL Green has theright to sell it to a third party within 6 months at not less than 99% of theprice offered to us. If the investment is not sold within 6 months, it willagain be subject to our right of first offer.

In the event theManagement Agreement is terminated for cause by us or if neither SL Green norany of its affiliates shall be the managing member of our Manager, then thenon-compete provisions in the origination agreement will survive suchtermination for a period of one year with respect only to potential investmentsby us as to which our Manager has commenced due diligence.

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**Hedging Activities**

We use derivative instruments, including forwards,futures, swaps and options, in our risk management strategy to limit theeffects of changes in interest rates on our operations. Our primary hedgingstrategy consists of entering into interest rate swap contracts. Additionally,we may in certain select instances choose to hedge our exposure to fluctuationsin CMBS credit spreads by purchasing swaps written against a broad-based CMBSindex. The value of our forwards, futures and swaps may fluctuate over time inresponse to changing market conditions, and will tend to change inversely withthe value of the risk in our liabilities that we intend to hedge. Hedges aresometimes ineffective because the correlation between changes in value of theunderlying investment and the derivative instrument is less than was expectedwhen the hedging transaction was undertaken. Since most of our hedging activitycovers the period between origination or purchase of loans and their eventualsale or securitization, unmatched losses in our hedging program will tend tooccur when the planned securitization fails to occur, or if the hedge proves tobe ineffective. We continuously monitor the effectiveness of our hedgingstrategies and adjust our strategies as appropriate. These transactions mayinclude interest rate swaps, the purchase or sale of interest rate collars,caps or floors, options, other hedging instruments and such other hedginginstruments as may be developed in the future and which we determine aresuitable to achieve our hedging objectives.

We have retained the services of an outside financialservices firm with expertise in the use of derivative instruments to advise uson our overall hedging strategy, to effect hedging trades, and to provide theappropriate designation and accounting of all hedging activities from a GAAPand tax accounting and reporting perspective.

These instruments are usedto hedge as much of the interest rate risk as our Manager determines is in thebest interest of our stockholders, given the cost of such hedges and the needto maintain our status as a REIT. To the extent that we enter into a hedgingcontract to reduce interest rate risk on indebtedness incurred to acquire orcarry real estate assets, any income that we derive from the contract isqualifying income for purposes of the REIT 95% gross income test, but not forthe 75% gross income test. Our Manager can elect to have us bear a level ofinterest rate risk that could otherwise be hedged when it believes, based onall relevant facts, that bearing such risk is advisable.

**DispositionPolicies**

Our Manager evaluates ourassets on a regular basis to determine if they continue to satisfy ourinvestment criteria. Subject to certain restrictions applicable to REITs, ourManager may cause us to sell our investments opportunistically and use theproceeds of any such sale for debt reduction, additional acquisitions orworking capital purposes.

**Equity CapitalPolicies**

Subject to applicable law, our board of directors hasthe authority, without further stockholder approval, to issue additionalauthorized common stock and preferred stock or otherwise raise capital,including through the issuance of senior securities, in any manner and on theterms and for the consideration it deems appropriate.

We may, under certaincircumstances, repurchase our common stock in private transactions with ourstockholders if those purchases are approved by our board of directors. Ourboard of directors has no present intention of causing us to repurchase anyshares, and any action would only be taken in conformity with applicablefederal and state laws and the applicable requirements for qualifying as aREIT, for so long as our board of directors concludes that we should remain aREIT.

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**Other Policies**

We operate in a mannerthat will not subject us to regulation under the Investment Company Act. We mayinvest in the securities of other issuers for the purpose of exercising controlover such issuers. We do not underwrite the securities of other issuers.

**Future Revisions inPolicies and Strategies**

Our board of directors hasthe power to modify or waive our investment guidelines, policies andstrategies. Among other factors, developments in the market that either affectthe policies and strategies mentioned herein or that change our assessment ofthe market may cause our board of directors to revise our investmentguidelines, policies and strategies. However, if such modification or waiverinvolves the relationship of, or any transaction between, us and our Manager orany affiliate of our Manager, the approval of a majority of our independentdirectors is also required. We may not, however, amend our charter to changethe requirement that a majority of our board of directors consist ofindependent directors or the requirement that a majority of our independentdirectors approve related party transactions without the approval of two-thirdsof the votes entitled to be cast by our stockholders.

**Competition**

Our net income depends, in large part, on our abilityto originate investments with spreads over our borrowing cost. In originatingthese investments, we compete with other mortgage REITs, specialty financecompanies, savings and loan associations, banks, mortgage bankers, insurancecompanies, mutual funds, institutional investors, investment banking firms,other lenders, governmental bodies and other entities, which may have greaterfinancial resources and lower costs of capital available to them than we have.In addition, there are numerous mortgage REITs with asset acquisitionobjectives similar to ours, and others may be organized in the future, whichmay increase competition for the available investments suitable for us.Competitive variables include market presence and visibility, size of loansoffered and underwriting standards.

To the extent that acompetitor is willing to risk larger amounts of capital in a particulartransaction or to employ more liberal underwriting standards when evaluatingpotential loans than we are, our origination volume and profit margins for ourinvestment portfolio could be adversely affected. Our competitors may also bewilling to accept lower returns on their investments and may succeed inoriginating or acquiring the assets that we have targeted for origination oracquisition. Although we believe that we are well positioned to competeeffectively in each facet of our business, there is considerable competition inour market sector and there can be no assurance that we will competeeffectively or that we will not encounter further increased competition in thefuture that could limit our ability to conduct our business effectively.

**Industry Segments**

Statement of FinancialAccounting Standard No. 131, or “SFAS No. 131,” establishes standardsfor the way that public entities report information about operating segments intheir annual financial statements. We are a REIT focused primarily onoriginating and acquiring loans and securities related to real estate andcurrently operate in only one segment.

**Employees**

We do not currently haveany employees, nor do we anticipate hiring any employees in the near term. Ourexecutive officers and other staff are all employed by our Manager orSL Green and leased by us pursuant to the management agreement with ourManager and the outsourcing agreement with SL Green.

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**EnvironmentalMatters**

Under various federal, state and local environmentallaws, ordinances and regulations, a current or previous owner of real estate(including, in certain circumstances, a secured lender that succeeds toownership or control of a property) may become liable for the costs of removalor remediation of certain hazardous or toxic substances at, on, under or in itsproperty. Those laws typically impose cleanup responsibility and liabilitywithout regard to whether the owner or control party knew of or was responsiblefor the release or presence of such hazardous or toxic substances. The costs ofinvestigation, remediation or removal of those substances may be substantial.The owner or control party of a site may be subject to common law claims bythird parties based on damages and costs resulting from environmentalcontamination emanating from a site. Certain environmental laws also imposeliability in connection with the handling of or exposure to asbestos-containingmaterials, pursuant to which third parties may seek recovery from owners ofreal properties for personal injuries associated with asbestos-containingmaterials. Absent succeeding to ownership or control of real property, asecured lender is not likely to be subject to any of these forms ofenvironmental liability. We are not currently aware of any environmental issueswhich could materially affect the Company.

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**ITEM1A.**        RISK FACTORS

**Risks Related toOur Management and Our Relationship with SL Green**

***We are dependent onour Manager and its key employees and may not find a suitable replacement ifour Manager terminates the management agreement or the key personnel are nolonger available to us.***

We have no directemployees. We are completely reliant on our Manager, which has significantdiscretion as to the implementation of our operating policies and strategies.We have entered into a management agreement with our Manager that terminates inDecember 2009, subject to automatic, one-year renewals. We are subject tothe risk that our Manager will terminate the management agreement and that nosuitable replacement will be found to manage us. We believe that our success dependsto a significant extent upon the experience of our Manager’s executiveofficers, whose continued service is not guaranteed. If our Manager terminatesthe management agreement, we may not be able to execute our business plan.

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

We are subject to potential conflicts of interestarising out of our relationship with SL Green and our Manager. Several of SLGreen’s executive officers are also directors and executive officers of ourManager and us. Specifically, our chairman and each of our executive officersalso serve as officers of our Manager or SL Green. As a result, the managementagreement was not negotiated at arm’s-length and its terms, including feespayable, may not be as favorable to us as if it had been negotiated with anunaffiliated third party.

In addition, our Manager and our executives may haveconflicts between their duties to us and their duties to, and interests in, SLGreen and/or our Manager. Our Manager is not required to devote a specificamount of time to our operations. There may also be conflicts in allocatinginvestments which are suitable both for us and SL Green. SL Green has agreedgenerally that it will not acquire fixed income or preferred equity investmentsduring the term of the management agreement. However, there are severalexceptions, including debt instruments with equity characteristics, distresseddebt and refinancings of existing SL Green debt investments. As a result, SLGreen may compete with us with respect to certain investments which we may wantto acquire, and as a result we may either not be presented with the opportunityor have to compete with SL Green to acquire these investments. Our Manager andour executive officers may choose to allocate favorable investments to SL Greeninstead of to us.

We pay our Manager substantial base management feesregardless of the performance of our portfolio. SL Green, our Manager andcertain other parties, including certain of our officers, also own Class Blimited partner interests in our operating partnership, which entitles them toreceive quarterly distributions based on financial performance. In evaluatinginvestments and other management strategies, this may lead our Manager to placeemphasis on the maximization of revenues at the expense of other criteria, such as preservation of capital. Investmentswith higher yield potential are generally riskier or more speculative. Thiscould result in increased risk to the value of our invested portfolio.

Termination of or failureto renew the management agreement without cause requires us to pay substantialamounts of termination fees and redeem the Class B limited partnerinterests. If the management agreement is terminated or not renewed other thanfor cause, we will be required to pay a termination fee equal to two times thehigher of the total annual fees paid in either of the two calendar years priorto the termination, unless we become self-managed, in which event this amountwill be reduced by 50%. We are also required to redeem the Class B limitedpartner interests upon termination of the management agreement. Theseprovisions may increase the effective cost to us of terminating or failing to 

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renewthe management agreement, thereby adversely affecting our ability to terminateor not renew the management agreement without cause.

***Our assets that weacquire by foreclosure or similar conveyance may be subject to purchase rightsor rights of first offer in favor of SL Green, which could reduce theirmarketability or value.***

Pursuant to our origination agreement with SL Green,we have granted SL Green purchase rights with respect to certain of our assets.When we acquire a direct or indirect ownership interest in real property orinterests in real property located in metropolitan New York or Washington, D.C.by foreclosure or similar conveyance or transfer, SL Green has the right topurchase such ownership interest at a price equal to the sum of (i) ourunpaid principal balance on the date we foreclosed on or acquired the asset, (ii) unpaidinterest through the date of SL Green’s purchase and (iii) legal costsincurred by us directly related to the conveyance of the property and the exitfee due upon prepayment or repayment, both to the extent payable by theborrower under the initial loan documentation. We refer to this amount as the“par value”. If we seek to sell the asset and receive a bona fide offer toacquire the asset for cash that we desire to accept, SL Green may purchase theasset at the lower of the par value and the third party’s offer price.

Similarly, our agreements with SL Green in connectionwith our investments in the South Building located at One Madison Avenue and 55Corporate Drive contain a buy-sell provision that can be triggered by us in theevent we and SL Green are unable to agree upon a major decision that wouldmaterially impair the value of the assets. Such major decisions involve thesale or refinancing of the assets, any extensions or modifications to the netleases with the tenant therein or any material capital expenditures.

These rights may make itmore difficult to sell such assets because third parties may not want to incurthe expense and effort to bid on assets when they perceive that SL Green mayacquire them at the lower of the same terms proposed by the third party or par value.As a result, we may not receive the same value on the sale of such assets as wemight receive from an independent third party submitting an offer through acompetitive bidding process.

***Our financial condition and results of operationsdepend on our ability to manage future growth effectively.***

Our ability to achieve ourinvestment objective depends on our ability to grow, which depends, in turn, onour Manager’s ability to identify and invest in debt investments or othersecurities that meet our investment criteria. Accomplishing this result on acost-effective basis is largely a function of our Manager’s structuring of theinvestment process, its ability to provide competent, attentive and efficientservices to us and our access to financing on acceptable terms. The seniormanagement team of our Manager has substantial responsibilities under themanagement agreement. We can offer no assurance that the senior management teamof our Manager or any of the other employees of our Manager will contribute to ourgrowth. Any failure to manage our future growth effectively could have amaterial adverse effect on our business, financial condition and results ofoperations.

***Our board ofdirectors has approved very broad investment guidelines for our Manager and doesnot approve each investment decision made by our Manager.***

Our Manager is authorizedto follow very broad investment guidelines. Our directors review our investmentguidelines and our investment portfolio annually and as often as they deemnecessary. However, our board of directors does not review each proposedinvestment. The investment committee of our board of directors must unanimouslyapprove all transactions involving investments of (i) $35 million ormore with respect to whole loans, (ii) $30 million or more withrespect to subordinate interests in whole loans, and (iii) $20 millionor over with respect to mezzanine loans, preferred equity, and CTLs. The fullboard of directors must approve investments (i) over $75 million withrespect to whole loans, (ii) over $65 million with respect tosubordinate interests in whole loans, (iii) over $55 million withrespect to 

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mezzanineloans, and (iv) over $50 million with respect to preferred equity andCTLs. Our Manager will have full discretion to make investments on our behalfunder (i) $35 million with respect to whole loans, (ii) $30 millionwith respect to subordinate interests in whole loans, and (iii) $20 millionwith respect to mezzanine loans, preferred equity and CTLs. Our chiefinvestment officer may approve investments of less than $3 million. Approvallimits are based on the investment amount less any origination fees, discountsor other up-front fees we receive in connection with the investment. Inaddition, in conducting periodic reviews, the directors rely primarily oninformation provided to them by our Manager. Our Manager has great latitudewithin the broad parameters of our investment guidelines in determining thetypes of assets it may decide are proper investments for us. Decisions made andinvestments entered into by our Manager may not fully reflect the stockholder’sbest interests.

***We may change our investment and operational policieswithout stockholder consent.***

We may change ourinvestment and operational policies, including our policies with respect toinvestments, acquisitions, growth, operations, indebtedness, capitalization anddistributions, at any time without the consent of our stockholders, which couldresult in our making investments that are different from, and possibly riskier than,the types of investments described in this filing. A change in our investmentstrategy may increase our exposure to interest rate risk, default risk and realestate market fluctuations, all of which could adversely affect our ability tomake distributions.

**Risks Related toOur Business**

***Maintenance of our Investment Company Act exemptionimposes limits on our operations.***

We have conducted our operations and intend tocontinue to conduct our operations so as not to become regulated as aninvestment company under the Investment Company Act. We believe that there area number of exemptions under the Investment Company Act that may be applicableto us. For example, Section 3(c)(5)(C) exempts from the definition of“investment company” any person who is “primarily engaged in the business ofpurchasing or otherwise acquiring mortgages and other liens on and interests inreal estate.” Additionally, Section 3(c)(6) exempts from thedefinition of “investment company” any company primarily engaged, directly orthrough majority-owned subsidiaries, in the business of purchasing or otherwiseacquiring mortgages and other liens on and interests in real estate. Further, Rule 3a-1under the Investment Company Act exempts from the definition of “investmentcompany” a company if no more than 45% of the value of its assets (exclusive ofU.S. Government securities and cash items) consists of, and no more than 45% ofits net income after taxes for the past four quarters is derived from,securities other than U.S. Government securities, securities issued byemployees’ securities companies, securities issued by certain majority-ownedsubsidiaries of such company and securities issued by certain companies thatare controlled primarily by such company, provided, that certain other requirementsare met. The assets that we have acquired and may acquire in the future,therefore, are limited by the provisions of the Investment Company Act and theexemptions on which we rely. In addition, we could, among other things, berequired either (a) to change the manner in which we conduct ouroperations to avoid being required to register as an investment company or (b) toregister as an investment company, either of which could have an adverse effecton our business and our ability to pay dividends.

To maintain our qualification for an exemption fromregistration under the Investment Company Act pursuant to Section 3(c)(5)(C) and3(c)(6) at least 55% of our portfolio, or the assets of our majority-ownedsubsidiaries, must be comprised of qualifying assets under Section 3(c)(5)(C) ofthe Investment Company Act, and 80% of our portfolio, or the assets of ourmajority-owned subsidiaries, must be comprised of qualifying assets and realestate-related assets under Section 3(c)(5)(C) of the Investment CompanyAct. In addition, we may not issue redeemable securities. To comply with theseregulations, we may from time to time buy RMBS and other qualifying assets. Wegenerally expect that mortgage loans, 

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whole pool MBS, CTLs andcertain distressed debt securities to be qualifying assets under the Section 3(c)(5)(C) and3(c)(6) exemptions from the Investment Company Act. The treatment ofdistressed debt securities as qualifying assets is, and will be, based on thecharacteristics of the particular type of loan, including its foreclosurerights. Junior (first loss) interests in MBS pools may constitute qualifyingassets under Section 3(c)(5)(C) provided that we have the unilateralright to foreclose, directly or indirectly, on the mortgages in the pool andthat we may act as the controlling class or directing holder of the pool.Similarly, subordinate interests in whole loans may constitute qualifyingassets under Section 3(c)(5)(C) provided that we have the unilateral rightto foreclose, directly or indirectly, on the mortgage and that we may act asthe controlling class or directing holder of the note. We generally do nottreat mezzanine loans and preferred equity investments as qualifying assets. Althoughwe monitor our portfolio periodically and prior to each origination oracquisition of a new asset or disposition of an existing asset, there can be noassurance that we will be able to maintain this exemption from registration.Further, we may not be able to invest in sufficient qualifying and/or realestate-related assets and future revisions or interpretations of the InvestmentCompany Act may cause us to lose our exemption or force us to re-evaluate ourportfolio and our business strategy. Such changes may prevent us from operatingour business successfully. To the extent that the staff of the Securities andExchange Commission, or the SEC, provides more specific guidance regarding thetreatment of assets as qualifying assets or real estate-related assets, we maybe required to adjust our investment strategy accordingly. Any additionalguidance from the staff of the SEC could provide additional flexibility to us,or it could further inhibit our ability to pursue the investment strategy wehave chosen.

As part of its dutiesunder the management agreement, our Manager periodically evaluates our assets,and also evaluates prior to an acquisition or origination the structure of eachprospective investment, to determine whether our Manager believes theinvestment will be a qualifying asset for purposes of maintaining our exemptionfrom registration under the Investment Company Act, and we consult with counselto verify such determination. If we are obligated to register as an investmentcompany, we would have to comply with a variety of substantive requirements underthe Investment Company Act, including limitations on capital structure,restrictions on specified investments; prohibitions on transactions withaffiliates, changes in the composition of the board of directors and compliancewith reporting, record keeping, voting, proxy disclosure and other rules andregulations that would significantly change our operations. In addition, theterms of our management agreement would need to be substantially revised orsuch agreement would need to be terminated. If the management agreement isterminated, we will, among other things, be in default under our repurchasefacilities and financial institutions will have the right to terminate thosefacilities and their obligation to advance funds to us to finance our futureinvestments. In addition, we may not be able to identify a replacement manageron favorable terms or at all.

***We utilize asignificant amount of debt to finance our portfolio, which may subject us to anincreased risk of loss, adversely affecting the return on our investments andreducing cash available for distribution.***

We utilize a significant amount of debt to finance ouroperations, which can compound losses and reduce the cash available fordistributions to our stockholders. We generally leverage our portfolio throughthe use of bank credit facilities, repurchase agreements, securitizations,including the issuance of CDOs and other borrowings. The leverage we employvaries depending on our ability to obtain financing, the loan-to-value and debtservice coverage ratios of our assets, the yield on our assets, the targetedleveraged return we expect from our portfolio and our ability to meet ongoingcovenants related to our asset mix and financial performance. Substantially allof our assets are pledged, or subject to a negative pledge, as collateral forour secured borrowings or to support our unsecured borrowings. Our return onour investments and cash available for distribution to our stockholders may bereduced to the extent that changes in market conditions cause the cost of ourfinancing to increase relative to the income that we can derive from the assetswe acquire. For example, we have purchased and expect to purchase in thefuture, subordinate classes of bonds in our CDOs, which represent leveragedinvestments in the collateral debt 

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securities and otherunderlying assets. The use of leverage through such CDOs create the risk forthe holders of the subordinate classes of bonds of increased exposure to losseson a leveraged basis as a result of defaults with respect to such collateraldebt securities. As a result, the occurrence of defaults with respect to only asmall portion of the collateral debt securities could result in the completeloss of the investment of the holders of the subordinate classes of bonds.

Our debt service payments,including payments in connection with any CDOs, reduce the net income availablefor distributions. Moreover, we may not be able to meet our debt serviceobligations and, to the extent that we cannot, we risk the loss of some or allof our assets to foreclosure or sale to satisfy our debt obligations. Under ourrepurchase agreements, our lenders take title to our assets and may have anability to liquidate our assets through an expedited process. Currently,neither our charter nor our bylaws impose any limitations on the extent towhich we may leverage our assets.

***If GKK Manager LLCceases to be our manager pursuant to the management agreement,  financial institutions providing ourrepurchase facilities may not provide future financing to us.***

The financial institutionsthat finance our investments pursuant to our repurchase agreements require thatGKK Manager LLC remain our Manager pursuant to the management agreement. If GKKManager LLC ceases to be our Manager, it is an event of default and thefinancial institutions under these facilities have the right to terminate thefacilities and their obligation to advance funds to us to finance our futureinvestments. If GKK Manager LLC ceases to be our Manager for any reason and weare unable to obtain financing under these or replacement credit and repurchasefacilities, our growth may be limited.

***Our repurchase agreements and our CDO financingagreements may limit our ability to make investments.***

In order to borrow money to make investments under ourrepurchase agreements, our lenders, Wachovia and Goldman have the right toreview the potential investment for which we are seeking financing. We may beunable to obtain the consent of our lenders to make investments that we believeare favorable to our company. In the event that Wachovia or Goldman do notconsent to the inclusion of the potential asset in the repurchase facility, wemay be unable to obtain alternate financing for that investment. Our lender’sconsent rights with respect to our repurchase agreements may limit our abilityto execute our business plan.

Each CDO financing that weengage in will contain certain eligibility criteria with respect to thecollateral that we seek to acquire and sell to the CDO issuer. If thecollateral does not meet the eligibility criteria for eligible collateral asset forth in the transaction documents of such CDO transaction, we may not beable to acquire and sell such collateral to the CDO issuer. The inability ofthe collateral to meet eligibility requirements with respect to our CDOs maylimit our ability to execute our business plan.

***We may not be ableto issue CDO securities on attractive terms, which may require us to seek morecostly financing for our investments or to liquidate assets.***

Conditions in the capitalmarkets may make the issuance of a CDO less attractive to us even in instanceswhen we have a sufficient pool of eligible collateral. If we are unable toissue a CDO to finance these assets, or if doing so is not economical, we maybe required to seek other forms of potentially less attractive financing orotherwise to liquidate the collateral.

***We may not be ableto access financing sources on favorable terms, or at all, which couldadversely affect our ability to execute our business plan and our ability todistribute dividends.***

We finance our assets over the long-term through avariety of means, including repurchase agreements, credit facilities, CDOs andother structured financings. We have also financed our investments through theissuance of $150 million of trust preferred securities. Our ability toexecute this strategy 

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depends on variousconditions in the markets for financing in this manner which are beyond ourcontrol, including lack of liquidity and wider credit spreads. We cannot assurethe stockholders that these markets will remain an efficient source oflong-term financing for our assets. If our strategy is not viable, we will haveto find alternative forms of long-term financing for our assets, as securedrevolving credit facilities and repurchase facilities may not accommodatelong-term financing. This could subject us to more recourse indebtedness andthe risk that debt service on less efficient forms of financing would require alarger portion of our cash flows, thereby reducing cash available fordistribution to our stockholders, funds available for operations as well as forfuture business opportunities.

In addition, we depend upon the availability ofadequate financing sources and capital for our operations. As a REIT, we arerequired to distribute at least 90% of our REIT taxable income, determinedwithout regard to the deduction for dividends paid and excluding net capitalgain, to our stockholders and are therefore not able to retain our earnings fornew investments. However, our taxable REIT subsidiaries are able to retain (andlikely will retain) earnings for investment in new capital, subject tomaintaining our qualification as a REIT. We cannot assure the stockholders thatany, or sufficient, funding or capital will be available to us in the future onterms that are acceptable to us.

Furthermore, if theminimum dividend distribution required to maintain our REIT qualificationbecomes large relative to our cash flow due to our taxable income exceeding ourcash flow from operations, then we could be forced to borrow funds, sell assetsor raise capital on unfavorable terms, if we are able to at all, in order tomaintain our REIT qualification. In the event that we cannot obtain sufficientfunding on acceptable terms, there may be a negative impact on the market priceof our common shares and our ability to distribute dividends.

***Lack of diversification in number of investmentsincreases our dependence on individual investments.***

If we acquire larger loansor property interests, our portfolio will be concentrated in a smaller numberof assets, increasing the risk of loss to stockholders if a default or otherproblem arises.

***Interest rate fluctuations could reduce our ability togenerate income on our investments.***

The yield on our investments in real estate securitiesand loans is sensitive to changes in prevailing interest rates and changes inprepayment rates. Changes in interest rates can affect our net interest income,which is the difference between the interest income we earn on ourinterest-earning investments and the interest expense we incur in financingthese investments. We tend to price loans at a spread to either United StatesTreasury obligations, swaps or LIBOR. A decrease in these indexes will lowerthe yield on our investments. Conversely, if these indexes rise materially,borrowers may be unable to borrow the higher-leverage loans that we target.

***In a period ofrising interest rates, our interest expense could increase while the interestwe earn on our fixed-rate assets would not change, which would adversely affectour profitability.***

Our operating resultsdepend in large part on differences between the income from our assets, net ofcredit losses, and financing costs. In most cases, for any period during whichour assets are not match-funded, the income from such assets will respond moreslowly to interest rate fluctuations than the cost of our borrowings.Consequently, changes in interest rates, particularly short-term interestrates, may significantly influence our net income. Increases in these rateswill tend to decrease our net income and market value of our assets. Interestrate fluctuations resulting in our interest expense exceeding our interestincome would result in operating losses for us and may limit or eliminate ourability to make distributions to our stockholders.

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***If credit spreads widen before we obtain long-termfinancing for our assets, the value of our assets may suffer.***

We price our assets basedon our assumptions about future credit spreads for financing of those assets.We have obtained, and will obtain in the future, longer term financing for ourassets using structured financing techniques. Such issuances entail interestrates set at a spread over a certain benchmark, such as the yield on UnitedStates Treasury obligations, swaps or LIBOR. If the spread that investors arepaying on our current structured finance vehicle and will pay on futurestructured finance vehicles we may engage in over the benchmark widens and therates we are charging or will charge on our securitized assets are notincreased accordingly, this may reduce our income or cause losses.

***The repurchaseagreements and credit facilities that we use to finance our investments mayrequire us to provide additional collateral.***

We use credit facilities and repurchase agreements tofinance some of our debt investments, primarily on an interim basis. If themarket value of the loans pledged or sold by us to a funding source decline invalue, we may be required by the lending institution to provide additionalcollateral or pay down a portion of the funds advanced. We may not have thefunds available to pay down our debt, which could result in defaults. Postingadditional collateral to support our repurchase and credit facilities will reduceour liquidity and limit our ability to leverage our assets. In the event we donot have sufficient liquidity to meet such requirements, lending institutionscan accelerate our indebtedness, increase interest rates and terminate ourability to borrow. Such a situation would likely result in a rapiddeterioration of our financial condition and possibly necessitate a filing forprotection under the United States Bankruptcy Code.

Further, facilityproviders may require us to maintain a certain amount of cash uninvested or setaside unlevered assets sufficient to maintain a specified liquidity positionwhich would allow us to satisfy our collateral obligations. As a result, we maynot be able to leverage our assets as fully as we would choose, which could reduceour return on assets. In the event that we are unable to meet these collateralobligations, our financial condition could deteriorate rapidly.

***Lenders may require us to enter into restrictivecovenants relating to our operations.***

When we obtain financing,lenders impose restrictions on us that affect our ability to incur additionaldebt, our capability to make distributions to stockholders and our flexibilityto determine our operating policies. Loan documents we execute contain negativecovenants that limit, among other things, our ability to repurchase stock,distribute more than a certain amount of our funds from operations, and employleverage beyond certain amounts.

***The use of CDOfinancings with coverage tests may have a negative impact on our operatingresults and cash flows.***

We have purchased, and expect to purchase in thefuture, subordinate classes of bonds issued by certain of our subsidiaries inour CDO financings. The terms of the CDO securities issued by us include andwill include coverage tests, including over-collateralization tests, usedprimarily to determine whether and to what extent principal and interestproceeds on the underlying collateral debt securities and other assets may beused to pay principal of and interest on the subordinate classes of bonds inthe CDO. In the event the coverage tests are not satisfied, interest andprincipal that would otherwise be payable on the subordinate classes may bere-directed to pay principal on the senior bond classes. Therefore, failure tosatisfy the coverage tests could adversely affect our operating results andcash flows. Although these coverage tests are currently being met, we cannotassure you that the coverage tests will continue to be satisfied in the future.

Certain coverage tests(based on delinquency levels or other criteria) may also restrict our abilityto receive net income from assets pledged to secure the CDOs. We cannot assureyou, in advance of 

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completingnegotiations with the rating agencies or other key transaction parties on anyfuture CDOs, the actual terms of the delinquency tests, over-collateralizationterms, cash flow release mechanisms or other significant factors regarding thecalculation of net income to us. Failure to obtain favorable terms with regardto these matters may materially and adversely affect the availability of netincome to us. If our assets fail to perform as anticipated, ourover-collateralization or other credit enhancement expense associated with ourCDOs will increase.

***If we issue seniorsecurities we will be exposed to additional restrictive covenants andlimitations on our operating flexibility, which could adversely affect ourability to pay dividends.***

If we decide to issue senior securities in the future,it is likely that they will be governed by an indenture or other instrumentcontaining covenants restricting our operating flexibility. Holders of seniorsecurities may be granted specific rights, including but not limited to: theright to hold a perfected security interest in certain of our assets, the rightto accelerate payments due under the indenture, rights to restrict dividendpayments, and rights to require approval to sell assets. Additionally, anyconvertible or exchangeable securities that we issue in the future may haverights, preferences and privileges more favorable than those of our commonstock. We, and indirectly our stockholders, will bear the cost of issuing andservicing such securities.

***We may not be ableto renew the total return swaps that we enter into, which could adverselyimpact our leveraging strategy.***

Subject tomaintaining our qualification as a REIT, we leverage certain of our investmentsthrough the use of total return swaps. We may wish to renew many of the swaps,which are for specified terms, as they mature. However, there is a limitednumber of providers of such swaps, and there is no assurance the initial swapproviders will choose to renew the swaps, and—if they do not renew—that wewould be able to obtain suitable replacement providers. Providers may choosenot to renew our total return swaps for a number of reasons, including:

·       increasesin the provider’s cost of funding;

·       insufficientvolume of business with a particular provider;

·       adesire by our company to invest in a type of swap that the provider does notview as economically attractive due to changes in interest rates or othermarket factors; or

·       theinability of our company and a provider to agree on terms.

Furthermore, our abilityto invest in total return swaps, other than through a taxable REIT subsidiary,or TRS, may be severely limited by the REIT qualification requirements becausetotal return swaps are not qualifying assets and do not produce qualifyingincome for purposes of the REIT asset and income tests.

***We may be required to repurchase loans that we havesold or to indemnify holders of our CDOs.***

If any of the loans weoriginate or acquire and sell or securitize do not comply with representationsand warranties that we make about certain characteristics of the loans, theborrowers and the underlying properties, we may be required to repurchase thoseloans (including from a trust vehicle used to facilitate a structured financingof the assets through CDOs) or replace them with substitute loans. In addition,in the case of loans that we have sold instead of retained, we may be requiredto indemnify persons for losses or expenses incurred as a result of a breach ofa representation or warranty. Repurchased loans typically require a significantallocation of working capital to carry on our books, and our ability to borrowagainst such assets is limited. Any significant repurchases or indemnificationpayments could materially and adversely affect our financial condition andoperating results.

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***Our hedging transactions may limit our gains or resultin losses.***

Subject to maintaining our qualification as a REIT, weuse derivative instruments, including forwards, futures, swaps and options, inour risk management strategy to limit the effects of changes in interest rateson our operations. Our primary hedging strategy consists of entering intointerest rate swap contracts. Additionally, we, in certain select instanceschoose to hedge our exposure to fluctuations in CMBS credit spreads bypurchasing swaps written against a broad-based CMBS index. The value of ourforwards, futures and swaps may fluctuate over time in response to changingmarket conditions, and will tend to change inversely with the value of the riskin our liabilities that we intend to hedge. Hedges are sometimes ineffectivebecause the correlation between changes in value of the underlying investmentand the derivative instrument is less than was expected when the hedgingtransaction was undertaken. Since a portion of our hedging activity is intendedto cover the period between origination or purchase of loans and their eventualsale or securitization, unmatched losses in our hedging program can occur whenthe planned securitization fails to occur, or if the hedge proves to be ineffective.

Our hedging transactions,which are intended to limit losses, may actually limit gains and increase ourexposure to losses. The use of derivatives to hedge our liabilities carriescertain risks, including the risk that losses on a hedge position will reducethe cash available for distribution to stockholders and that these losses mayexceed the amount invested in such instruments. A hedge may not be effective ineliminating all of the risks inherent in any particular position and couldresult in higher interest rates than we would otherwise have. In addition,there will be many market risks against which we may not be able to hedgeeffectively. Moreover, no hedging activity can completely insulate us from therisks associated with changes in interest rates, and our qualification as aREIT may limit our ability to effectively hedge our interest rate exposure. Ourprofitability may be adversely affected during any period as a result of theuse of derivatives.

***We are subject to significant competition and we maynot compete successfully.***

We have significantcompetition with respect to our acquisition and origination of assets with manyother companies, including other REITs, insurance companies, commercial banks,private investment funds, hedge funds, specialty finance companies and otherinvestors. Some competitors may have a lower cost of funds and access tofunding sources that are not available to us. In addition, some of ourcompetitors may have higher risk tolerances or different risk assessments,which could allow them to consider a wider variety of investments and establishmore relationships than us. We cannot assure you that the competitive pressureswe face will not have a material adverse effect on our business, financialcondition and results of operations. Also, as a result of this competition, wemay not be able to take advantage of attractive investment opportunities fromtime to time, and we can offer no assurance that we will be able to identifyand make investments that are consistent with our investment objective.

***Rapid changes inthe values of our MBS and other real estate related investments may make itmore difficult for us to maintain our qualification as a REIT or exemption fromthe Investment Company Act.***

If the market value orincome potential of our MBS and other real estate-related investments declinesas a result of increased interest rates, prepayment rates or other factors, wemay need to increase our real estate investments and income and/or liquidateour non-qualifying assets in order to maintain our REIT qualification orexemption from the Investment Company Act. If the decline in real estate assetvalues and/or income occurs quickly, this may be especially difficult toaccomplish. This difficulty may be exacerbated by the illiquid nature of manyof our non-real estate assets. We may have to make investment decisions that weotherwise would not make absent the REIT and Investment Company Actconsiderations.

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***If we fail to achieve adequate operating cash flow,our ability to make distributions will be adversely affected.***

As a REIT, we mustdistribute annually at least 90% of our REIT taxable income to ourstockholders, determined without regard to the deduction for dividends paid andexcluding net capital gain. Our ability to make and sustain cash distributionsis based on many factors, including the return on our investments, operatingexpense levels and certain restrictions imposed by Maryland law. Some of thefactors are beyond our control and a change in any such factor could affect ourability to pay future dividends. No assurance can be given as to our ability topay distributions.

***Terrorist attacksand other acts of violence or war may affect the market for our common stock,the industry in which we conduct our operations and our profitability.***

Terrorist attacks may harm our results of operationsand the stockholder’s investment. We cannot assure the stockholders that therewill not be further terrorist attacks against the U.S. or U.S. businesses.These attacks or armed conflicts may directly impact the property underlyingour asset-based securities or the securities markets in general. Lossesresulting from these types of events are uninsurable.

More generally, any ofthese events could cause consumer confidence and spending to decrease or resultin increased volatility in the U.S. and worldwide financial markets andeconomy. Adverse economic conditions could harm the value of the propertyunderlying our asset-backed securities or the securities markets in generalwhich could harm our operating results and revenues and may result in thevolatility of the value of our securities.

***We are highlydependent on information systems and third parties, and systems failures couldsignificantly disrupt our business, which may, in turn, negatively affect themarket price of our common stock and our ability to pay dividends.***

***Our business is highly dependent oncommunications and information systems. Any failure or interruption of oursystems could cause delays or other problems in our securities tradingactivities, including mortgage-backed securities trading activities, whichcould have a material adverse effect on our operating results and negativelyaffect the market price of our common stock and our ability to pay dividends.***

**Risks Related to OurInvestments**

***Some of ourportfolio investments may be recorded at fair value as determined in good faithby our Manager and, as a result, there will be uncertainty as to the value ofthese investments.***

Some of our portfolioinvestments may be in the form of securities that are not publicly traded. Thefair value of securities and other investments that are not publicly traded maynot be readily determinable. We value these investments quarterly at fair valueas determined in good faith by our Manager. Because such valuations areinherently uncertain, may fluctuate over short periods of time and may be basedon estimates, our determinations of fair value may differ materially from thevalues that would have been used if a ready market for these securities existed.The value of our common stock could be adversely affected if our determinationsregarding the fair value of these investments were materially higher than thevalues that we ultimately realize upon their disposal. At December 31,2006, we held no such investments.

***We may not realize gains or income from ourinvestments.***

We seek to generate bothcurrent income and capital appreciation. However, the securities we invest inmay not appreciate in value and, in fact, may decline in value, and the debtsecurities we invest in may default on interest and/or principal payments.Accordingly, we may not be able to realize gains or income from ourinvestments. Any gains that we do realize may not be sufficient to offset anyother losses we experience. Any income that we realize may not be sufficient tooffset our expenses.

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***A prolongedeconomic slowdown, a lengthy or severe recession, or declining real estatevalues could harm our operations.***

We believe the risksassociated with our business is more severe during periods of economic slowdownor recession if these periods are accompanied by declining real estate values.Declining real estate values will likely reduce our level of new mortgage loanoriginations, since borrowers often use increases in the value of theirexisting properties to support the purchase or investment in additionalproperties. Borrowers may also be less able to pay principal and interest onour loans if the real estate economy weakens. Further, declining real estatevalues significantly increase the likelihood that we will incur losses on ourloans in the event of default because the value of our collateral may beinsufficient to cover our cost on the loan. Any sustained period of increasedpayment delinquencies, foreclosures or losses could adversely affect both ournet interest income from loans in our portfolio as well as our ability tooriginate, sell and securitize loans, which would significantly harm ourrevenues, results of operations, financial condition, business prospects andour ability to make distributions to the stockholders.

***We may be adverselyaffected by unfavorable economic changes in geographic areas where ourproperties are concentrated.***

Adverse conditions in theareas where the properties underlying our investments are located (includingbusiness layoffs or downsizing, industry slowdowns, changing demographics andother factors) and local real estate conditions (such as oversupply of, orreduced demand for, office and industrial properties) may have an adverseeffect on the value of our properties. A material decline in the demand or theability of tenants to pay rent for office and industrial space in thesegeographic areas may result in a material decline in our cash available fordistribution.

***Joint investmentscould be adversely affected by our lack of sole decision-making authority andreliance upon a co-venturer’s financial condition.***

We co-invest with third parties through partnerships,joint ventures, co-tenancies or other entities, acquiring non-controllinginterests in, or sharing responsibility for managing the affairs of, aproperty, partnership, joint venture, co-tenancy or other entity. Therefore, wewill not be in a position to exercise sole decision-making authority regardingthat property, partnership, joint venture or other entity. Investments inpartnerships, joint ventures, or other entities may involve risks not presentwere a third party not involved, including the possibility that our partners,co-tenants or co-venturers might become bankrupt or otherwise fail to fundtheir share of required capital contributions. Additionally, our partners orco-venturers might at any time have economic or other business interests orgoals which are inconsistent with our business interests or goals. Theseinvestments may also have the potential risk of impasses on decisions such as asale, because neither we nor the partner, co-tenant or co-venturer would havefull control over the partnership or joint venture. Consequently, actions bysuch partner, co-tenant or co-venturer might result in subjecting propertiesowned by the partnership or joint venture to additional risk. In addition, wemay in specific circumstances be liable for the actions of our third-partypartners, co-tenants or co-venturers.

We may in the future enterinto joint venture agreements that contain terms in favor of our partners thatmay have an adverse effect on the value of our investments in the jointventures. For example, we may be entitled under a particular joint ventureagreement to an economic share in the profits of the joint venture that issmaller than our ownership percentage in the joint venture, our partner may beentitled to a specified portion of the profits of the joint venture before weare entitled to any portion of such profits and our partner may have rights tobuy our interest in the joint venture, to force us to buy the partner’sinterest in the joint venture or to compel the sale of the property owned by suchjoint venture. These rights may permit our partner in a particular jointventure to obtain a greater benefit from the value or profits of the 

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jointventure than us, which may have an adverse effect on the value of ourinvestment in the joint venture and on our financial condition and results ofoperations.

***Liability relatingto environmental matters may impact the value of the properties that we mayacquire or underlying our investments.***

Under various U.S. federal, state and local laws, anowner or operator of real property may become liable for the costs of removalof certain hazardous substances released on its property. These laws oftenimpose liability without regard to whether the owner or operator knew of, or,was responsible for, the release of such hazardous substances.

If we acquire properties directly, there may beenvironmental problems associated with the property which we were unaware of atthe time of acquisition. The presence of hazardous substances may adverselyaffect an owner’s ability to sell real estate or borrow using real estate ascollateral. To the extent that an owner of a property underlying one of ourdebt investments becomes liable for removal costs, the ability of the owner tomake debt payments to us may be reduced. This, in turn, may adversely affectthe value of the relevant mortgage asset held by us and our ability to makedistributions to stockholders.

If we acquire anyproperties, the presence of hazardous substances on a property may adverselyaffect our ability to sell the property and we may incur substantialremediation costs, thus harming our financial condition. In addition, althoughour leases, if any, will generally require our tenants to operate in compliancewith all applicable laws and to indemnify us against any environmentalliabilities arising from a tenant’s activities on the property, we nonethelesswould be subject to strict liability by virtue of our ownership interest forenvironmental liabilities created by such tenants, and we cannot ensure thestockholders that any tenants we might have would satisfy their indemnificationobligations under the applicable sales agreement or lease. The discovery ofmaterial environmental liabilities attached to such properties could have amaterial adverse effect on our results of operations and financial conditionand our ability to make distributions to our stockholders.

***Hedging instrumentsoften are not traded on regulated exchanges, guaranteed by an exchange or itsclearing house, or regulated by any U.S. or foreign governmental authoritiesand involve risks and costs.***

The cost of using hedging instruments increases as theperiod covered by the instrument increases and during periods of rising andvolatile interest rates. We may increase our hedging activity and thus increaseour hedging costs during periods when interest rates are volatile or rising andhedging costs have increased.

In addition, hedginginstruments involve risk since they often are not traded on regulatedexchanges, guaranteed by an exchange or its clearing house, or regulated by anyU.S. or foreign governmental authorities. Consequently, there are norequirements with respect to record keeping, financial responsibility orsegregation of customer funds and positions. Furthermore, the enforceability ofagreements underlying derivative transactions may depend on compliance withapplicable statutory and commodity and other regulatory requirements and,depending on the identity of the counterparty, applicable internationalrequirements. The business failure of a hedging counterparty with whom we enterinto a hedging transaction will most likely result in a default. Default by aparty with whom we enter into a hedging transaction may result in the loss ofunrealized profits and force us to cover our resale commitments, if any, at thethen current market price. Although generally we will seek to reserve the rightto terminate our hedging positions, it may not always be possible to dispose ofor close out a hedging position without the consent of the hedging counterparty,and we may not be able to enter into an offsetting contract in order to coverour risk. We cannot be assured that a liquid secondary market will exist forhedging instruments purchased or sold, and we may be required to maintain aposition until exercise or expiration, which could result in losses.

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***Prepayments can adversely affect the yields on ourinvestments.***

The yield of our assetsmay be affected by the rate of prepayments differing from our projections.Prepayments on debt instruments, where permitted under the debt documents, areinfluenced by changes in current interest rates and a variety of economic,geographic and other factors beyond our control, and consequently, suchprepayment rates cannot be predicted with certainty. In periods of declininginterest rates, prepayments on mortgage at similar yields, and loans generallyincrease. If we are unable to invest the proceeds of such prepayments received,the yield on our portfolio will decline. In addition, we may acquire assets ata discount or premium and if the asset does not repay when expected, ouranticipated yield may be impacted. Under certain interest rate and prepaymentscenarios we may fail to recoup fully our cost of acquisition of certaininvestments.

***The loans we investin and the commercial mortgage loans underlying the CMBS we invest in aresubject to risks of delinquency and foreclosure.***

Commercial mortgageloans are secured by commercial or multi-family property and are subject torisks of delinquency and foreclosure. These risks of loss are greater thansimilar risks associated with loans made on the security of single-familyresidential property. The ability of a borrower to pay principal and intereston a loan secured by an income-producing property typically is dependent primarilyupon the successful operation of the property rather than upon the existence ofindependent income or assets of the borrower. If the net operating income ofthe property is reduced, the borrower’s ability to repay the loan may beimpaired. Net operating income of an income-producing property can be affectedby a number of conditions beyond our control, including:

·       tenantmix;

·       successof tenant businesses;

·       propertymanagement decisions;

·       propertylocation and condition;

·       competitionfrom comparable types of properties;

·       changesin laws that increase operating expense or limit rents that may be charged;

·       anyneed to address environmental contamination at the property;

·       theoccurrence of any uninsured casualty at the property;

·       changesin national, regional or local economic conditions and/or specific industrysegments;

·       declinesin regional or local real estate values;

·       declinesin regional or local rental or occupancy rates;

·       increasesin interest rates, real estate tax rates and other operating expenses; and

·       changesin governmental rules, regulations and fiscal policies, including environmentallegislation, acts of God, terrorism, social unrest and civil disturbances.

Any of these factors could have an adverse affect onthe ability of the borrower to make payments of principal and interest in atimely fashion, or at all, on the mortgage loans in which we invest and couldadversely affect the cash flows we intend to receive from these investments.

In the event of any default under a mortgage loan helddirectly by us, we will bear the risk of loss of principal to the extent of anydeficiency between the value of the collateral and the principal and accruedinterest on the mortgage loan, which could have a material adverse effect onour cash flow from operations 

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and our ability to makedistributions to our stockholders. In the event of the bankruptcy of a mortgageloan borrower, the mortgage loan to the borrower will be deemed to be securedonly to the extent of the value of the underlying collateral at the time ofbankruptcy (as determined by the bankruptcy court), and the lien securing themortgage loan will be subject to the avoidance powers of the bankruptcy trusteeor debtor-in-possession to the extent the lien is unenforceable under state law.Foreclosure of a mortgage loan can be an expensive and lengthy process whichcould have a substantial negative effect on our anticipated return on theforeclosed mortgage loan.

CMBS evidence interests inor are secured by a single commercial mortgage loan or a pool of commercialmortgage loans. Residential MBS evidence interests in or are secured by a poolof single-family residential mortgage loans. Accordingly, multi-property MBS weinvest in are subject to all of the risks of the underlying mortgage loans.

***The subordinateinterests in whole loans in which we invest may be subject to additional risksrelating to the privately negotiated structure and terms of the transaction,which may result in losses to us.***

A subordinate interest ina whole loan is a mortgage loan typically (i) secured by a whole loan on asingle large commercial property or group of related properties and (ii) subordinatedto an senior interest secured by the same whole loan on the same collateral. Asa result, if a borrower defaults, there may not be sufficient funds remainingfor subordinate interest owners after payment to the senior interest owners.Subordinate interests reflect similar credit risks to comparably rated CMBS.However, since each transaction is privately negotiated, subordinate interestscan vary in their structural characteristics and risks. For example, the rightsof holders of subordinate interests to control the process following a borrowerdefault may be limited in certain investments. We cannot predict the terms ofeach subordinate investment. Further, subordinate interests typically aresecured by a single property, and so reflect the increased risks associatedwith a single property compared to a pool of properties. Subordinate interestsalso are less liquid than CMBS, thus we may be unable to dispose ofunderperforming or non-performing investments. The higher risks associated withour subordinate position in these investments could subject us to increasedrisk of losses.

***Investment in non-conforming and non-investment gradeloans may involve increased risk of loss.***

We acquire or originateand may continue to acquire or originate in the future certain loans that donot conform to conventional loan criteria applied by traditional lenders andare not rated or are rated as non-investment grade (for example, forinvestments rated by Moody’s Investors Service, ratings lower than Baa3, andfor Standard & Poor’s, BBB- or below). The non-investment graderatings for these loans typically result from the overall leverage of theloans, the lack of a strong operating history for the properties underlying theloans, the borrowers’ credit history, the properties’ underlying cash flow orother factors. As a result, these loans have a higher risk of default and lossthan conventional loans. Any loss we incur may reduce distributions to ourstockholders. There are no limits on the percentage of unrated ornon-investment grade assets we may hold in our portfolio.

***Investments inmezzanine loans involve greater risks of loss than senior loans secured byincome producing properties.***

Investments in mezzanineloans are secured by a pledge of the ownership interests in the entity thatdirectly or indirectly owns the property. These types of investments involve ahigher degree of risk than a senior mortgage loan because the investment maybecome unsecured as a result of foreclosure by the senior lender. In the eventof a bankruptcy of the entity providing the pledge of its ownership interestsas security, we may not have full recourse, to the assets of the propertyowning entity, or the assets of the entity may not be sufficient to satisfy ourmezzanine loan. If a borrower defaults on our mezzanine loan or debt senior toour loan, or in the event of a borrower bankruptcy, our mezzanine loan will besatisfied only 

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afterthe senior debt is paid in full. As a result, we may not recover some or all ofour investment, which could result in losses. In addition, mezzanine loans mayhave higher loan to value ratios than conventional mortgage loans, resulting inless equity in the property and increasing the risk of loss of principal.

***Bridge loansinvolve a greater risk of loss than traditional mortgage loans.***

We provide bridge loanssecured by first lien mortgages on a property to borrowers who are typicallyseeking short-term capital to be used in an acquisition or renovation of realestate. The borrower has usually identified an undervalued asset that has beenunder-managed or is located in a recovering market. If the market in which theasset is located fails to recover according to the borrower’s projections, orif the borrower fails to improve the quality of the asset’s management or thevalue of the asset, the borrower may not receive a sufficient return on theasset to satisfy the bridge loan, and we may not recover some or all of ourinvestment.

In addition, ownersusually borrow funds under a conventional mortgage loan to repay a bridge loan.We may therefore be dependent on a borrower’s ability to obtain permanentfinancing to repay our bridge loan, which could depend on market conditions andother factors. Bridge loans are also subject to risks of borrower defaults,bankruptcies, fraud, losses and special hazard losses that are not covered bystandard hazard insurance. In the event of any default under bridge loans heldby us, we bear the risk of loss of principal and non-payment of interest andfees to the extent of any deficiency between the value of the mortgagecollateral and the principal amount of the bridge loan. To the extent we suffersuch losses with respect to our investments in bridge loans, the value of ourcompany and the price of our common stock may be adversely affected.

***Preferred equityinvestments involve a greater risk of loss than traditional debt financing.***

Preferred equityinvestments are subordinate to debt financing and are not secured. Should theissuer default on our investment, we would only be able to proceed against theentity that issued the preferred equity in accordance with the terms of thepreferred security, and not any property owned by the entity. Furthermore, inthe event of bankruptcy or foreclosure, we would only be able to recoup ourinvestment after any lenders to the entity are paid. As a result, we may notrecover some or all of our investment, which could result in losses.

***Our investments insubordinate loans and subordinated CMBS are subject to losses.***

We acquire subordinatedloans and may invest in subordinated CMBS. In the event a borrower defaults ona loan and lacks sufficient assets to satisfy our loan, we may suffer a loss ofprincipal or interest. In the event a borrower declares bankruptcy, we may nothave full recourse to the assets of the borrower, or the assets of the borrowermay not be sufficient to satisfy the loan. In addition, certain of our loansmay be subordinate to other debt of the borrower. If a borrower defaults on ourloan or on debt senior to our loan, or in the event of a borrower bankruptcy,our loan will be satisfied only after the senior debt is paid in full. Wheredebt senior to our loan exists, the presence of intercreditor arrangements maylimit our ability to amend our loan documents, assign our loans, acceptprepayments, exercise our remedies (through “standstill periods”) and controldecisions made in bankruptcy proceedings relating to borrowers.

In general, losses on amortgage loan included in a securitization will be borne first by the equityholder of the property, then by a cash reserve fund or letter of credit, ifany, and then by the “first loss” subordinated security holder. In the event ofdefault and the exhaustion of any equity support, reserve fund, letter ofcredit and any classes of securities junior to those in which we invest, wewill not be able to recover all of our investment in the securities we purchase.Likewise, we may not be able to recover some or all of our investment incertain subordinated loans in which we obtain interests. In addition, if the 

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underlyingmortgage portfolio has been overvalued by the originator, or if the valuessubsequently decline and, as a result, less collateral is available to satisfyinterest and principal payments due on the related MBS, the securities in whichwe invest may effectively become the “first loss” position behind the moresenior securities, which may result in significant losses to us.

An economic downturn couldincrease the risk of loss on our investments in subordinated MBS. The prices oflower credit-quality securities, such as the subordinated MBS in which we mayinvest, are generally less sensitive to interest rate changes than more highlyrated investments, but are more sensitive to adverse economic downturns orindividual property developments. An economic downturn or a projection of aneconomic downturn could cause a decline in the price of lower credit qualitysecurities because the ability of obligors of mortgages underlying MBS to makeprincipal and interest payments may be impaired. In such event, existing creditsupport to a securitized structure may be insufficient to protect us againstloss of our principal on these securities.

***Our investments in debt securities are subject tospecific risks relating to the particular issuer of the securities and to thegeneral risks of investing in subordinated real estate securities.***

Ourinvestments in debt securities involve special risks. REITs generally arerequired to invest substantially in real estate or real estate-related assetsand are subject to the inherent risks associated with real estate-relatedinvestments discussed in this filing. Our investments in debt are subject tothe risks described above with respect to mortgage loans and MBS and similarrisks, including:

·       risksof delinquency and foreclosure, and risks of loss in the event thereof;

·       thedependence upon the successful operation of and net income from real property;

·       risksgenerally incident to interests in real property; and

·       risksthat may be presented by the type and use of a particular commercial property.

Debtsecurities may be unsecured and may also be subordinated to other obligations ofthe issuer. We may also invest in debt securities that are rated belowinvestment grade. As a result, investments in debt securities are also subjectto risks of:

·       limitedliquidity in the secondary trading market;

·       substantialmarket price volatility resulting from changes in prevailing interest rates;

·       subordinationto the prior claims of banks and other senior lenders to the issuer;

·       theoperation of mandatory sinking fund or call/redemption provisions duringperiods of declining interest rates that could cause the issuer to reinvestpremature redemption proceeds in lower yielding assets;

·       thepossibility that earnings of the debt security issuer may be insufficient tomeet its debt service; and

·       thedeclining creditworthiness and potential for insolvency of the issuer of suchdebt securities during periods of rising interest rates and economic downturn.

These risks may adverselyaffect the value of outstanding debt securities and the ability of the issuersthereof to repay principal and interest.

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***Our real estateinvestments are subject to risks particular to real property.***

We own assetssecured by real estate and may own real estate directly. Real estateinvestments are subject to risks particular to real property.

·       actsof God, including earthquakes floods and other natural disasters, which mayresult in uninsured losses;

·       actsof war or terrorism, including the consequences of terrorist attacks, such asthose that occurred on September 11, 2001;

·       adversechanges in national and local economic and market conditions;

·       changesin governmental laws and regulations, fiscal policies and zoning ordinances andthe related costs of compliance with laws and regulations, fiscal policies andordinances;

·       costsof remediation and liabilities associated with environmental conditions such asindoor mold; and

·       thepotential for uninsured or under-insured property losses.

If any of these or similar events occur, it may reduceour return from an affected property or investment and reduce or eliminate ourability to make distributions to stockholders.

***Our real estateinvestments may be illiquid, which could restrict our ability to respondrapidly to changes in economic conditions.***

The real estate and real estate-related assets inwhich we invest are generally illiquid. In addition, the instruments that wepurchase in connection with privately negotiated transactions are notregistered under the relevant securities laws, resulting in a prohibitionagainst their transfer, sale, pledge or other disposition except in atransaction that is exempt from the registration requirements of, or isotherwise in accordance with, those laws. A majority of the MBS and debtinstruments that we purchase are purchased in private, unregisteredtransactions. As a result, the majority of our investments in securities aresubject to restrictions on resale or otherwise have no established tradingmarket. As a result, our ability to sell under-performing assets in ourportfolio or respond to changes in economic and other conditions may be relativelylimited.

***Investments in CTLproperties may generate losses.***

The value of ourinvestments and the income from our investments in CTL properties may besignificantly adversely affected by a number of factors, including:

·       national,state and local economic climates;

·       realestate conditions, such as an oversupply of or a reduction in demand for realestate space in the area;

·       theperceptions of tenants and prospective tenants of the convenience,attractiveness and safety of our properties;

·       competitionfrom comparable properties;

·       theoccupancy rate of our properties;

·       theability to collect on a timely basis all rent from tenants;

·       theeffects of any bankruptcies or insolvencies of major tenants;

·       theexpense of re-leasing space;

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·       changesin interest rates and in the availability, cost and terms of mortgage funding;

·       theimpact of present or future environmental legislation and compliance withenvironmental laws;

·       costof compliance with the American with Disabilities Act of 1990;

·       adversechanges in governmental rules and fiscal policies;

·       civilunrest;

·       actsof nature, including earthquakes, hurricanes and other natural disasters (whichmay result in uninsured losses);

·       actsof terrorism or war;

·       adversechanges in zoning laws; and

·       otherfactors which are beyond our control.

***We may enter into derivative contracts that couldexpose us to contingent liabilities in the future.***

Subject to maintaining our qualification as a REIT,part of our investment strategy involves entering into derivative contractsthat could require us to fund cash payments in the future under certaincircumstances, e.g., the early termination of the derivative agreement causedby an event of default or other early termination event, or the decision by acounterparty to request margin securities it is contractually owed under theterms of the derivative contract. The amount due would be equal to theunrealized loss of the open swap positions with the respective counterparty andcould also include other fees and charges. These economic losses will bereflected in our financial results of operations, and our ability to fund theseobligations will depend on the liquidity of our assets and access to capital atthe time, and the need to fund these obligations could adversely impact ourfinancial condition.

***Our due diligencemay not reveal all of a borrower’s liabilities and may not reveal otherweaknesses in its business.***

Before investing in acompany or making a loan to a borrower, we assess the strength and skills ofsuch entity’s management and other factors that we believe are material to theperformance of the investment. In making the assessment and otherwiseconducting customary due diligence, we rely on the resources available to usand, in some cases, an investigation by third parties. This process isparticularly subjective with respect to newly organized entities because theremay be little or no information publicly available about the entities. Therecan be no assurance that our due diligence processes will uncover all relevantfacts or that any investment will be successful.

**Risks Related toOur Organization and Structure**

***The concentrationof our ownership may adversely affect the ability of investors to influence ourpolicies.***

SL Green owns approximately 25% of the outstandingshares of our common stock. In addition, SL Green has the right to purchase 25%of the shares in any future offering of common stock. Accordingly, SL Green hassignificant influence over us. The ownership level of SL Green may discourage orprevent others from trying to acquire control of us and increase the difficultyof consummating any offer, including potential acquisitions that might involvea premium price for our common stock or otherwise be in the best interest ofour stockholders. This concentration of ownership may result in decisionsaffecting us that may not serve the best interest of all stockholders.

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***Maryland takeover statutes may prevent a change ofcontrol of our company, which could depress our stock price.***

Under Maryland law, “business combinations” between aMaryland corporation and an interested stockholder or an affiliate of aninterested stockholder are prohibited for five years after the most recent dateon which the interested stockholder becomes an interested stockholder. Thesebusiness combinations include a merger, consolidation, share exchange, or, incircumstances specified in the statute, an asset transfer or issuance orreclassification of equity securities. An interested stockholder is defined as:

·       anyperson who beneficially owns 10% or more of the voting power of the corporation’sshares; or

·       anaffiliate or associate of the corporation who, at any time within the two-yearperiod prior to the date in question, was the beneficial owner of 10% or moreof the voting power of the then outstanding voting stock of the corporation.

A person is not an interested stockholder under thestatute if the board of directors approves in advance the transaction by whichhe otherwise would have become an interested stockholder.

After the five-yearprohibition, any business combination between the Maryland corporation and aninterested stockholder generally must be recommended by the board of directorsof the corporation and approved by the affirmative vote of at least:

·       80%of the votes entitled to be cast by holders of outstanding shares of votingstock of the corporation; and

·       two-thirdsof the votes entitled to be cast by holders of voting stock of the corporationother than shares held by the interested stockholder with whom or with whoseaffiliate the business combination is to be effected or held by an affiliate orassociate of the interested stockholder.

The business combination statute may discourage othersfrom trying to acquire control of us and increase the difficulty ofconsummating any offer, including potential acquisitions that might involve apremium price for our common stock or otherwise be in the best interest of ourstockholders.

We have opted out of these provisions of the MarylandGeneral Corporation Law, or the MGCL, with respect to its business combinationprovisions and its control share provisions by resolution of our board ofdirectors and a provision in our bylaws, respectively. However, in the futureour board of directors may reverse its decision by resolution and elect to optin to the MGCL’s business combination provisions, or amend our bylaws and electto opt in to the MGCL’s control share provisions.

Additionally, Title 8, Subtitle 3 of the MGCL permitsour board of directors, without stockholder approval and regardless of what isprovided in our charter or bylaws, to implement takeover defenses, some ofwhich we do not have. These provisions may have the effect of inhibiting athird party from making us an acquisition proposal or of delaying, deferring orpreventing a change in our control under circumstances that otherwise couldprovide the stockholders with an opportunity to realize a premium over thethen-current market price.

***Our authorized butunissued preferred stock may prevent a change in our control which could be inthe shareholders’ best interests.***

Our charter authorizes us to issue additionalauthorized but unissued shares of our common stock or preferred stock. Any suchissuance could dilute our existing stockholders’ interests. In addition, ourboard of directors may classify or reclassify any unissued shares of preferredstock and may set the preferences, rights and other terms of the classified orreclassified shares. As a result, our board of directors may establish a seriesof preferred stock that could delay or prevent a transaction or a change incontrol that might be in the best interest of our stockholders.

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***Our staggered boardof directors and other provisions of our charter and bylaws may prevent achange in our control.***

Our board of directors is divided into three classesof directors. The current terms of the directors expire in 2006, 2007 and 2008.Directors of each class are chosen for three-year terms upon the expiration oftheir current terms, and each year one class of directors is elected by thestockholders. The staggered terms of our directors may reduce the possibilityof a tender offer or an attempt at a change in control, even though a tenderoffer or change in control might be in the best interest of our stockholders. Inaddition, our charter and bylaws also contain other provisions that may delayor prevent a transaction or a change in control that might be in the bestinterest of our stockholders.

***Changes in marketconditions could adversely affect the market price of our common stock.***

As with otherpublicly traded equity securities, the value of our common stock depends onvarious market conditions which may change from time to time. Among the marketconditions that may affect the value of our common stock are the following:

·       thegeneral reputation of REITs and the attractiveness of our equity securities incomparison to other equity securities, including securities issued by otherreal estate-based companies;

·       ourfinancial performance; and

·       generalstock and bond market conditions.

The market value of our common stock is basedprimarily upon the market’s perception of our growth potential and our currentand potential future earnings and cash dividends. Consequently, our commonstock may trade at prices that are higher or lower than our net asset value pershare of common stock. If our future earnings or cash dividends are less thanexpected, it is likely that the market price of our common stock will diminish.

***An increase inmarket interest rates may have an adverse effect on the market price of ourcommon stock.***

One of the factors thatinvestors may consider in deciding whether to buy or sell shares of our commonstock is our distribution rate as a percentage of our share price relative tomarket interest rates. If the market price of our common stock is basedprimarily on the earnings and return that we derive from our investments andincome with respect to our investments and our related distributions tostockholders, and not from the market value of the investments themselves, theninterest rate fluctuations and capital market conditions will likely affect themarket price of our common stock. For instance, if market rates rise without anincrease in our distribution rate, the market price of our common stock coulddecrease as potential investors may require a higher distribution yield on ourcommon stock or seek other securities paying higher distributions or interest.In addition, rising interest rates would result in increased interest expenseon our variable rate debt, thereby adversely affecting cash flow and ourability to service our indebtedness and pay distributions.

**Risks Related toOur Taxation as a REIT**

***Our failure toqualify as a REIT would result in higher taxes and reduced cash available forstockholders.***

We intend to continue to operate in a manner so as toqualify as a REIT for U.S. federal income tax purposes. Our continuedqualification as a REIT depends on our satisfaction of certain asset, income,organizational, distribution and stockholder ownership requirements on acontinuing basis. Our ability to satisfy some of the asset tests depends uponthe fair market values of our assets, some of which are not able to beprecisely determined and for which we will not obtain independent appraisals.If we were to fail to qualify as a REIT in any taxable year, and certainstatutory relief provisions were not available, we would be subject to U.S.federal income tax, including any applicable alternative minimum tax, on our 

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taxable income at regularcorporate rates, and distributions to stockholders would not be deductible byus in computing our taxable income. Any such corporate tax liability could besubstantial and would reduce the amount of cash available for distribution.Unless entitled to relief under certain Internal Revenue Code provisions, wealso would be disqualified from taxation as a REIT for the four taxable yearsfollowing the year during which we ceased to qualify as a REIT.

***REIT distributionrequirements could adversely affect our liquidity.***

In order to qualify as a REIT, each year we mustdistribute to our stockholders at least 90% of our REIT taxable income,determined without regard to the dividends paid deduction, and not includingany net capital gain. To the extent that we satisfy this distributionrequirement, but distribute less than 100% of our net taxable income, we willbe subject to U.S. federal corporate income tax on our undistributed nettaxable income. In addition, we will be subject to a 4% nondeductible excisetax if the actual amount that we pay out to our stockholders in a calendar yearis less than a minimum amount specified under U.S. federal tax laws.

We intend to continue to make distributions to ourstockholders to comply with the REIT distribution requirements and avoid corporateincome tax and/or excise tax. However, differences in timing between therecognition of taxable income and the actual receipt of cash could require usto sell assets or borrow funds on a short-term or long-term basis to meet the90% distribution requirement or avoid corporate income or excise tax. We mayown assets that generate mismatches between taxable income and available cash.These assets may include (a) securities that have been financed throughfinancing structures which require some or all of available cash flows to beused to service borrowings, (b) loans or MBS we hold that have been issuedat a discount and require the accrual of taxable economic interest in advanceof receipt in cash, and (c) distressed debt on which we may be required toaccrue taxable interest income even though the borrower is unable to makecurrent debt service payments in cash. As a result, the requirement todistribute a substantial portion of our net taxable income could cause us to: (a) sellassets in adverse market conditions, (b) borrow on unfavorable terms or (c) distributeamounts that would otherwise be invested in future acquisitions, capitalexpenditures or repayment of debt to comply with REIT requirements.

To maximize the return on our funds, cash generatedfrom operations is expected to be used to temporarily pay down borrowings. Whenmaking distributions, we may borrow the required funds by drawing on creditcapacity available under our credit or repurchase facilities. If distributionsexceed the amount of cash generated from operations, we may be required toborrow additional funds, which, in turn, would reduce the amount of fundsavailable for other purposes.

Further, amounts distributed will not be available tofund investment activities. We expect to fund our investments by raising equitycapital and through borrowings from financial institutions. If we fail toobtain debt or equity capital in the future, it could limit our ability togrow, which could have a material adverse effect on the value of our commonstock.

***Complying with REITrequirements may limit our ability to hedge effectively.***

The existing REIT provisions of the Internal RevenueCode may substantially limit our ability to hedge our operations. Except to theextent provided by Treasury regulations, any income from a hedging transactionwe enter into in the normal course of our business primarily to manage risk ofinterest rate or price changes or currency fluctuations with respect toborrowings made or to be made, or ordinary obligations incurred or to beincurred, to acquire or carry real estate assets, which is clearly identifiedas specified in Treasury regulations before the close of the day on which itwas acquired, originated, or entered into, including gain from the sale ordisposition of such a transaction, will not constitute gross income forpurposes of the 95% gross income test (and will generally constitutenon-qualifying income for purposes of the 75% gross income test). To the extentthat we enter into other types of hedging 

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transactions, the incomefrom those transactions is likely to be treated as non-qualifying income forpurposes of both of the gross income tests. In addition, we must limit ouraggregate income from non-qualified hedging transactions, from our provision ofservices and from other non-qualifying sources, to less than 5% of our annualgross income (determined without regard to gross income from qualified hedgingtransactions). As a result, we may have to limit our use of certain hedgingtechniques or implement those hedges through TRSs. This could result in greaterrisks associated with changes in interest rates than we would otherwise want toincur or could increase the cost of our hedging activities. If we fail tosatisfy the 25% or 5% limitations, we could lose our REIT qualification forU.S. federal income tax purposes, unless our failure was due to reasonablecause and not due to willful neglect, and we meet certain other technicalrequirements. Even if our failure was due to reasonable cause, we might incur apenalty tax.

***The stock ownershiplimit imposed by the Internal Revenue Code for REITs and our charter mayinhibit market activity in our stock and may restrict our business combinationopportunities.***

In order for us to maintain our qualification as a REITunder the Internal Revenue Code, not more than 50% in value of our outstandingstock may be owned, directly or indirectly, by five or fewer individuals (asdefined in the Internal Revenue Code to include certain entities) at any timeduring the last half of each taxable year. Our charter, with certainexceptions, authorizes our directors to take such actions as are necessary anddesirable to preserve our qualification as a REIT. Unless exempted by our boardof directors, no person may own more than 9.8% of the aggregate value of theoutstanding shares of our stock. Our board of directors may not grant such anexemption to any proposed transferee whose ownership of in excess of 9.8% ofthe value of our outstanding shares would result in the termination of ourstatus as a REIT. Our board of directors has waived this provision inconnection with SL Green’s purchase of our shares. We have also granted waiversto two other purchasers in connection with their purchase of our shares in aprevious private placement. These ownership limits could delay or prevent atransaction or a change in our control that might be in the best interest ofour stockholders.

***The tax onprohibited transactions will limit our ability to engage in transactions,including certain methods of securitizing mortgage loans, that would be treatedas sales for U.S. federal income tax purposes.***

A REIT’s net income from prohibited transactions issubject to a 100% tax. In general, prohibited transactions are sales or otherdispositions of property, other than foreclosure property, but includingmortgage loans, held primarily for sale to customers in the ordinary course ofbusiness. We might be subject to this tax if we were to sell or securitizeloans in a manner that was treated as a sale of the loans for U.S. federalincome tax purposes. Therefore, in order to avoid the prohibited transactionstax, we may choose not to engage in certain sales of loans and may limit thestructures we utilize for our securitization transactions even though such salesor structures might otherwise be beneficial for us.

It may be possible to reduce the impact of theprohibited transaction tax by engaging in securitization transactions treatedas sales through one or more of our TRSs, subject to certain limitations as describedbelow. To the extent that we engage in such activities through one or moreTRSs, the income associated with such activities may be subject to fullcorporate income tax.

***The “taxablemortgage pool” rules may limit the manner in which we effect futuresecuritizations and may subject us to U.S. federal income tax and increase thetax liability of our stockholders.***

Certain of our current and future securitizations,such as our CDOs, could be considered to result in the creation of taxablemortgage pools for U.S. federal income tax purposes. As a REIT, so long as weor another private subsidiary REIT own 100% of the equity interests in ataxable mortgage pool, our qualification as a REIT would not be adverselyaffected by the characterization of the securitization as a taxable mortgagepool. We would generally be precluded, however, from holding equity interestsin such securitizations through our operating partnership (unless held througha private subsidiary REIT), selling 

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to outside investorsequity interests in such securitizations or from selling any debt securitiesissued in connection with such securitizations that might be considered to beequity interests for tax purposes. These limitations will preclude us fromusing certain techniques to maximize our returns from securitizationtransactions.

Furthermore, we are taxable at the highest corporateincome tax rate on a portion of the income arising from a taxable mortgage poolthat is allocable to the percentage of our shares held by “disqualified organizations,”which are generally certain cooperatives, governmental entities and tax-exemptorganizations that are exempt from unrelated business taxable income. We expectthat disqualified organizations will own our shares from time to time.

In addition, if we realize excess inclusion income andallocate it to stockholders, this income cannot be offset by net operatinglosses of our stockholders. If the stockholder is a tax-exempt entity and not adisqualified organization, then this income would be fully taxable as unrelatedbusiness taxable income under Section 512 of the Internal Revenue Code. Ifthe stockholder is a foreign person, it would be subject to U.S. federal incometax withholding on this. Nominees or other broker/dealers who hold our stock onbehalf of disqualified organizations are subject to tax at the highestcorporate income tax rate on a portion of our excess inclusion income allocableto the stock held on behalf of disqualified organizations. If the stockholderis a REIT, a regulated investment company, or RIC, common trust fund, or otherpass-through entity, its allocable share of our excess inclusion income couldbe considered excess inclusion income of such entity and such entity will besubject to tax at the highest corporate tax rate on any excess inclusion incomeallocated to their owners that are disqualified organizations. Accordingly,such investors should be aware that a portion of our income may be consideredexcess inclusion income. Finally, if we fail to qualify as a REIT, our taxablemortgage pool securitizations will be treated as separate taxable corporationsfor U.S. federal income tax purposes.

***We may be unable togenerate sufficient revenue from operations to pay our operating expenses andto pay distributions to our stockholders.***

As a REIT, we are generally required to distribute atleast 90% of our REIT taxable income (determined without regard to thedividends paid deduction and not including net capital gains) each year to ourstockholders. To qualify for the tax benefits accorded to REITs, we have andintend to continue to pay quarterly distributions and to make distributions toour stockholders in amounts such that we distribute all or substantially allour net taxable income each year, subject to certain adjustments. However, ourability to make distributions may be adversely affected by the risk factorsdescribed in this Annual Report on Form 10-K. In the event of adownturn in our operating results and financial performance or unanticipateddeclines in the value of our asset portfolio, we may be unable to declare orpay quarterly distributions or make distributions to our stockholders. Thetiming and amount of distributions are in the sole discretion of our board ofdirectors, which considers, among other factors, our earnings, financialcondition, debt service obligations and applicable debt covenants, REITqualification requirements and other tax considerations and capital expenditurerequirements as our board may deem relevant from time to time.

***Although our use ofTRSs may be able to partially mitigate the impact of meeting the requirementsnecessary to maintain our qualification as a REIT, our ownership of andrelationship with our TRSs will be limited and a failure to comply with thelimits would jeopardize our REIT qualification and may result in theapplication of a 100% excise tax.***

A REIT may own up to 100% of the stock of one or moreTRSs. A TRS generally may hold assets and earn income that would not bequalifying assets or income if held or earned directly by a REIT. Both thesubsidiary and the REIT must jointly elect to treat the subsidiary as a TRS. Acorporation of which a TRS directly or indirectly owns more than 35% of thevoting power or value of the stock will automatically be treated as a TRS.Overall, no more than 20% of the value of a REIT’s assets may consist of stockor 

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securities of one or moreTRSs. In addition, the TRS rules limit the deductibility of interest paidor accrued by a TRS to its parent REIT to assure that the TRS is subject to anappropriate level of corporate taxation. The rules also impose a 100%excise tax on certain transactions between a TRS and its parent REIT that arenot conducted on an arm’s-length basis.

Our TRSs, including GKKTrading Corp. and GIT Trading Corp., will pay U.S. federal, state and localincome tax on their taxable income, and their after-tax net income will beavailable for distribution to us but will not be required to be distributed tous. We anticipate that the aggregate value of TRS securities owned by us willbe less than 20% of the value of our total assets (including such TRSsecurities). Furthermore, we will monitor the value of our respectiveinvestments in our TRSs for the purpose of ensuring compliance with the rule thatno more than 20% of the value of a REIT’s assets may consist of TRS securities(which is applied at the end of each calendar quarter). In addition, we willscrutinize all of our transactions with our TRSs for the purpose of ensuringthat they are entered into on arm’s-length terms in order to avoid incurringthe 100% excise tax described above. The value of the securities that we holdin our TRSs may not be subject to precise valuation. Accordingly, there can beno complete assurance that we will be able to comply with the 20% limitationdiscussed above or avoid application of the 100% excise tax discussed above.

**Cautionary NoteRegarding Forward-Looking Information**

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

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

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

·       theperformance and financial condition of borrowers and corporate customers;

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

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

·       availabilityof qualified personnel;

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

·       theadequacy of our cash reserves and working capital;

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

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

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·       risksof structured finance investments;

·       GKKManager LLC remaining as our Manager;

·       environmentaland/or safety requirements;

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

·       competitionwith other companies;

·       ourability to satisfy complex rules in order for us to qualify as a REIT forfederal income tax purposes and qualify for our exemption under the InvestmentCompany Act, our operating partnership’s ability to satisfy the rules inorder for it to qualify as a partnership for federal income tax purposes, theability of certain of our subsidiaries to qualify as REITs, and the ability ofcertain of our subsidiaries to qualify as taxable REIT subsidiaries for federalincome tax purposes, and our ability and the ability of our subsidiaries tooperate effectively within the limitations imposed by these rules;

·       changesin governmental regulations, tax rates and similar matters; and

·       legislativeand regulatory changes (including changes to laws governing the taxation ofREITs), and other factors, many of which are beyond our control.

We undertake no obligation to publicly update orrevise any forward-looking statements, whether as a result of future events,new information or otherwise.

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

**ITEM 1B. UNRESOLVEDSTAFF COMMENTS**

As of December 31,2006, we did not have any unresolved comments with the Staff of the SEC.

**ITEM 2. PROPERTIES**

Our corporate offices arelocated in midtown Manhattan at 420 Lexington Avenue, New York, New York 10170.We can be contacted at (212) 297-1000. We maintain a website at *www.gramercycapitalcorp.com*.

**ITEM 3. LEGALPROCEEDINGS**

As of December 31,2006, we were not involved in any material litigation nor, to management’sknowledge, is any material litigation threatened against us or our Manager.

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

No matters were submitted to a vote of ourstockholders during the fourth quarter ended December 31, 2006.

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**PART II**

**ITEM 5.**                MARKETFOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUERPURCHASES OF EQUITY SECURITIES

**Our common stock began trading onthe New York Stock Exchange (“NYSE”) on August 2, 2004 under the symbol “GKK.”On February 27, 2007, the reported closing sale price per share of commonstock on the NYSE was $31.94 and there were approximately 42 holders of recordof our common stock. The table below sets forth the quarterly high and lowclosing sales prices of our common stock on the NYSE since our initial publicoffering and the distributions paid by us with respect to the periodsindicated.**

| ** **             | ** ** | **2006** | ** ** | **2005** | ** ** |
|------------------------|------------|----------|------------|----------|------------|
| **Quarter Ended** | ** ** | **High** | ** ** | **Low**  | ** ** | **Dividends** | ** ** | **High** | ** ** | **Low** | ** ** | **Dividends** | ** ** |
| March 31          |       | $        | 31.15      |     | $          | 24.70 |   |   | $ | 0.50 |   |   | $ | 22.25 |   | $ | 19.23 |   |   | $ | 0.22 |   |   |
| June 30           |       | $        | 27.10      |     | $          | 24.89 |   |   | $ | 0.51 |   |   | $ | 24.98 |   | $ | 18.64 |   |   | $ | 0.35 |   |   |
| September 30      |       | $        | 27.40      |     | $          | 23.61 |   |   | $ | 0.51 |   |   | $ | 26.91 |   | $ | 22.47 |   |   | $ | 0.45 |   |   |
| December 31       |       | $        | 26.80      |     | $          | 23.18 |   |   | $ | 0.56 |   |   | $ | 24.00 |   | $ | 22.41 |   |   | $ | 0.475 |   |   |

 

If dividends are declared in a quarter, thosedividends will be paid during the subsequent quarter. We expect to continue ourpolicy of generally distributing 100% of our taxable income through regularcash dividends on a quarterly basis, although there is no assurance as tofuture dividends because they depend on future earnings, capital requirementsand financial condition. See Item 7 “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations—Dividends” for additionalinformation regarding our dividends.

We declared a quarterly dividend of $0.56 per share,payable on January 12, 2007, for stockholders of record of our commonstock on December 29, 2006.

Thefollowing table summarizes information, as of December 31, 2006, relatingto our equity compensation plans pursuant to which shares of our common stockor other equity securities may be granted from time to time.

| **Plan category**                                      | ** ** | **(a)  Number of securities  to be issued upon  exercise of  outstanding options,  warrants and rights** | ** ** | **(b)  Weighted average  exercise price of  outstanding options,  warrants and rights** | ** ** | **(c)  Number of securities**

**remaining available for  future issuance under  equity compensation  plans (excluding  securities reflected in  column (a))** | ** ** |
|-------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| Equity  compensation plans approved by security holders(1)  |       |                                                                                                                                                  | 830,001    |                                                                                                                  |       |                                                                                                                                                                                                                  | $          | 18.02 |   |   |   | 1,212,840 |   |   |
| Equity  compensation plans not approved by security holders |       |                                                                                                                                                  | N/A        |                                                                                                                  |       |                                                                                                                                                                                                                  | N/A        |   |   |   | N/A |   |   |
| Total                                                       |       |                                                                                                                                                  | 830,001    |                                                                                                                  |       |                                                                                                                                                                                                                  | $          | 18.02 |   |   |   | 1,212,840 |   |   |

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(1)          Includesinformation related to our 2004 Equity Incentive Plan.

**SALE OFUNREGISTERED AND REGISTERED SECURITIES; USE OF PROCEEDS FROM REGISTEREDSECURITIES**

On August 2, 2004, we consummated the initialpublic offering of our common stock, $0.001 par value per share. The shares ofcommon stock sold in the offering were registered under the Securities Act of1933, as amended, or the Securities Act. All 12,500,000 shares of common stockregistered under the Registration Statement were sold at a price to the publicof $15.00 per share, generating gross proceeds of 

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approximately $187.5million. We paid underwriting discounts and commissions of $9.8 million in thisoffering. The net proceeds to us were approximately $172.9 million, which werecontributed to our Operating Partnership to make investments in commercial realestate-related loans and securities and for general corporate purposes,including financing and operating expenses and other expenses of our company. Allof the shares of common stock were sold by us and there were no sellingstockholders in the offering. Wachovia Capital Markets, LLC, Merrill Lynch,Pierce, Fenner & Smith Incorporated, Banc of America LLC and JMPSecurities LLC acted as our principal underwriters in this offering.

On December 3, 2004 we sold 5,500,000 shares ofcommon stock, at a price of $17.27 per share, through a private placementexempt from registration pursuant to Section 4(2) of the SecuritiesAct. We subsequently registered the resale of these shares under the SecuritiesAct in August 2005. A total of 4,225,000 shares were sold to variousinstitutional investors and an additional 1,275,000 were sold to SL GreenOperating Partnership, L.P., an affiliate of SL Green Realty Corp., pursuant toits contractual right to choose to maintain a 25% ownership interest in theoutstanding shares of our common stock. On December 31, 2004, 2,000,000shares sold in the offering were issued. The remaining 3,500,000 shares wereissued on January 3, 2005. The net proceeds from the offering(approximately $93.7 million) were used to fund additional investments, repayborrowings and for general corporate purposes. We did not use an underwriter;however, our Manager arranged the transaction and received a fee of $1.0million.

On September 14, 2005 we sold 3,833,333 shares ofcommon stock, at a price of $25.80 per share, under our $350 million shelfregistration statement declared effective in August 2005, resulting in netproceeds of approximately $97.8 million. We paid underwriting discounts andcommissions of $0.5 million in this offering. A total of 2,875,000 shares were soldthrough a public offering and an additional 958,333 shares were sold to SLGreen Operating Partnership, L.P. pursuant to its contractual right to chooseto maintain a 25% ownership interest in our outstanding shares of common stock.Net proceeds were used for loan acquisitions and originations, repayment ofoutstanding principal under one of our repurchase facilities and generalcorporate purposes. Wachovia Capital Markets, LLC acted as our underwriter inthis offering.

On May 16, 2006, wesold 3,000,000 shares of common stock, at a price of $26.75 per share, underour $350 million shelf registration statement declared effective in August 2005,resulting in net proceeds of approximately $80.0 million. We paid underwritingdiscounts and commissions of $0.2 million in this offering. A total of2,250,000 shares were sold through a public offering and an additional 750,000shares were sold to SL Green Operating Partnership, L.P. pursuant to itscontractual right to choose to maintain a 25% ownership interest in ouroutstanding shares of common stock. Net proceeds were used for loanacquisitions and originations, repayment of outstanding principal under ourrepurchase facilities and general corporate purposes. Wachovia Capital Markets,LLC acted as our underwriter in this offering.

**ITEM 6.**                SELECTEDFINANCIAL DATA

The following tables setforth our selected financial data and should be read in conjunction with ourFinancial Statements and notes thereto included in Item 8, “FinancialStatements and Supplementary Data” and Item 7, “Management’s Discussion andAnalysis of Financial Condition and Results of Operations” in this Form 10-K.

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**Operating Data**

| **(In thousands, except per share data)**                                       | ** ** | **For the Year  ended  December 31,  2006** | ** ** | **For the Year  ended  December 31,  2005** | ** ** | **For the Period  April 12, 2004  (formation)  through  December 31,  2004** | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------|------------|------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------|------------|
| Total revenues                                                                                           |       |                                                       | $          | 198,215                                                    |       |                                                                                                  |       | $ | 88,085 |   |   |   | $ | 7,151 |   |   |
| Interest expense                                                                                         |       |                                                       | 98,299     |                                                       |       |                                                                                                  | 33,771     |   |   |   | 1,463 |   |   |
| Management fees                                                                                          |       |                                                       | 16,668     |                                                       |       |                                                                                                  | 9,600      |   |   |   | 1,965 |   |   |
| Incentive fee                                                                                            |       |                                                       | 7,609      |                                                       |       |                                                                                                  | 2,276      |   |   |   | — |   |   |
| Depreciation and  amortization                                                                           |       |                                                       | 1,582      |                                                       |       |                                                                                                  | 672        |   |   |   | 38 |   |   |
| Marketing,  general and administrative                                                                   |       |                                                       | 11,957     |                                                       |       |                                                                                                  | 6,976      |   |   |   | 1,358 |   |   |
| Provision for  loan loss                                                                                 |       |                                                       | 1,430      |                                                       |       |                                                                                                  | 1,030      |   |   |   | — |   |   |
| Total expenses                                                                                           |       |                                                       | 137,545    |                                                       |       |                                                                                                  | 54,325     |   |   |   | 4,824 |   |   |
| Income from  continuing operations before equity in net loss of unconsolidated joint  ventures and taxes |       |                                                       | 60,670     |                                                       |       |                                                                                                  | 33,760     |   |   |   | 2,327 |   |   |
| Equity in net  loss of unconsolidated joint ventures                                                     |       |                                                       | (2,960     | )                                                          |       |                                                                                                  | (1,489     | ) |   |   | — |   |   |
| Income from  continuing operations before provision for taxes and GKK formation costs                    |       |                                                       | 57,710     |                                                       |       |                                                                                                  | 32,271     |   |   |   | 2,327 |   |   |
| Provision for  taxes                                                                                     |       |                                                       | (1,808     | )                                                          |       |                                                                                                  | (900       | ) |   |   | — |   |   |
| GKK formation  costs                                                                                     |       |                                                       | —     |                                                       |       |                                                                                                  | —     |   |   |   | (275 | ) |   |
| Net income  available to common stockholders                                                             |       |                                                       | $          | 55,902                                                     |       |                                                                                                  |       | $ | 31,371 |   |   |   | $ | 2,052 |   |   |
| Net income per  common share—Basic                                                                  |       |                                                       | $          | 2.26                                                       |       |                                                                                                  |       | $ | 1.57 |   |   |   | $ | 0.15 |   |   |
| Net income per  common share—Diluted                                                                |       |                                                       | $          | 2.15                                                       |       |                                                                                                  |       | $ | 1.51 |   |   |   | $ | 0.15 |   |   |
| Cash dividends  declared per common share                                                                |       |                                                       | $          | 2.08                                                       |       |                                                                                                  |       | $ | 1.495 |   |   |   | $ | 0.15 |   |   |
| Basic weighted  average common shares outstanding                                                        |       |                                                       | 24,722     |                                                       |       |                                                                                                  | 20,027     |   |   |   | 13,348 |   |   |
| Diluted weighted average  common shares and common share equivalents outstanding                         |       |                                                       | 26,009     |                                                       |       |                                                                                                  | 20,781     |   |   |   | 13,411 |   |   |

 

**Balance Sheet Data**

| ** **                                                                                                 | ** ** | **Year Ended December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| **(In thousands)**                                                                                    | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| Loans and other  lending investments, net                                                                  |       | $                                          | 2,144,151  |   | $ | 1,163,745 |   | $ | 395,717 |   |
| Commercial  mortgage backed securities, net                                                                |       | —                                     |       | — |   | 10,898 |   |
| Loans held for  sale, net                                                                                  |       | 42,733                                     |       | 42,000 |   | — |   |
| Commercial real  estate, net                                                                               |       | 99,821                                     |       | 51,173 |   | — |   |
| Investment in  unconsolidated joint ventures                                                               |       | 57,567                                     |       | 58,040 |   | — |   |
| Total assets                                                                                               |       | 2,766,113                                  |       | 1,469,810 |   | 514,047 |   |
| Collateralized  debt obligations                                                                           |       | 1,714,250                                  |       | 810,500 |   | — |   |
| Repurchase  agreements                                                                                     |       | 277,412                                    |       | 117,366 |   | 238,885 |   |
| Credit facilities                                                                                          |       | 15,000                                     |       | — |   | — |   |
| Mortgage note  payable                                                                                     |       | 94,525                                     |       | 41,000 |   | — |   |
| Junior  subordinated deferrable interest debentures held by trusts that issued trust  preferred securities |       | 150,000                                    |       | 100,000 |   | — |   |
| Total liabilities                                                                                          |       | 2,305,453                                  |       | 1,097,406 |   | 245,088 |   |
| Stockholders’ equity                                                                                  |       | 460,660                                    |       | 372,404 |   | 268,959 |   |
|                                                                                                            |            |                                            |            |  |  |  |  |  |  |  |

 

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**Other Data**

| **(In thousands)**                      | ** ** | **For the year  ended  December 31,  2006** | ** ** | **For the year  ended  December 31,  2005** | ** ** | **For the Period  April 12, 2004  (formation)  through  December 31,  2004** | ** ** |
|----------------------------------------------|------------|------------------------------------------------------------|------------|------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------|------------|
| Funds from  operations(1)                    |       | $                                                          | 64,027     |                                                       |       | $                                                                                                     | 36,490     |   |   |   | $ | 2,052 |   |   |
| Cash flows  provided by operating activities |       | $                                                          | 154,707    |                                                       |       | $                                                                                                     | 2,160      |   |   |   | $ | 1,145 |   |   |
| Cash flows used  in investing activities     |       | ($1,149,526                                                | )          |                                                       | ($867,995  | )                                                                                                     |       |   | ($407,056 | ) |   |
| Cash flows provided by  financing activities |       | $                                                          | 943,557    |                                                       |       | $                                                                                                     | 897,317    |   |   |   | $ | 444,805 |   |   |

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(1)          We present FFO becausewe consider it an important supplemental measure of our operating performanceand believe that it is frequently used by securities analysts, investors andother interested parties in the evaluation of REITS. We also use FFO for thecalculation of the incentive fee payable to the holders of Class B limitedpartner interests in our Operating Partnership and as one of several criteriato determine performance-based incentive compensation for members of our seniormanagement, which may be payable in cash or equity awards. The revised WhitePaper on FFO approved by the Board of Governors of the National Association ofReal Estate Investment Trusts, or NAREIT, in April 2002 defines FFO as netincome (loss) (computed in accordance with GAAP), excluding gains (or losses)from items which are not a recurring part of our business, such as debtrestructurings, and sales of properties, plus real estate-related depreciationand amortization and after adjustments for unconsolidated partnerships andjoint ventures. We consider gains andlosses on the sales of debt investments and real estate investments includingtenancy-in-common investments to be a normal part of our recurring operationsand therefore include such gains and losses when arriving at FFO. FFOdoes not represent cash generated from operating activities in accordance withGAAP and should not be considered as an alternative to net income (determinedin accordance with GAAP), as an indication of our financial performance, or tocash flow from operating activities (determined in accordance with GAAP) as ameasure of our liquidity, nor is it entirely indicative of funds available tofund our cash needs, including our ability to make cash distributions. Ourcalculation of FFO may be different from the calculation used by othercompanies and, therefore, comparability may be limited.

A reconciliation of FFO to net income computed inaccordance with GAAP is provided under the heading of “Management’s Discussionand Analysis of Financial Condition and Results of Operations—Funds FromOperations.”

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**ITEM 7.**                MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

**Overview**

We are a commercial real estate specialty financecompany that focuses on the direct origination and acquisition of whole loans,subordinate interests in whole loans, mezzanine loans, preferred equity, andnet lease investments involving commercial properties throughout the UnitedStates. When evaluating transactions, we assess our risk-adjusted return andtarget transactions with yields that seek to provide excess returns for therisks being taken. We conduct substantially all of our operations through ouroperating partnership, GKK Capital LP, or our Operating Partnership. We areexternally managed and advised by GKK Manager LLC, or our Manager, a majority-ownedsubsidiary of SL Green Realty Corp. (NYSE: SLG), or SL Green. We have electedto be taxed as a REIT under the Internal Revenue Code and generally will not besubject to federal income taxes to the extent we distribute our income to ourstockholders. However, we may establish TRSs to effect various taxabletransactions. Those TRSs would incur federal, state and local taxes on thetaxable income from their activities. Unless the context requires otherwise,all references to “we,” “our” and “us” mean Gramercy Capital Corp.

In each financing transaction we undertake, we seek tocontrol as much of the capital structure as possible in order to be able toidentify and retain that portion that provides the best risk adjusted returns. Thisis generally achieved through the direct origination of whole loans, theownership of which permits a wide variety of financing, syndication, andsecuritization executions to achieve excess returns. By providing a singlesource of financing for developers and sponsors, we streamline the lendingprocess, provide greater certainty for borrowers, and retain the high yielddebt instruments that we manufacture. By originating, rather than buying, wholeloans, subordinate interests in whole loans, mezzanine debt and preferred equity,we strive to deliver superior returns to our stockholders.

Since our inception, we have completed transactions ina variety of markets and secured by a variety of property types, and the marketfor commercial real estate debt has continued to demonstrate low rates ofdefault, high relative returns and inflows of capital. Consequently, the marketfor debt instruments has evidenced moderately declining yields and moreflexible credit standards and loan structures. In particular, “conduit”originators who package whole loans for resale to investors have driven debtyields lower while maintaining substantial liquidity because of the strongdemand for the resulting securities. Because of reduced profits in the mostliquid sectors of the mortgage finance business, several large institutionshave begun originating large bridge loans for the purpose of generatinginterest income, rather than the typical focus on trading profits. In thisenvironment we have focused on areas where we have comparative advantages ratherthan competing for product merely on the basis of yield or structure. This hasparticularly included whole loan origination in markets and transactions wherewe have an advantage due to (i) knowledge or relationships we have, (ii) knowledgeor relationships of our largest stockholder, SL Green, and (iii) where wehave an ability to better assess and manage risks over time. When consideringinvestment opportunities in secondary market transactions in tranched debt, wegenerally avoid first loss risk in larger transactions due to the high currentvaluation of the underlying real estate relative to historic valuation levels. Becauseof the significant increase in the value of institutional quality assetsrelative to historic norms, we typically focus on positions in which aconventional refinancing at loan maturity would provide for a complete returnof our investment.

Because of the high relative valuation of debtinstruments in the current market and a generally increasing rate environment,we have carefully managed our exposure to interest rate changes that couldaffect our liquidity. We generally match our assets and liabilities in terms ofbase interest rate (generally one-month LIBOR) and expected duration. We raised$95,000 of additional equity in December 2004 and January 2005 toreduce our outstanding indebtedness and maintain sufficient liquidity for ourinvestment portfolio. We have sold a total of $150,000 of trust preferredsecurities in three $50,000 issuances in 

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May and August 2005and January 2006 through wholly-owned subsidiaries of our OperatingPartnership with 30 year terms. The securities issued in May bear interestat a fixed rate of 7.57% for the first ten years ending, the securities issuedin August bear interest at a fixed rate of 7.75% for the first ten yearsand the securities issued in January 2006 bear interest at a fixed rate of7.65% for the first ten years. After the first ten years, the 2005 issuancesbear interest at three-month LIBOR plus 300 basis points while the 2006 issuancebears interest at three-month LIBOR plus 270 basis points. The proceeds fromthe issuances of the trust preferred securities were used to fund existing andfuture investment opportunities.  In July 2005we closed our first $1,000,000 CDO which extended the term of our liabilitiesand reduced our overall cost of funds with respect to debt investments financedby the CDO and previously financed by our repurchase agreements, toapproximately 49 basis points over LIBOR, excluding transaction costs. Oursecond $1,000,000 CDO was closed in August 2006 at a weighted averageinterest spread of approximately 37 basis points over LIBOR, excludingtransaction costs. The proceeds of the CDOs were used to repay our repurchasefacilities and to fund additional investment activities. In September 2005we sold 3,833,333 shares of common stock resulting in net proceeds ofapproximately $97,830 and in May 2006 we sold 3,000,000 shares of commonstock resulting in net proceeds of approximately $80,000. The proceeds of theseofferings were used to fund loan acquisitions and originations, repayoutstanding principal amounts under our repurchase facilities and for generalcorporate purposes. In May 2006 we also closed on a $100,000 unsecuredcredit facility with an initial term of three years and interest spreadsbetween 1.90% and 2.10%.

As of December 31, 2006, we held loans and otherlending investments of $2,186,884 net of fees, discounts, and unfundedcommitments with an average spread to LIBOR of 384 basis points for our floatingrate investments, and an average yield of 10.04% for our fixed rate investments.As of December 31, 2006, we also held interests in four credit tenantlease, or CTL, investments comprised of a 49.75% tenancy-in-common, or TIC,interest in 55 Corporate Drive in Bridgewater, New Jersey, and three jointventure investments.

Theaggregate carrying values, allocated by product type and weighted averagecoupons of our loans and other lending investments as of December 31, 2006and December 31, 2005 were as follows: 

| ** **                                                | ** ** | **Carrying Value(1)   ($ in thousands)** | ** ** | **Allocation by  Investment Type** | ** ** | **Fixed Rate:  Average Yield** | ** ** | **Floating Rate:  Average Spread  over LIBOR(2)** | ** ** |
|-----------------------------------------------------------|------------|--------------------------------------------------------------|------------|----------------------------------------------|------------|------------------------------------------|------------|-------------------------------------------------------------|------------|
| ** **                                                | ** ** | **2006**                                                     | ** ** | **2005**                                     | ** ** | **2006**                                 | ** ** | **2005**                                                    | ** ** | **2006** | ** ** | **2005** | ** ** | **2006** | ** ** | **2005** | ** ** |
| Whole loans, floating rate                                |       | $                                                            | 1,372,316  |                                         | $          | 561,388                                  |       |                                                        | 63         | % |   |   | 46 | % |   | — |   | — |   | 327 bps |   | 325 bps |   |
| Whole loans, fixed rate                                   |       | 42,376                                                       |       | 94,448                                       |       |                                     | 2          | %                                                           |       |   | 8 | % |   | 11.69 | % | 10.67 | % | — |   | — |   |
| Subordinate interests in whole loans, floating rate  |       | 236,308                                                      |       | 362,983                                      |       |                                     | 11         | %                                                           |       |   | 30 | % |   | — |   | — |   | 445 bps |   | 443 bps |   |
| Subordinate interests in whole loans, fixed  rate         |       | 48,769                                                       |       | 37,104                                       |       |                                     | 2          | %                                                           |       |   | 3 | % |   | 8.54 | % | 8.80 | % | — |   | — |   |
| Mezzanine loans, floating rate                            |       | 226,675                                                      |       | 82,793                                       |       |                                     | 10         | %                                                           |       |   | 7 | % |   | — |   | — |   | 665 bps |   | 858 bps |   |
| Mezzanine loans, fixed rate                               |       | 216,216                                                      |       | 43,352                                       |       |                                     | 10         | %                                                           |       |   | 4 | % |   | 9.92 | % | 8.51 | % | — |   | — |   |
| Preferred equity, floating rate                           |       | —                                                       |       | 11,795                                       |       |                                     | —     |                                                        |       |   | 1 | % |   | — |   | — |   | 900 bps |   | 900 bps |   |
| Preferred equity, fixed rate                              |       | 44,224                                                       |       | 11,882                                       |       |                                     | 2          | %                                                           |       |   | 1 | % |   | 10.68 | % | 10.27 | % | — |   | — |   |
| Total / Weighted  average                                 |       | $                                                            | 2,186,884  |                                         | $          | 1,205,745                                |       |                                                        | 100        | % |   |   | 100 | % |   | 10.04 | % | 9.78 | % | 384 bps |   | 417 bps |   |
|                                                           |            |                                                              |            |                                              |            |                                          |            |                                                             |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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(1)             Debt investments are presented after scheduledamortization payments and prepayments, and are net of unamortized fees,discounts, asset sales and unfunded commitments.

(2)             Spreads over an index other than LIBOR have beenadjusted to a LIBOR based equivalent.

The following discussionrelated to our consolidated financial statements should be read in conjunctionwith financial statements appearing in Item 8 of the Annual Report on Form 10K.

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**Critical AccountingPolicies**

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

**Loans andInvestments and Loans Held for Sale**

Loans held for investment are intended to be held tomaturity and, accordingly, are carried at cost, net of unamortized loanorigination fees, discounts, repayments, sales of partial interests in loans,and unfunded commitments unless such loan or investment is deemed to beimpaired. Loans held for sale are carried at the lower of cost or market valueusing available market information obtained through consultation with dealersor other originators of such investments. We may originate or acquire preferredequity interests that allow us to participate in a percentage of the underlyingproperty’s cash flows from operations and proceeds from a sale or refinancing. Shouldwe make such a preferred equity investment, we must determine whether thatinvestment should be accounted for as a loan, joint venture or as an interestin real estate.

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

If upon completion of the valuation, the fair value ofthe underlying collateral securing the impaired loan is less than the netcarrying value of the loan, an allowance is created with a corresponding chargeto the provision for loan losses. The allowance for each loan is maintained ata level we believe is adequate to absorb probable losses. We maintained areserve of $2,460 and $1,030 at December 31, 2006 and December 31,2005, respectively.

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

**Classifications ofMortgage-Backed Securities**

Mortgage-backedsecurities, or MBS, are classified as available-for-sale securities. As aresult, changes in fair value will be recorded as a balance sheet adjustment toaccumulated other comprehensive income, which is a component of stockholdersequity, rather than through our statement of operations. If available-for-salesecurities were classified as trading securities, there could be substantiallygreater volatility in earnings from period-to-period as these investments wouldbe marked to market and any reduction in the value of the securities versus theprevious carrying value would be considered an expense on our statement 

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ofoperations. We had no investments as of December 31, 2006 that wereaccounted for as trading securities.

**Valuations ofMortgage-Backed Securities**

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

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

**Credit Tenant LeaseInvestments**

Consolidated CTL investments are recorded at cost lessaccumulated depreciation. Costs directly related to the acquisition of suchinvestments are capitalized. Certain improvements are capitalized when they aredetermined to increase the useful life of the building. Capitalized items aredepreciated using the straight-line method over the shorter of the useful livesof the capitalized item or 40 years for buildings or facilities, the remaininglife of the facility for facility improvements, four to seven years forpersonal property and equipment, and the shorter of the remaining lease term orthe expected life for tenant improvements.

Consolidated depreciation expense for the years ended December 31,2006 and 2005 were $614 and $324, respectively. We did not have anyconsolidated CTL investments during the period from April 12, 2004(formation) through December 31, 2004.

Results of operations of properties acquired areincluded in the Statement of Income from the date of acquisition.

In accordance with Financial Accounting StandardsBoard, or FASB, No. 144, or SFAS 144, “Accounting for the Impairment ofDisposal of Long-Lived Assets,” a property to be disposed of is reported at thelower of its carrying amount or its estimated fair value, less its cost to sell.Once an asset is held for sale, depreciation expense and straight-line rentadjustments are no longer recorded and historic results are reclassified asDiscontinued Operations.

In accordance with FASB No. 141, or SFAS 141, “BusinessCombinations,” we allocate the purchase price of real estate to land andbuilding and, if determined to be material, intangibles, such as the value ofabove, below and at-market leases and origination costs associated with thein-place leases. We depreciate the amount allocated to building and otherintangible assets over their estimated useful lives, which generally range fromthree to 40 years. The values of the above and below-market leases areamortized and recorded as either an increase (in the case of below-marketleases) or a decrease (in the case of above-

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marketleases) to rental income over the remaining term of the associated lease. Thevalue associated with in-place leases and tenant relationships are amortizedover the expected term of the relationship, which includes an estimatedprobability of the lease renewal, and its estimated term. If a tenant vacatesits space prior to the contractual termination of the lease and no rentalpayments are being made on the lease, any unamortized balance of the relatedintangible will be written off. The tenant improvements and origination costsare amortized as an expense over the remaining life of the lease (or charged againstearnings if the lease is terminated prior to its contractual expiration date). Weassess fair value of the leases based on estimated cash flow projections thatutilize appropriate discount and capitalization rates and available marketinformation. Estimates of future cash flows are based on a number of factorsincluding the historical operating results, known trends, and market/economicconditions that may affect the property.

**Investments inUnconsolidated Joint Ventures**

**Weaccount for our investments in unconsolidated joint ventures under the equitymethod of accounting since we exercise significant influence, but do notunilaterally control, the entities and are not considered to be the primarybeneficiary under FIN 46. In the joint ventures, the rights of the otherinvestor are protective and participating. Unless we are determined to be theprimary beneficiary, these rights preclude us from consolidating theinvestments. The investments are recorded initially at cost as an investment inunconsolidated joint ventures, and subsequently are adjusted for equity in netincome (loss) and cash contributions and distributions. Any difference betweenthe carrying amount of the investments on our balance sheet and the underlyingequity in net assets is amortized as an adjustment to equity in net income(loss) of unconsolidated joint ventures over the lesser of the joint ventureterm or 40 years. None of the joint venture debt is recourse to us. As of December 31,2006 and 2005, we had investments of $57,567 and $58,040 in unconsolidatedjoint ventures, respectively.**

**Revenue Recognition**

Interest income on debt investments is recognized overthe life of the investment using the effective interest method and recognizedon the accrual basis. Fees received in connection with loan commitments aredeferred until the loan is funded and are then recognized over the term of theloan using the effective interest method. Anticipated exit fees, whosecollection is expected, are also recognized over the term of the loan as anadjustment to yield. Fees on commitments that expire unused are recognized atexpiration. Fees received in exchange for the credit enhancement of anotherlender, either subordinate or senior to us, in the form of a guarantee arerecognized over the term of that guarantee using the straight-line method.

Income recognition is generally suspended for debtinvestments at the earlier of the date at which payments become 90 days pastdue or when, in our opinion, a full recovery of income and principal becomesdoubtful. Income recognition is resumed when the loan becomes contractuallycurrent and performance is demonstrated to be resumed.

In some instances we may sell all or a portion of ourinvestments to a third party. To the extent the fair value received for aninvestment exceeds the amortized cost of that investment and FASB Statement No. 140,or SFAS 140, “Accounting for Transfers and Servicing of Financial Assets andExtinguishments of Liabilities,” criteria is met, under which control of theasset that is sold is surrendered making it a “true sale,” a gain on the salewill be recorded through earnings as other income. To the extent an investmentthat is sold has a discount or fees, which were deferred at the time theinvestment was made and were being recognized over the term of the investment,the unamortized portion of the discount or fees are recognized at the time ofsale and recorded as a gain on the sale of the investment through other income.For the years ended December 31, 2006 and 2005, we recognized $5,349 and$10,474 in net gains from the sale of debt investments or commitments. We didnot recognize any such gains for the period from April 12, 2004(formation) through December 31, 2004.

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

In addition to base rent,the tenants in our CTL investments also pay all operating costs of ownedproperty including real estate taxes.

**Reserve forPossible Loan Losses**

The expense for possible loan losses in connectionwith debt investments is the charge to earnings to increase the allowance forpossible loan losses to the level that management estimates to be adequateconsidering delinquencies, loss experience and collateral quality. Otherfactors considered relate to geographic trends and project diversification, thesize of the portfolio and current economic conditions. Based upon thesefactors, we may establish the provision for possible loan losses by individualasset or category of asset. When it is probable that we will be unable tocollect all amounts contractually due, the account is considered impaired.

Where impairment isindicated, a valuation write-down or write-off is measured based upon theexcess of the recorded investment amount over the net fair value of thecollateral, as reduced by selling costs. Any deficiency between the carryingamount of an asset and the net sales price of foreclosed collateral is chargedto the allowance for loan losses. We maintained a reserve for possible loanlosses of $2,460 against investments with a carrying value of $131,427 as of December 31,2006, and a reserve for possible loan losses of $1,030 against investments witha carrying value of $68,293 as of December 31, 2005.

**Stock BasedCompensation Plans**

We have a stock-based compensation plan, describedmore fully in Note 14 to our Consolidated Financial Statements. We account forthis plan using the fair value recognition provisions of FASB Statement 123(R),“Share-Based Payment, a revision of FASB Statement No. 123, Accounting forStock-Based Compensation.”

The Black-Scholes option-pricing model was developedfor use in estimating the fair value of traded options, which have no vestingrestrictions and are fully transferable. In addition, option valuation modelsrequire the input of highly subjective assumptions including the expected stockprice volatility. Because our plan has characteristics significantly differentfrom those of traded options and because changes in the subjective inputassumptions can materially affect the fair value estimate, in our opinion, theexisting models do not necessarily provide a reliable single measure of thefair value of our stock options.

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

Thefair value of each stock option granted is estimated on the date of grant forawards to co-leased employees, and quarterly for options issued tonon-employees, using the Black-Scholes option pricing model with the followingweighted average assumptions for grants in 2006 and 2005.

| ** **                       | ** ** | **2006**  | ** ** | **2005**  | ** ** |
|----------------------------------|------------|-----------|------------|-----------|------------|
| Dividend yield                   |       | 8.0       | %          | 8.4       | %          |
| Expected life of  option         |       | 6.7 years |       | 6.9 years |       |
| Risk-free  interest rate         |       | 4.14      | %          | 4.16      | %          |
| Expected stock price  volatility |       | 21.0      | %          | 19.1      | %          |

 

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

The Class B limitedpartner interests are entitled to receive an incentive return equal to 25% ofthe amount by which funds from operations, or FFO, plus certain accountinggains (as defined in the partnership agreement of our Operating Partnershipwhich was amended and restated in April 2006) exceed the product of ourweighted average stockholders equity (as defined in the amended and restatedpartnership agreement of our Operating Partnership) multiplied by 9.5% (dividedby 4 to adjust for quarterly calculations). We will record any distributions onthe Class B limited partner interests as an incentive distribution expensein the period when earned and when payment of such amounts has become probableand reasonably estimable in accordance with the partnership agreement. Thesecash distributions will reduce the amount of cash available for distribution toour common unitholders in our Operating Partnership and to common stockholders.We incurred approximately $7,609 and $2,276 with respect to such Class Blimited partner interests for the years ended December 31, 2006 and 2005,respectively. We did not recognize such an expense for the period from April 12,2004 through December 31, 2004.

**DerivativeInstruments**

In the normal course of business, we use a variety ofderivative instruments to manage, or hedge, interest rate risk. We require thathedging derivative instruments be effective in reducing the interest rate riskexposure that they are designated to hedge. This effectiveness is essential forqualifying for hedge accounting. Some derivative instruments are associatedwith an anticipated transaction. In those cases, hedge effectiveness criteriaalso require that it be probable that the underlying transaction occurs. Instrumentsthat meet these hedging criteria are formally designated as hedges at theinception of the derivative contract.

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

In the normal course of business, we are exposed tothe effect of interest rate changes and limit these risks by followingestablished risk management policies and procedures including the use ofderivatives. To address exposure to interest rates, we use derivativesprimarily to hedge the mark-to-market risk of our liabilities with respect tocertain of our assets. We may also use derivatives to hedge variability insales proceeds to be received upon the sale of loans held for sale.

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

FASB No. 133, or SFAS 133, “Accounting forDerivative Instruments and Hedging Activities,” as amended by FASB No. 149,requires us to recognize all derivatives on the balance sheet at fair value. Derivativesthat are not hedges must be adjusted to fair value through income. If aderivative is a hedge, depending on the nature of the hedge, changes in thefair value of the derivative will either be offset against the change in fairvalue of the hedged asset, liability, or firm commitment through earnings, orrecognized in other comprehensive income until the hedged item is recognized inearnings. The ineffective portion of a derivative’s change in fair value willbe immediately recognized in earnings. SFAS 133 may increase or decreasereported net income and stockholders’ equity prospectively, depending on future

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levels of LIBOR, swapspreads and other variables affecting the fair values of derivative instrumentsand hedged items, but will have no effect on cash flows, provided the contractis carried through to full term.

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

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

**Income Taxes**

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

Our TRSs are subject tofederal, state and local taxes.

**Results ofOperations (Amounts in thousands)**

***Comparison of the year ended December 31, 2006 tothe year ended December 31, 2005***

***Revenues***

| ** **                                           | ** ** | **2006** | ** ** | **2005** | ** ** | **$ Change** | ** ** |
|------------------------------------------------------|------------|----------|------------|----------|------------|-------------------|------------|
| Investment income                                    |       | $        | 176,421    |     | $          | 73,302            |       | $ | 103,119 |   |
| Rental revenue,  net                                 |       | 2,402    |       | 1,219    |       | 1,183             |       |
| Gain on sales and  other income                      |       | 19,392   |       | 13,564   |       | 5,828             |       |
| Total revenues                                       |       | $        | 198,215    |     | $          | 88,085            |       | $ | 110,130 |   |
| Equity in net loss of  unconsolidated joint ventures |       | ($2,960  | )          | ($1,489  | )          | ($1,471           | )          |

 

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Investment income isgenerated on our whole and bridge loans, subordinate interests in whole loans,mezzanine loans, preferred equity interests and CMBS investments. For the yearended December 31, 2006, $24,236 was earned on fixed rate investmentswhile the remaining $152,185 was earned on floating rate investments. Theincrease over the prior year is due primarily to a significantly largerinvestment balance in 2006 versus 2005.

Rental revenue of $2,402in 2006 was earned on 200 Franklin Square Drive, which was held as aconsolidated operating property for the three months ended March 31, 2006,and on our TIC interest in 55 Corporate Drive, which has been held as aproportionately consolidated property since its acquisition in June 2006.Following its acquisition, 55 Corporate Drive was being redeveloped. Theproperty is accounted for as an operating property beginning in the threemonths ended December 31, 2006. Rental revenue in 2006 includes the effectof adjustments for straight-line rent and FASB 141 adjustments for below-marketleases for 55 Corporate Drive. Rental revenue of $1,219 in 2005 was earned ononly 200 Franklin Square Drive.

Other income of $19,392for the year ended December 31, 2006 is comprised primarily of gainsrecorded on the sale of loans and securities of $7,361, and the gain on thesale of 75% of the security interests in the entity that owns 200 FranklinSquare Drive of $4,530. The remaining increase over the prior year is primarilyattributable to interest on restricted cash balances in our two CDOs (only oneof which was in place in the same period of 2005) and other cash balances heldby us. For the year ended December 31, 2005, other income of $13,564 wascomprised primarily of income recorded on the sale of loans of $7,997.

The loss on investments inunconsolidated joint ventures of $2,960 for the year ended December 31,2006 represents our proportionate share of the losses generated by our jointventure interests including $7,753 of real estate-related depreciation andamortization, which when added back, results in a contribution to FFO of $4,793.The loss on investments in unconsolidated joint venture of $1,219 for the yearended December 31, 2005 was generated primarily on our investment in OneMadison Avenue in New York, New York. Our use of FFO as an important financialmeasure is discussed in more detail below.

***Expenses***

| ** **                             | ** ** | **2006** | ** ** | **2005** | ** ** | **$ Change** | ** ** |
|----------------------------------------|------------|----------|------------|----------|------------|-------------------|------------|
| Interest expense                       |       | $        | 98,299     |     | $          | 33,771            |       | $ | 64,528 |   |
| Management fees                        |       | 16,668   |       | 9,600    |       | 7,068             |       |
| Incentive fee                          |       | 7,609    |       | 2,276    |       | 5,333             |       |
| Depreciation and  amortization         |       | 1,582    |       | 672      |       | 910               |       |
| Marketing,  general and administrative |       | 11,957   |       | 6,976    |       | 4,981             |       |
| Provision for  loan loss               |       | 1,430    |       | 1,030    |       | 400               |       |
| Provision for  taxes                   |       | 1,808    |       | 900      |       | 908               |       |
| Total expenses                         |       | $        | 139,353    |     | $          | 55,225            |       | $ | 84,128 |   |

 

Interest expense was$98,299 for the year ended December 31, 2006 compared to $33,771 for theyear ended December 31, 2005. Interest expense for the year ended December 31,2006 consisted primarily of $64,445 of interest on the investment gradetranches of our two CDOs (only one of which was in place during the same periodin 2005), $16,138 of interest on borrowings on our master repurchase facilitieswith Wachovia and Goldman, $11,086 of expense on our three $50,000 issuances oftrust preferred securities, and the amortization of deferred financing costsrelated to our CDOs, repurchase facilities and unsecured revolving credit facility.The $33,771 of interest expense during the same period in 2005 was comprisedprimarily of $17,429 of interest on the investment grade tranches of our firstCDO, $11,756 of interest on borrowings on our master repurchase facilities withWachovia and Goldman and $3,838 of interest expense incurred against only two$50,000 issuances of trust preferred securities.

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Management fees increased$7,068 for the year ended December 31, 2006 to $16,668 versus $9,600 forthe same period in 2005 due primarily to an increase in our stockholder’sequity as a result of additional issuances of common equity and the issuance of$150,000 of trust preferred securities, on which base management fees arecalculated. The remaining increase is comprised of $2,868 paid or payable toour Manager on investments in our two CDOs (only one of which was in placeduring the same period in 2005) in accordance with the CDO collateralmanagement agreements in lieu of the 0.15% fee otherwise payable to SL GreenOperating Partnership, L.P. on those investments under the asset servicingagreement, higher fees paid or payable to SL Green Operating Partnership, L.P.under our outsourcing and servicing agreements due to the increase in ourinvestment balances and the scheduled 3% annual increase in the fee payableunder our outsourcing agreement.

We recorded an incentivefee expense of $7,609 during the year ended December 31, 2006 inaccordance with requirements of the partnership agreement of our OperatingPartnership which entitles owners of Class B limited partner interests inour Operating Partnership to an incentive return equal to 25% of the amount bywhich FFO plus certain accounting gains (as defined in the amended and restatedpartnership agreement of our Operating Partnership) exceed the product of ourweighted average stockholders equity (as defined in the amended and restatedpartnership agreement of our Operating Partnership) multiplied by 9.5% (dividedby 4 to adjust for quarterly calculations). This threshold was only reachedduring the last six months of 2005 resulting in a lower total expense for 2005.

The increase in marketing,general and administrative expenses to $11,957 for the year ended December 31,2006 versus the same period in 2005 was due primarily to higher equity and equityrelated compensation, including an accrual of $1,625 in December 2006,which is directly linked to the performance of our company, professional fees,insurance and general overhead costs and a nonrecurring charge of $525 forthird-party professional expenses in connection with a possible businesscombination involving the acquisition of a publicly-traded commercial realestate finance company with business lines considered by management to behighly complementary to ours. The decision to expense these costs was made oncemanagement concluded the proposed transaction was unlikely to occur on termsadvantageous to us.

***Comparison of the year ended December 31, 2005 tothe period from April 12, 2004 (formation) through December 31, 2004***

***Revenues***

| ** **                                           | ** ** | **2005** | ** ** | **2004** | ** ** | **$ Change** | ** ** |
|------------------------------------------------------|------------|----------|------------|----------|------------|-------------------|------------|
| Investment income                                    |       | $        | 73,302     |     | $          | 6,841             |       | $ | 66,461 |   |
| Rental revenue,  net                                 |       | 1,219    |       | —   |       | 1,219             |       |
| Gain on sales and  other income                      |       | 13,564   |       | 310      |       | 13,254            |       |
| Total revenues                                       |       | $        | 88,085     |     | $          | 7,151             |       | $ | 80,934 |   |
| Equity in net loss of  unconsolidated joint ventures |       | ($1,489  | )          | $        | —     |              | ($1,489    | ) |

 

Investment income is generated on our whole and bridgeloans, subordinate interests in whole loans, mezzanine loans, preferred equityinterests and CMBS investments. For the year ended December 31, 2005$10,701 was earned on fixed rate investments while the remaining $62,601 wasearned on floating rate investments. The increase over the prior year is due toa significantly larger investment balance in 2005 versus 2004 and the effect ofa full twelve months of operations in 2005.

Rental revenue of $1,219 in 2005 was earned on 200Franklin Square Drive, which was acquired in September 2005. This amountincludes the effect of adjustments for straight-line rent and FASB 141adjustments for below-market leases. We did not hold any real estateinvestments during 2004.

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Other income of $13,564 for the year ended December 31,2005 is comprised primarily of income recorded on the sale of fixed andfloating rate debt investments of $10,474, including $1,849 attributable to therecognition of unamortized discounts and fees on the investments sold andinterest on restricted cash balances in the CDO (which was not in place in2004) of approximately $2,274. For the period from April 12, 2004(formation) through December 31, 2004, other income of $310 was comprisedonly of interest income on cash balances.

The loss on investments inunconsolidated joint ventures of $1,489 in 2005 represents our proportionateshare of the losses generated by our joint venture interests including $4,804of real estate related depreciation and amortization, which when added back,results in a contribution to FFO of $3,315. We did not maintain any jointventure investments during 2004. Our use of FFO as an important financialmeasure is discussed in more detail in Item 6.

***Expenses***

| ** **                             | ** ** | **2005** | ** ** | **2004** | ** ** | **$ Change** | ** ** |
|----------------------------------------|------------|----------|------------|----------|------------|-------------------|------------|
| Interest expense                       |       | $        | 33,771     |     | $          | 1,463             |       | $ | 32,308 |   |
| Management fees                        |       | 9,600    |       | 1,965    |       | 7,635             |       |
| Incentive fee                          |       | 2,276    |       | —   |       | 2,276             |       |
| Depreciation and  amortization         |       | 672      |       | 38       |       | 634               |       |
| Marketing,  general and administrative |       | 6,976    |       | 1,358    |       | 5,618             |       |
| Provision for  loan loss               |       | 1,030    |       | —   |       | 1,030             |       |
| Provision for  taxes                   |       | 900      |       | —   |       | 900               |       |
| GKK formation  costs                   |       | —   |       | 275      |       | (275              | )          |
| Total expenses                         |       | $        | 55,225     |     | $          | 5,099             |       | $ | 50,126 |   |

 

Interest expense was $33,771 for the year ended December 31,2005 versus $1,463 for the period from April 12, 2004 (formation) through December 31,2004. Interest expense in 2005 consists primarily of $17,429 of interest on theinvestment grade tranches of our CDO, that was not in place in 2004, $11,756 ofinterest on borrowings on our master repurchase facilities with Wachovia andGoldman, and $3,838 of expense on our two $50,000 issuances of trust preferredsecurities. The $1,463 of interest expense in 2004 was comprised primarily ofinterest on borrowings on the master repurchase facility with Wachovia and theamortization of deferred financing costs.

Management fees increased $7,635 for the year ended December 31,2005 versus the period from April 12, 2004 (formation) through December 31,2004 due primarily to an increase in our stockholder’s equity, the issuance oftrust preferred securities and a full twelve months of operations in 2005. Theremaining increase is comprised of $944 payable to our Manager under the CDOcollateral management agreement in lieu of the 0.15% fee otherwise payable toSL Green Operating Partnership, L.P. on investments in the CDO under the assetservicing agreement, and higher fees paid or payable to SL Green OperatingPartnership, L.P. of $745 and $942 under our outsourcing and servicing agreements,respectively, due to a full twelve months of operations in 2005 and a largerasset base on which to calculate the servicing fee. These fees and therelationship between us, our Manager and SL Green Operating Partnership, L.P.are discussed further in “Related Party Transactions.”

We recorded an incentive fee expense of $2,276 duringthe twelve months ended December 31, 2005 in accordance with requirementsof the partnership agreement of our Operating Partnership which entitles ownersof Class B limited partner interests in our Operating Partnership to anincentive return equal to 25% of the amount by which funds from operations (asdefined in the partnership agreement of our Operating Partnership) plus certainaccounting gains exceed the product of our weighted average stockholders equity(as defined in the partnership agreement of our Operating Partnership)multiplied by 

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9.5% (divided by 4 toadjust for quarterly calculations). This threshold was not reached during 2004and, consequently, no expense was recorded. This fee and the relationshipbetween us, our Manager and SL Green Operating Partnership, L.P. are discussedfurther in “Related Party Transactions.”

The increase in marketing,general and administrative expenses of $5,618 for the year ended December 31,2005 versus the period from April 12, 2004 (formation) through December 31,2004 reflects a full twelve months of operations in 2005 and a correspondingincrease in professional fees, stock-based compensation, insurance and generaloverhead costs.

**Liquidity andCapital Resources**

Liquidity is a measurement of the ability to meet cashrequirements, including ongoing commitments to repay borrowings, fund andmaintain loans and investments, pay dividends and other general business needs.Our principal sources of working capital and funds for additional investmentsprimarily include: 1) cash flow from operations; 2) borrowings under ourrepurchase facilities and unsecured revolving credit facility; 3) our CDOs; 4)other forms of financing or additional securitizations including CMBS orsubsequent CDO offerings; 5) proceeds from common or preferred equityofferings, 6) issuances of trust preferred securities and, to a lesser extent,7) the proceeds from principal payments on our investments, and 8) the sale orsyndication of certain of our debt investments. We believe these sources offinancing will be sufficient to meet our short-term liquidity needs.

Our ability to fund our short-term liquidity needs,including distributions to stockholders, through cash flow from operations canbe evaluated through the consolidated statement of cash flows provided in ourfinancial statements. However, the net cash from operations or net cash used inoperations disclosed on the statement of cash flows should be adjusted toexclude the effect of loans originated for sale and the proceeds of loans soldduring any respective reporting period. These activities are included in cashflow from operations in accordance with GAAP, but constitute an integral partof our investment activity. Consequently, net cash flow from operations is notnecessarily reflective of our true recurring operating activities and ourability to fund our required distributions to stockholders through ouroperating activities.

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

To maintain our status asa REIT under the Internal Revenue Code, we must distribute annually at least90% of our taxable income. These distribution requirements limit our ability toretain earnings and thereby replenish or increase capital for operations. However,we believe that our significant capital 

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resourcesand access to financing, as noted above, will provide us with financialflexibility at levels sufficient to meet current and anticipated capitalrequirements, including funding new lending and investment opportunities.

**Cash Flows (Amountsin thousands)**

**2006 Compared to2005**

Net cash provided byoperating activities increased $152,547 to $154,707 for the year ended December 31,2006 compared to cash provided of $2,160 for the year ended December 31,2005. Operating cash flow was generated primarily by interest income on ourwhole and bridge loans, subordinate interests in whole loans, mezzanine loansand preferred equity interests and gains on loan sales due, in part, to alarger number of investments in 2006 versus 2005. In addition, $175,050 ofproceeds from the sales of loans was offset primarily by a $104,931 use of cashrelated to the origination of loans held for sale during the year ended December 31,2006, whereas we realized proceeds of $140,431 from the sales of loans whileoriginating $182,431 of loans that were held for sale during the year ended December 31,2005.

Net cash used in investingactivities increased $281,531 to $1,149,526 for the year ended December 31,2006 compared to $867,995 used during the year ended December 31, 2005. Theprimary reason for the additional use of cash is related to increased debtinvestment originations of $817,827, offset by higher principal collections onour debt investments of $537,050.

Net cash provided byfinancing activities increased $46,240 to $943,557 for the year ended December 31,2006 compared to $897,317 provided during the same period in 2005. Thisincrease was due primarily to the issuance of $903,750 of collateralized debtobligations during the year ended December 31, 2006 versus only $810,500during the same period in 2005, net proceeds from our proportionate share ofthe mortgage payable of $94,525 on our TIC interest in 55 Corporate Drive andincreased net proceeds from our repurchase facilities of $296,564, offset bylower proceeds from the sale of common stock of $77,057 and an increase in thedividend paid to our common stockholders of $25,545.

**2005 Compared to 2004**

Net cash provided byoperating activities increased $1,015 to $2,160 for the year ended December 31,2005 compared to $1,145 for the period from April 12, 2004 (formation)through December 31, 2004. Operating cash flow was generated primarily byinterest income on our whole and bridge loans, subordinate interests in wholeloans, mezzanine loans, preferred equity interests and CMBS investments andgains on loan sales. Cash flow from a higher number of investments in 2005versus 2004 and the effect of a full twelve months of operations in 2005 wasoffset primarily by a $42,000 net use of cash related to the origination ofinvestments held for sale at December 31, 2005.

Net cash used in investingactivities increased $460,939 to $867,995 for the year ended December 31,2005 compared to $407,056 used during the period from April 12, 2004(formation) through December 31, 2004. The primary reason for the increaseis a full twelve months of operations in 2005, during which we invested$1,030,149 in new debt investments and $110,145 in new real estate investments,including joint ventures, offset by $273,897 of principal collections on ourdebt investments. This compares to $407,603 invested during the period from April 12,2004 (formation) through December 31, 2004 in new debt investments, offsetby $736 of principal repayments on debt investments.

Net cash provided byfinancing activities increased $452,512 to $897,317 for the year ended December 31,2005 compared to $444,805 provided during the period from April 12, 2004(formation) through December 31, 2004. The increase was due primarily toproceeds of $100,000 from the sale of trust preferred securities in May andAugust 2005, proceeds of $810,500 from the issuance the CDO in July 2005and $41,000 in new mortgage debt on 200 Franklin Square Drive, offset by areduction in borrowings on our repurchase facilities of $360,405 and reducedproceeds from the issuance of common stock of $48,761.

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**Capitalization**

Our authorized capitalstock consists of 125,000,000 shares, $0.001 par value, of which we haveauthorized the issuance of up to 100,000,000 shares of common stock, $0.001 parvalue per share, and 25,000,000 shares of preferred stock, par value $0.001 pershare.

As of the date of ourformation, April 12, 2004, we had 500,000 shares of common stockoutstanding valued at approximately $200. On August 2, 2004 we completedour initial public offering of 12,500,000 shares of common stock resulting innet proceeds of approximately $172.9 million, which was used to fundinvestments and commence our operations. As of December 31, 2006, 350,000restricted shares had also been issued under our 2004 Equity Incentive Plan, orour Equity Incentive Plan. These shares have a vesting period of two to fouryears and are not entitled to receive distributions declared by us on ourcommon stock until such time as the shares have vested, or the shares have beendesignated to receive dividends by the Compensation Committee of our Board ofDirectors.

On December 3, 2004,we sold 5,500,000 shares of our common stock resulting in net proceeds ofapproximately $93.7 million under a private placement exemption from theregistration requirements of Section 5 of the Securities Act of 1933, asamended. We subsequently registered the resale of these shares under theSecurities Act in August 2005. A total of 4,225,000 shares were sold tovarious institutional investors and an additional 1,275,000 shares were sold toSL Green Operating Partnership, L.P. pursuant to its contractual right tochoose to maintain a 25% ownership interest in the outstanding shares of ourcommon stock. Of the 5,500,000 shares sold, 2,000,000 shares were settled on December 31,2004 and the remaining 3,500,000 shares were settled on January 3, 2005.

On September 14,2005, we sold 3,833,333 shares of our common stock, at a price of $25.80 pershare, resulting in net proceeds of approximately $97.8 million. A total of2,875,000 shares were sold through a public offering and an additional 958,333shares were sold to SL Green Operating Partnership, L.P. pursuant to itscontractual right to choose to maintain a 25% ownership interest in ouroutstanding shares of common stock. Net proceeds were used for loanacquisitions and originations, repayment of outstanding principal under one ofour repurchase facilities and general corporate purposes.

On May 16, 2006, wesold 3,000,000 shares of our common stock, at a price of $26.75 per share,resulting in net proceeds of approximately $80.0 million. A total of 2,250,000shares were sold through a public offering and an additional 750,000 shareswere sold to SL Green Operating Partnership, L.P. pursuant to its contractualright to choose to maintain a 25% ownership interest in the outstanding sharesof our common stock. After this offering, SL Green Operating Partnership, L.P.owned 6,418,333 shares of our common stock. Net proceeds were used for loanacquisitions and originations, repayment of outstanding principal under ourrepurchase facilities and general corporate purposes.

In August 2005, our$350 million shelf registration statement was declared effective by theSecurities and Exchange Commission, or SEC. This registration statementprovides us with the ability to issue common and preferred stock, depositoryshares and warrants. We currently have $170.9 million available under theshelf.

On May 10, 2006, weentered into a sales agreement with Cantor Fitzgerald & Co., as salesagent, to offer and sell up to 1,000,000 shares of our common stock from timeto time through the sales agent. On May 10, 2006, we also entered into aseparate sales agreement with Merrill Lynch & Co., Merrill Lynch,Pierce, Fenner & Smith Incorporated, as sales agent, to offer and sellup to 1,000,000 shares of our common stock from time to time through the salesagent. To date we have not issued any shares under either agreement.

As of December 31,2006, 25,878,391 shares of our common stock and no shares of our preferredstock were issued and outstanding.

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**Outperformance Plan**

In June 2005, thecompensation committee of our board of directors approved a long-term incentivecompensation program, the 2005 Outperformance Plan. Participants in the 2005Outperformance Plan, all of whom are co-leased employees, will share in a “performancepool” if our total return to stockholders for the period from June 1, 2005through May 31, 2008 exceeds a cumulative total return to stockholders of30% during the measurement period over a base share price of $20.21 per share. Thesize of the pool will be 10% of the outperformance amount in excess of the 30%benchmark, subject to a maximum limit equal to the lesser of 4% of ouroutstanding shares and units of limited partnership interest as of the end ofthe performance period, or 1,200,000 shares. If our total return tostockholders from June 1, 2005 to any subsequent date exceeds 80% andremains at that level or higher for 30 consecutive days, then a minimumperformance pool will be established. In the event the potential performancepool reaches the maximum dilution cap before May 31, 2008 and remains atthat level or higher for 30 consecutive days, the performance period will endearly and the pool will be formed on the last day of such 30-day period. Eachparticipant’s award under the 2005 Outperformance Plan is designated as aspecified percentage of the aggregate performance pool to be allocated to suchparticipant assuming the 30% benchmark is achieved. Individual awards under the2005 Outperformance Plan will be made in the form of partnership units, or LTIPUnits, that may ultimately become exchangeable for shares of our common stockor cash, at our election. Under the 2005 Outperformance Plan, LTIP Units havebeen granted and additional LTIP Units may be granted in the future prior tothe determination of the performance pool; however, these LTIP Units will only vestupon satisfaction of performance and other thresholds, and will not be entitledto distributions until after the performance pool, or minimum performance pool,is established. The 2005 Outperformance Plan provides that if a pool isestablished, each participant will also be entitled to the distributions thatwould have been paid on the number of LTIP Units earned, had they been issuedat the beginning of the performance period. Those distributions will be paid inthe form of additional LTIP Units. Once a performance pool has beenestablished, the earned LTIP Units will receive regular quarterly distributionson a per unit basis equal to the dividends per share paid on our common stock,whether or not they are vested. Any LTIP Units that are not earned upon theestablishment of the performance pool will be automatically forfeited, and theLTIP Units that are earned will be subject to time-based vesting, with 50% ofthe LTIP Units earned vesting in May 2009 and the balance vesting one yearlater based on continued employment with our Manager or SL Green.  We will record the expense of the restrictedstock award in accordance with FASB Statement No. 123(R). Compensationexpense of $1,174 was recorded for the years ended December 31, 2006 and2005 related to the 2005 Outperformance Plan.

**Deferred Stock Compensation Plan for Directors**

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

As of December 31,2006, there were approximately 15,301 phantom stock units outstanding, of which11,301 units are vested.

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**Market Capitalization**

At December 31, 2006,our CDOs and borrowings under our repurchase facilities, unsecured revolvingcredit facility and mortgage loans (excluding our share of joint venture debtof $342.8 million) represented 72% of our consolidated market capitalization of$2.9 billion (based on a common stock price of $30.89 per share, the closingprice of our common stock on the New York Stock Exchange on December 31,2006). Market capitalization includes our consolidated debt and common stock.

**Indebtedness**

Thetable below summarizes borrowings under our Wachovia and Goldman repurchasefacilities, KeyBank unsecured revolving credit facility and any proportionatelyconsolidated mortgage debt or term loans at December 31, 2006 and 2005,respectively (amounts in thousands).

| **Debt Summary:**                       | ** ** | **December 31,  2006** | ** ** | **December 31,  2005** | ** ** |
|----------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| **Balance:**                                 | ** ** | ** **                  | ** ** | ** **                  | ** ** |
| Fixed rate                                   | ** ** | $                           | 94,525     | (1)                         | $          | 41,000 |   |
| Variable rate                                |       | 292,412                     |       | 117,366                     |       |
| Total                                        |       | $                           | 386,937    |                        | $          | 158,366 |   |
| **Effective  interest rate for the period:** | ** ** | ** **                  | ** ** | ** **                  | ** ** |
| Fixed rate                                   |       | 5.75                        | %          | 4.90                        | %          |
| Variable rate                                |       | LIBOR+1.72                  | %          | LIBOR+1.59                  | %          |

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(1)          Wehave a 49.75% interest in the mortgage note.

**Repurchase Facilities**

We have two repurchasefacilities with an aggregate of $900,000 of total debt capacity. In August 2004,we closed on a $250,000 repurchase facility with Wachovia. This facility wasthen increased to $350,000 on January 3, 2005 and subsequently increasedto $500,000 on April 22, 2005. On March 21, 2006 we further modifiedthe facility by reducing the interest spreads. As a result of themodifications, the $500,000 facility bears interest at spreads of 1.00% to2.50% over one-month LIBOR and, based on our expected investment activities,provides for advance rates that vary from 60% to 100% based upon the collateralprovided under a borrowing base calculation. On October 13, 2006, weextended the facility’s maturity date until October 2009. The lender has aconsent right with respect to the inclusion of investments in this facility,determines periodically the market value of the investments, and has the rightto require additional collateral if the estimated market value of the includedinvestments declines. We had no accrued interest and borrowings of $151,403 ata weighted average spread to LIBOR of 1.86% as of December 31, 2006, andno accrued interest and borrowings of $67,717 at a weighted average spread toLIBOR of 1.50%, under this facility at December 31, 2005.

On January 3, 2005,we closed an additional repurchase facility with Goldman. On October 13,2006, we increased this facility from $200,000 to $400,000 and extended itsmaturity date until September 2009. On March 21, 2006, we modifiedthis facility by reducing the interest spreads. As a result of themodifications, the facility bears interest at spreads of 1.00% to 2.25% overone-month LIBOR and, based on our expected investment activities, provides foradvance rates that vary from 40% to 85% based upon the collateral providedunder a borrowing base calculation. As with the Wachovia repurchase facility,the lender has a consent right to the inclusion of investments in thisfacility, determines periodically the market value of the investments, and hasthe right to require additional collateral if the estimated market value of theincluded investments declines. We had accrued interest of $261 and borrowingsof $126,009 at a 

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weightedaverage spread to LIBOR of 1.51% as of December 31, 2006, and accruedinterest of $163 and borrowings of $49,649 at a weighted average spread toLIBOR of 1.71% under this facility at December 31, 2005.

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

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

**Restrictive Covenants**

The terms of ourrepurchase facilities (together with any related guarantees) include covenantsthat****(a) limit our maximumtotal indebtedness to no more than 85% of total assets under the Wachovia facilityor a debt to equity ratio less than or equal to 5:1 under the Goldman facility,(b) require us to maintain minimum liquidity of at least $10,000 for thefirst two years and $15,000 thereafter under the Goldman facility, and at least$15,000 under the Wachovia facility, (c) require our fixed charge coverageratio to be at no time less than 1.50 to 1.00, (d) require our minimuminterest coverage ratio to be at no time less than 1.75 to 1.00 under theWachovia facility, (e) require us to maintain minimum tangible net worthof not less than (i) $129,750, plus (ii) 75% of the net proceeds ofour subsequent equity issuances following our initial public offering under theGoldman facility and not less than (i) $400,000, plus (ii) 75% of theproceeds of our subsequent equity issuances following the date of the October 2006amendment under the Wachovia facility and (f) restrict the maximum amountof our total indebtedness. The covenants also restrict us from makingdistributions in excess of a maximum of 100% of our FFO (as defined therein)under the Wachovia facility, except that we may in any case pay distributionsnecessary to maintain our REIT status. Anevent of default can be triggered on our repurchase facilities if, among otherthings, GKK Manager LLC is terminated as our Manager. As of December 31,2006 and 2005, we were in compliance with all such covenants.

**Unsecured Revolving Credit Facility**

In May 2006 we closedon a $100,000 senior unsecured revolving credit facility with KeyBank NationalAssociation, or KeyBank, with an initial term of three years and a one-yearextension option. The facility is supported by a negative pledge of anidentified asset base with advance rates that vary from 30% to 90% of the assetvalue provided under a borrowing base calculation. The lender also has consentrights to the 

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inclusionof assets in the borrowing base calculation. The facility bears interest at1.90% over one-month LIBOR to the extent our leverage ratio, defined as totalliabilities to total assets, including our proportionate share of theliabilities and assets of our unconsolidated subsidiaries, is less than 80% and2.10% over one-month LIBOR to the extent out leverage ratio is equal to orgreater than 80%. We had accrued interest of $75 and borrowings of $15,000 at aspread to LIBOR of 2.10% against this facility as of December 31, 2006.

The terms of the unsecuredrevolving credit facility include covenants that****(a) limit our maximum total indebtedness to no more than85% of total assets, (b) require our fixed charge coverage ratio to be atno time less than 1.50, (c) require our minimum interest coverage ratio tobe at no time less than 1.70, (d) require us to maintain minimum tangiblenet worth of not less than $370,000 plus 75% of the net proceeds from equityofferings completed after the closing of the facility and (e) restrict themaximum amount of our total indebtedness. The covenants also restrict us frommaking distributions in excess of a maximum of 100% of our FFO (as defined bythe National Association of Real Estate Investment Trusts, or NAREIT), exceptthat we may in any case pay distributions necessary to maintain our REIT status.An event of default can be triggered onour unsecured revolving credit facility if, among other things, GKK Manager LLCis terminated as our Manager. As of December 31, 2006, we were incompliance with all such covenants.

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

**Mortgage Loan**

We have oneproportionately consolidated interest-only mortgage loan related to 55Corporate Drive in an amount equal to our ownership percentage in the entitymultiplied by the outstanding principal balance of the mortgage loan, which loanfinanced the acquisition of 55 Corporate Drive in June 2006. The mortgagehas an outstanding principal balance of $190,000, of which we have consolidated49.75% or $94,525, with an effective interest rate of 5.75% and a term of tenyears. Interest on this mortgage was capitalized for a portion of the yearended December 31, 2006 as the property was redeveloped. Capitalizedinterest was $1,841 for the year ended December 31, 2006.

**Collateralized Debt Obligations**

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

On August 24, 2006,we issued an additional approximately $1,000,000 of CDOs through twonewly-formed indirect subsidiaries, Gramercy Real Estate CDO 2006-1Ltd., or the 2006 Issuer, and Gramercy Real Estate CDO 2006-1 LLC, or the2006 Co-Issuer. The CDO consists of $903,750 of investment grade notes, $38,750of non-investment grade notes, which were co-issued by the 2006 Issuer and the2006 Co-Issuer, and $57,500 of preferred shares, which were issued by the 2006Issuer. The investment grade notes were issued with floating rate coupons witha combined weighted average rate of three-month LIBOR plus 0.37%. We incurredapproximately $11,273 of costs related to Gramercy Real Estate CDO 2006-1,which are amortized on a level yield basis over the average life of the CDO.

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We retained allnon-investment grade securities, the preferred shares and the common shares inthe Issuer of each CDO. The Issuer in each CDO holds assets, consistingprimarily of whole loans, subordinate interests in whole loans, mezzanine loansand preferred equity investments, which serve as collateral for the CDO. EachCDO may be replenished, pursuant to certain rating agency guidelines relatingto credit quality and diversification, with substitute collateral for loansthat are repaid during the first five years of the CDO. Thereafter, the CDOsecurities will be retired in sequential order from senior-most to junior-mostas loans are repaid. The financial statements of the Issuer of each CDO areconsolidated in our financial statements. The investment grade notes aretreated as a secured financing, and are non-recourse to us. Proceeds from thesale of the investment grade notes issued in each CDO were used to repaysubstantially all outstanding debt under our repurchase agreements and to fundadditional investments.

**Junior Subordinated Debentures**

On January 27, 2006,we completed a third issuance of $50,000 in unsecured trust preferredsecurities through a separate newly formed Delaware Statutory Trust, or DST,Gramercy Capital Trust III, or GCTIII, that is a wholly-owned subsidiary of ourOperating Partnership. The securities bear interest at a fixed rate of 7.65%for the first ten years ending January 2016, with an effective rate of7.43% when giving effect to the swap arrangement previously entered into incontemplation of this financing. Thereafter, the interest rate will float basedon the three-month LIBOR plus 270 basis points.

In May and August 2005,we completed issuances of $50,000 each in unsecured trust preferred securitiesthrough two DSTs, Gramercy Capital Trust I, or GCTI, and Gramercy Capital TrustII, or GCTII, that are also wholly-owned subsidiaries of our OperatingPartnership. The securities issued in May 2005 bear interest at a fixedrate of 7.57% for the first ten years ending June 2015 and the securitiesissued in August 2005 bear interest at a fixed rate of 7.75% for the firstten years ending October 2015. Thereafter the rates will float based onthe three-month LIBOR plus 300 basis points.

All issuances of trustpreferred securities require quarterly interest distributions; however, paymentsmay be deferred while the interest expense is accrued for a period of up tofour consecutive quarters if our Operating Partnership exercises its right todefer such payments. The trust preferred securities are redeemable, at theoption of our Operating Partnership, in whole or in part, with no prepaymentpremium any time after June 30, 2010, October 30, 2010 or January 30,2011 for the securities issued by GCTI, GCTII and GCTIII, respectively.

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

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

**Contractual Obligations**

Combined aggregateprincipal maturities of our CDOs, repurchase facilities, trust preferredsecurities, proportionately consolidated mortgage note related to our TICinterest in 55 Corporate Drive, unsecured revolving credit facility and ourobligations under our management agreement, outsourcing agreement, 

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CDOcollateral management agreement and operating lease as of December 31,2006 are as follows (amounts in thousands):

| ** ** | ** ** | **CDOs**  | ** ** | **Repurchase  Facilities** | ** ** | **Trust  Preferred  Securities** | ** ** | **Mortgage  Note  Payable(1)** | ** ** | **Revolving  Credit  Facility** | ** ** | **Outsourcing and  Management  Agreements(2)** | ** ** | **CDO  Collateral  Management  Agreements** | ** ** | **Operating  Lease** | ** ** | **Total** | ** ** |   |
|------------|------------|-----------|------------|----------------------------|------------|----------------------------------|------------|--------------------------------|------------|---------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------|------------|----------------------|------------|-----------|------------|--------|
| 2007       |       | $         | —     |                       |       | $                                | —     |                           |       | $                               | —     |                                                |       | $                                           | —     |                 |       |      | $          | — |   |   |   | $ | 12,082 |   |   |   | $ | 4,286 |   |   |   | $ | 256 |   |   | $ | 16,624 |   |
| 2008       |       | —    |       |                       | —     |                             |       | —                         |       |                            | —     |                                                |       |                                        | —     |                 |       |      | 12,123     |   |   |   | 4,286 |   |   |   | 261 |   |   | 16,670 |   |
| 2009       |       | —    |       |                       | 277,412    |                             |       | —                         |       |                            | —     |                                                |       |                                        | 15,000     |                 |       |      | 12,164     |   |   |   | 4,286 |   |   |   | 265 |   |   | 309,127 |   |
| 2010       |       | —    |       |                       | —     |                             |       | —                         |       |                            | —     |                                                |       |                                        | —     |                 |       |      | —     |   |   |   | 3,351 |   |   |   | 283 |   |   | 3,634 |   |
| 2011       |       | —    |       |                       | —     |                             |       | —                         |       |                            | —     |                                                |       |                                        | —     |                 |       |      | —     |   |   |   | 1,469 |   |   |   | 297 |   |   | 1,766 |   |
| Thereafter |       | 1,714,250 |       |                       | —     |                             |       | 150,000                        |       |                            | 94,525     |                                                |       |                                        | —     |                 |       |      | —     |   |   |   | — |   |   |   | 1,054 |   |   | 1,959,829 |   |
| Total      |       | $         | 1,714,250  |                       |       | $                                | 277,412    |                           |       | $                               | 150,000    |                                                |       | $                                           | 94,525     |                 |       |      | $          | 15,000 |   |   |   | $ | 36,369 |   |   |   | $ | 17,678 |   |   |   | $ | 2,416 |   |   | $ | 2,307,650 |   |

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(1)             We have a 49.75% interest in the mortgage.

(2)             Management fee is calculated as 1.75% ofour gross stockholders equity (as defined in the amended and restatedmanagement agreement) on December 31, 2006, inclusive of the trustpreferred securities issued on May 20, 2005, August 9, 2005 and January 27,2006.

**Off-Balance-SheetArrangements**

We have severaloff-balance-sheet investments, including joint ventures and structured financeinvestments. These investments all have varying ownership structures. Substantiallyall of our joint venture arrangements are accounted for under the equity methodof accounting as we have the ability to exercise significant influence, but notcontrol over the operating and financial decisions of these joint venturearrangements. Our off-balance-sheet arrangements are discussed in Note 6, “Investmentsin Unconsolidated Joint Ventures” in the accompanying financial statements.

**Dividends**

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

**Inflation**

A majority of our assetsand liabilities are interest rate sensitive in nature. As a result, interestrates and other factors influence our performance more so than inflation. Changesin interest rates do not necessarily correlate with inflation rates or changesin inflation rates. Further, our financial statements are prepared inaccordance with GAAP and our distributions are determined by our board ofdirectors based primarily on our net income as calculated for tax purposes, ineach case, our activities and balance sheet are measured with reference tohistorical cost or fair market value without considering inflation.

**Related PartyTransactions (Amounts in thousands)**

In connection with our initial public offering, weentered into a management agreement with our Manager, which was subsequentlyamended and restated in April 2006. The amended and restated managementagreement provides for a term through December 2009 with automaticone-year extension options and is subject to certain termination rights. We payour Manager an annual management fee equal to 1.75% of our gross stockholdersequity (as defined in the amended and restated management agreement) inclusiveof our trust preferred securities. We incurred expense to our Manager underthis 

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agreement of an aggregateof $10,147, $6,337 and $1,349 for the years ended December 31, 2006 and2005 and the period from April 12, 2004 (formation) through December 31,2004, respectively.

To provide an incentive to enhance the value of ourcommon stock, the holders of the Class B limited partner interests of ourOperating Partnership are entitled to an incentive return equal to 25% of theamount by which FFO plus certain accounting gains and losses (as defined in theamended and restated partnership agreement of our Operating Partnership) exceedthe product of our weighted average stockholders equity (as defined in theamended and restated partnership agreement of our Operating Partnership)multiplied by 9.5% (divided by 4 to adjust for quarterly calculations). We willrecord any distributions on the Class B limited partner interests as anincentive distribution expense in the period when earned and when payments ofsuch amounts have become probable and reasonably estimable in accordance withthe partnership agreement. We incurred $7,609 and $2,276 with respect to such Class Blimited partner interests for the years ended December 31, 2006 and 2005,respectively.

We are obligated to reimburse our Manager for itscosts incurred under an asset servicing agreement between our Manager and anaffiliate of SL Green Operating Partnership, L.P. and a separate outsourcingagreement between our Manager and SL Green Operating Partnership, L.P. Theasset servicing agreement, which was amended and restated in April 2006,provides for an annual fee payable to SL Green Operating Partnership, L.P. byus of 0.05% of the book value of all credit tenant lease assets andnon-investment grade bonds and 0.15% of the book value of all other assets. Theasset servicing fee is reduced by SL Green Operating Partnership, L.P. for feespaid directly to outside servicers by us. The outsourcing agreement currentlyprovides for an annual fee payable by us, which fee is currently $1,326 peryear, increasing 3% annually over the prior year on the anniversary date of theoutsourcing agreement in August of each year. For the years ended December 31,2006 and 2005 and the period from April 12, 2004 (formation) through December 31,2004, we realized expense of $1,304, $1,266 and $521, respectively, to ourManager under the outsourcing agreement. For the years ended December 31,2006 and 2005 and the period from April 12, 2004 (formation) through December 31,2004, we realized expense of $2,349, $1,037 and $95, respectively, to ourManager under the asset servicing agreement.

In connection with the closing of our first CDO in July 2005,the Issuer, Gramercy Real Estate CDO 2005-1 Ltd., entered into acollateral management agreement with our Manager. Pursuant to the collateralmanagement agreement, our Manager has agreed to provide certain advisory andadministrative services in relation to the collateral debt securities and othereligible investments securing the CDO notes. The collateral managementagreement provides for a senior collateral management fee, payable quarterly inaccordance with the priority of payments as set forth in the indenture, equalto 0.15% per annum of the net outstanding portfolio balance, and a subordinatecollateral management fee, payable quarterly in accordance with the priority ofpayments as set forth in the indenture, equal to 0.25% per annum of the netoutstanding portfolio balance. Net outstanding portfolio balance is the sum ofthe (i) aggregate principal balance of the collateral debt securities,excluding defaulted securities, (ii) aggregate principal balance of allprincipal proceeds held as cash and eligible investments in certain accounts,and (iii) with respect to the defaulted securities, the calculation amountof such defaulted securities. As compensation for the performance of itsobligations as collateral manager under the first CDO, our Board of Directorshas allocated to our Manager the subordinate collateral management fee paid onsecurities not held by us. At December 31, 2006, we owned all of thenon-investment grade bonds, preferred equity and equity in both CDOs. The senior collateral management fee andbalance of the subordinate collateral management fee is allocated to us. Forthe years ended December 31, 2006 and 2005, we realized expense of $2,065and $944, respectively, to our Manager under such collateral managementagreement.

Collateral manager fees paid on our CDO that closed inAugust 2006 are governed by the amended and restated management agreementas a “transitional managed” CDO, as defined in the amended and restatedmanagement agreement, consisting primarily of debt investments secured bynon-stabilized real estate. The amended and restated management agreementprovides that in connection with formations of 

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collateralized debtobligations or other securitization vehicles after the execution of the amendedand restated management agreement, if a collateral manager is retained, ourManager or an affiliate will be the collateral manager and will receive thefollowing fees:  (i) 0.25% per annum of the book value of the assetsowned for “transitional managed” CDOs, (ii) 0.15% per annum of the bookvalue of the assets owned for “non-transitional managed” CDOs, (iii) 0.10%per annum of the book value of the assets owned for static CDOs that ownprimarily non-investment grade bonds, and (iv) 0.05% per annum of the bookvalue of the assets owned for static CDOs that own primarily investment gradebonds; limited in each instance by the fees that are paid to the collateralmanager. The balance of the fees paid by the CDOs for collateral managementservices are paid to us. Forthe year ended December 31, 2006, we realized expense of $803 to ourManager under this agreement.

In connection with the 5,500,000 shares of our commonstock that were sold on December 3, 2004 and settled on December 31,2004 and January 3, 2005 in a private placement, we agreed to pay ourManager a fee of $1,000 as compensation for financial advisory, structuring andcosts incurred on our behalf.  This feewas recorded as a reduction in the proceeds of the private placement. Apartfrom legal fees and stock clearing charges totaling $245, no other fees were paidby us to an investment bank, broker/dealer or other financial advisor inconnection with the private placement, resulting in total costs of 1.3% oftotal gross proceeds.

On April 29, 2005, we closed on a $57,503 initialinvestment in a joint venture with SL Green to acquire, own and operate theSouth Building located at One Madison Avenue, New York, New York, or the SouthBuilding. The joint venture, which was created to acquire, own and operate theSouth Building, is owned 45% by a wholly-owned subsidiary of us and 55% by awholly-owned subsidiary of SL Green. The joint venture interests are *pari passu*. Also on April 29, 2005,the joint venture completed the acquisition of the South Building fromMetropolitan Life Insurance Company for the purchase price of approximately$802,800 plus closing costs, financed in part through a $690,000 first mortgageloan on the South Building. The South Building comprises approximately 1.2million square feet and is almost entirely net leased to Credit SuisseSecurities (USA) LLC, or CS, pursuant to a lease with a 15-year remainingterm.

On June 7, 2006, we closed on the acquisition ofa 49.75% TIC interest in 55 Corporate Drive, located in Bridgewater, New Jerseywith a 0.25% interest to be acquired in the future. The remaining 50% of theproperty is owned as a TIC interest by an affiliate of SL Green OperatingPartnership, L.P. The property is comprised of three buildings totalingapproximately six hundred and seventy thousand square feet which is 100% netleased to an entity whose obligations are guaranteed by Sanofi-Aventis Groupthrough April 2023. The transaction was valued at $236,000 and wasfinanced with a $190,000, 10-year, fixed-rate first mortgage loan.

Commencing May 1, 2005 we are party to a leaseagreement with SLG Graybar Sublease LLC, an affiliate of SL Green, for ourcorporate offices at 420 Lexington Avenue, New York, New York. The lease is forapproximately five thousand square feet with an option to lease an additionalapproximately two thousand square feet and carries a term of ten years withrents on the entire seven thousand square feet of approximately $249 per annumfor year one rising to $315 per annum in year ten. For the years ended December 31,2006 and 2005, we paid $252 and $90 under this lease, respectively.

Bright Star Couriers LLC, or Bright Star, providesmessenger services to us. Bright Star is owned by Gary Green, a son of StephenL. Green, our Chairman. The aggregate amount of fees paid by us for suchservices for the years ended December 31, 2006 and 2005 and the periodfrom April 12, 2004 (formation) through December 31, 2004 was $7, $3and less than $1, respectively.

SL Green Operating Partnership, L.P. is an equityholder in the joint venture that is the borrower on an investment with a bookvalue of $29,026 as of December 31, 2005. This investment was repaid in August 2006.

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

On February 27, 2006, we closed on the purchaseof a $90,000 whole loan, which bears interest at one-month LIBOR plus 2.15%, toa joint venture in which SL Green is an equity holder. The loan is secured by55 Corporate Drive in Bridgewater, New Jersey. The loan was repaid in full in June 2006with the proceeds from new mortgage financing obtained in connection with thesale of the property, 49.75% of which is now owned by us through a TICstructure.

On March 17, 2006, we closed on the purchase of a$25,000 mezzanine loan, which bears interest at one-month LIBOR plus 8.00%, toa joint venture in which SL Green is an equity holder. The loan was repaid infull on May 9, 2006, when we originated a $90,287 whole loan, which bearsinterest at one-month LIBOR plus 2.75%, to the joint venture. The loan issecured by office and industrial properties in northern New Jersey and has abook value of $90,049 as of December 31, 2006.

On August 1, 2006, we acquired from a financialinstitution a 50% pari-passu interest in a $65,000 preferred equity investmentsecured by an office property in New York, New York. An affiliate of SL Greensimultaneously acquired and owns the other 50% pari-passu interest. Theinvestment bears interest at a blended fixed rate of 10.52%.

On December 20, 2006, we acquired from afinancial institution a pari-passu interest of $125,000 in a $200,000 mezzanineloan, which bears interest at 6.384% and is secured by a multi-family portfolioin New York, New York. An affiliate of SL Green simultaneously acquired theremaining $75,000 pari-passu interest in the mezzanine loan.

During the year ended December 31, 2006, weearned fees of $163 from SL Green representing SL Green’s proportionate shareof fees for financing and structural advisory services related to a specificpotential transaction.

**Funds fromOperations**

We present FFO because weconsider it an important supplemental measure of our operating performance andbelieve that it is frequently used by securities analysts, investors and otherinterested parties in the evaluation of REITS. We also use FFO for thecalculation of the incentive fee payable to the holders of Class B limitedpartner interests in our Operating Partnership and as one of several criteria todetermine performance-based incentive compensation for members of our seniormanagement, which may be payable in cash or equity awards. The revised WhitePaper on FFO approved by the Board of Governors of the National Association ofReal Estate Investment Trusts, or NAREIT, in April 2002 defines FFO as netincome (loss) (computed in accordance with GAAP), excluding gains (or losses)from items which are not a recurring part of our business, such as debtrestructurings, and sales of properties, plus real estate-related depreciationand amortization and after adjustments for unconsolidated partnerships andjoint ventures. Weconsider gains and losses on the sales of debt investments and real estateinvestments including tenancy-in-common investments to be a normal part of ourrecurring operations and therefore include such gains and losses when arrivingat FFO. FFO does not represent cash generated from operating activitiesin accordance with GAAP and should not be considered as an alternative to netincome (determined in accordance with GAAP), as an indication of our financialperformance, or to cash flow from operating activities (determined inaccordance with GAAP) as a measure of our liquidity, nor is it entirelyindicative of funds available to fund our cash needs, including our ability tomake cash distributions. Our calculation of FFO may be different from thecalculation used by other companies and, therefore, comparability may belimited.

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Fundsfrom Operations for the years ended December 31, 2006 and 2005, and theperiod from April 12, 2004 (formation) through December 31, 2004 isas follows (amounts in thousands):

| ** **                                       | ** ** | ** **                 | ** ** | ** **                 | ** ** | **For the Period ** | ** ** |
|--------------------------------------------------|------------|----------------------------|------------|----------------------------|------------|------------------------------------|------------|
| ** **                                       | ** ** | ** **                 | ** ** | ** **                 | ** ** | **April 12, 2004**       | ** ** |
| ** **                                       | ** ** | **For the Year** | ** ** | **For the Year** | ** ** | **(formation)**                    | ** ** |
| ** **                                       | ** ** | **ended**                  | ** ** | **ended**                  | ** ** | **through**                        | ** ** |
| ** **                                       | ** ** | **December 31,**      | ** ** | **December 31,**      | ** ** | **December 31,**              | ** ** |
| ** **                                       | ** ** | **2006**                   | ** ** | **2005**                   | ** ** | **2004**                           | ** ** |
| Net income  available to common stockholders     |       | $                          | 55,902     |                       |       | $                                  | 31,371     |   |   |   | $ | 2,052 |   |   |
| Add:                                             |       |                       |       |                       |       |                               |       |   |   |   |   |
| Depreciation and amortization                    |       | 6,143                      |       |                       | 3,448      |                               |       |   | 327 |   |   |
| FFO adjustment for unconsolidated joint ventures |       | 7,753                      |       |                       | 4,804      |                               |       |   | — |   |   |
| Less:                                            |       |                       |       |                       |       |                               |       |   |   |   |   |
| Non real estate depreciation and amortization    |       | (5,771                     | )          |                       | (3,133     | )                                  |       |   | (327 | ) |   |
| Funds from  operations                           |       | $                          | 64,027     |                       |       | $                                  | 36,490     |   |   |   | $ | 2,052 |   |   |
| Cash flows provided by operating activities      |       | $                          | 154,707    |                       |       | $                                  | 2,160      |   |   |   | $ | 1,145 |   |   |
| Cash flows used  in investing activities         |       | $                          | (1,149,526 | )                          |       | $                                  | (867,995   | ) |   |   | $ | (407,056 | ) |   |
| Cash flows provided by  financing activities     |       | $                          | 943,557    |                       |       | $                                  | 897,317    |   |   |   | $ | 444,805 |   |   |

 

**Recently Issued Accounting Pronouncements**

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

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

In February 2006, theFASB issued Statement of Financial Accounting Standard No. 155, or SFAS No. 155,“Accounting for Certain Hybrid Financial Instruments—an amendment of FASBStatements No. 133 and 140.” SFAS No. 155 (1) permits fair valuere-measurement for any hybrid financial instrument that contains an embeddedderivative that would otherwise require bifurcation, (2) clarifies whichinterest-only strips and principal-only strips are not subject to therequirements of FASB Statement No. 133, (3) establishes a requirementto evaluate interests in securitized financial assets to identify intereststhat 

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arefreestanding derivatives or that are hybrid financial instruments that containan imbedded derivative requiring bifurcation, (4) clarifies thatconcentrations of credit risk in the form of subordination are not embeddedderivatives, and (5) amends FASB Statement No. 140 to eliminate theprohibition on a qualifying special-purpose entity from holding a derivativefinancial instrument that pertains to a beneficial interest in other thananother derivative financial instrument. SFAS No. 155 is effective January 1,2007 and we are currently evaluating the effect, if any, that thispronouncement will have on our future financial position or results ofoperations.

In July 2006, theFASB issued Interpretation No. 48, or FIN 48, “Accounting for Uncertaintyin Income Taxes.” This interpretation, among other things, creates a two-stepapproach for evaluating uncertain tax positions. Recognition (step one) occurswhen an enterprise concludes that a tax position, based solely on its technicalmerits, is more-likely-than-not to be sustained upon examination. Measurement(step two) determines the amount of benefit that more-likely-than-not will berealized upon settlement. Derecognition of a tax position that was previouslyrecognized would occur when a company subsequently determines that a taxposition no longer meets the more-likely-than-not threshold of being sustained.FIN 48 specifically prohibits the use of a valuation allowance as a substitutefor derecognition of tax positions, and it has expanded disclosure requirements.FIN 48 is effective for fiscal years beginning after December 15, 2006, inwhich the impact of adoption should be accounted for as a cumulative-effectadjustment to the beginning balance of retained earnings. We are currentlyevaluating the effect, if any, that this pronouncement will have on our futurefinancial position or results of operations.

In September 2006,the FASB issued Statement No. 157, Fair Value Measurements, or SFAS No. 157.SFAS No. 157 provides guidance for using fair value to measure assets andliabilities. This statement clarifies the principle that fair value should bebased on the assumptions that market participants would use when pricing theasset or liability. SFAS No. 157 establishes a fair value hierarchy,giving the highest priority to quoted prices in active markets and the lowestpriority to unobservable data. SFAS No. 157 applies whenever otherstandards require assets or liabilities to be measured at fair value. Thisstatement is effective in fiscal years beginning after November 15, 2007.

In September 2006,the Securities and Exchange Commission issued Staff Accounting Bulletin No. 108,or SAB 108, which becomes effective beginning on January 1, 2007. SAB 108provides guidance on the consideration of the effects of prior periodmisstatements in quantifying current year misstatements for the purpose of amateriality assessment. SAB 108 provides for the quantification of the impactof correcting all misstatements, including both the carryover and reversingeffects of prior year misstatements, on the current year financial statements.If a misstatement is material to the current year financial statements, theprior year financial statements should also be corrected, even though such revisionwas, and continues to be, immaterial to the prior year financial statements.Correcting prior year financial statements for immaterial errors would notrequire previously filed reports to be amended. Such correction should be madein the current period filings. We believe that the adoption of this standardwill not have a material effect on our financial position or results ofoperations.

**ITEM7A.**        QUANTITATIVE ANDQUALITATIVE DISCLOSURE ABOUT MARKET RISK

**Market Risk**

Market risk includes risksthat arise from changes in interest rates, commodity prices, equity prices andother market changes that affect market sensitive instruments. In pursuing ourbusiness plan, we expect that the primary market risks to which we will beexposed are real estate and interest rate risks.

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**Real Estate Risk**

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

**Interest Rate Risk**

Interest rate risk ishighly sensitive to many factors, including governmental monetary and taxpolicies, domestic and international economic and political considerations andother factors beyond our control. A hypothetical 100 basis point increase ininterest rates along the entire interest rate curve for the years ended December 31,2006 and 2005 and the period from April 12, 2004 (formation) through December 31,2004 would have increased our interest cost by approximately $14.1 million,$5.8 million and $204,000, respectively, offset by an increase in ourinvestment income of approximately $15.2 million, $7.9 million and $713,000,respectively.

Our operating results willdepend in large part on differences between the income from our assets and ourborrowing costs. Most of our assets and borrowings are variable-rateinstruments that we finance with variable rate debt. The objective of thisstrategy is to minimize the impact of interest rate changes on the spreadbetween the yield on our assets and our cost of funds. We enter into hedgingtransactions with respect to all liabilities relating to fixed rate assets. Ifwe were to finance fixed rate assets with variable rate debt and the benchmarkfor our variable rate debt increased, our net income would decrease. Furthermore,as most of our available financing provides for an ability of the lender tomark-to-market our assets and make margin calls based on a change in the valueof our assets, financing fixed rate assets with this debt creates the risk thatan increase in fixed rate benchmarks (such as “swap” yields) would decrease thevalue of our fixed rate assets. We have entered into certain swap transactionsin anticipation of drawing upon our mark-to-market debt to hedge against thisrisk. Some of our loans are subject to various interest rate floors. As aresult, if interest rates fall below the floor rates, the spread between theyield on our assets and our cost of funds will increase, which will generallyincrease our returns. Because we generate income principally from the spreadbetween the yields on our assets and the cost of our borrowing and hedgingactivities, our net income will generally increase if LIBOR increases anddecreases if LIBOR decreases, but this may not always be true in the future. Ourexposure to interest rates will also be affected by our overall corporateleverage, which we generally target to be 70% to 80% of the carrying value ofour assets, although our actual leverage may vary depending on our mix ofassets.

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

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Theaggregate carrying values, allocated by product type and weighted averagecoupons of our loans and other lending investments as of December 31, 2006and December 31, 2005 were as follows: 

| ** **                                            | ** ** | **Carrying Value(1)  ($ in thousands)** | ** ** | **Allocation by  Investment Type** | ** ** | **Fixed Rate:  Average Yield** | ** ** | **Floating Rate:  Average Spread over  LIBOR(2)** | ** ** |
|-------------------------------------------------------|------------|--------------------------------------------------------|------------|----------------------------------------------|------------|------------------------------------------|------------|------------------------------------------------------------------|------------|
| ** **                                            | ** ** | **2006**                                               | ** ** | **2005**                                     | ** ** | **2006**                                 | ** ** | **2005**                                                         | ** ** | **2006** | ** ** | **2005** | ** ** | **2006** | ** ** | **2005** | ** ** |
| Whole loans,  floating rate                           |       | $                                                      | 1,372,316  |                                         | $          | 561,388                                  |       |                                                             | 63         | % |   |   | 46 | % |   | — |   | — |   | 327 bps |   | 325 bps |   |
| Whole loans, fixed  rate                              |       | 42,376                                                 |       | 94,448                                       |       |                                     | 2          | %                                                                |       |   | 8 | % |   | 11.69 | % | 10.67 | % | — |   | — |   |
| Subordinate interests  in whole loans, floating  rate |       | 236,308                                                |       | 362,983                                      |       |                                     | 11         | %                                                                |       |   | 30 | % |   | — |   | — |   | 445 bps |   | 443 bps |   |
| Subordinate  interests in whole loans, fixed rate     |       | 48,769                                                 |       | 37,104                                       |       |                                     | 2          | %                                                                |       |   | 3 | % |   | 8.54 | % | 8.80 | % | — |   | — |   |
| Mezzanine loans,  floating rate                       |       | 226,675                                                |       | 82,793                                       |       |                                     | 10         | %                                                                |       |   | 7 | % |   | — |   | — |   | 665 bps |   | 858 bps |   |
| Mezzanine loans,  fixed rate                          |       | 216,216                                                |       | 43,352                                       |       |                                     | 10         | %                                                                |       |   | 4 | % |   | 9.92 | % | 8.51 | % | — |   | — |   |
| Preferred equity,  floating rate                      |       | —                                                 |       | 11,795                                       |       |                                     | —     |                                                             |       |   | 1 | % |   | — |   | — |   | 900 bps |   | 900 bps |   |
| Preferred equity,  fixed rate                         |       | 44,224                                                 |       | 11,882                                       |       |                                     | 2          | %                                                                |       |   | 1 | % |   | 10.68 | % | 10.27 | % | — |   | — |   |
| Total / Weighted  average                             |       | $                                                      | 2,186,884  |                                         | $          | 1,205,745                                |       |                                                             | 100        | % |   |   | 100 | % |   | 10.04 | % | 9.78 | % | 384 bps |   | 417 bps |   |

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(1)           Debt investments are presented after scheduledamortization payments and prepayments, and are net of unamortized fees,discounts, asset sales and unfunded commitments.

(2)           Spreads over an index other than LIBOR have beenadjusted to a LIBOR based equivalent.

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

| ** **                     | ** ** | **Number of** | ** ** | **Current**             | ** ** | ** **               | ** ** |
|--------------------------------|------------|--------------------|------------|-------------------------|------------|--------------------------|------------|
| ** **                     | ** ** | **Investments**    | ** ** | **Carrying Value** | ** ** | ** **               | ** ** |
| **Year of Maturity** | ** ** | **Maturing**       | ** ** | **(In thousands)** | ** ** | **% of Total** | ** ** |
| 2007                           |       |               | 26         |                    |       |                     | $          | 608,009 |   |   |   | 28 | % |   |
| 2008                           |       |               | 23         |                    |       |                     | 990,814    |   |   |   | 45 | % |   |
| 2009                           |       |               | 16         |                    |       |                     | 337,856    |   |   |   | 15 | % |   |
| 2010                           |       |               | 2          |                    |       |                     | 6,638      |   |   |   | — |   |   |
| 2011                           |       |               | 2          |                    |       |                     | 56,920     |   |   |   | 3 | % |   |
| Thereafter                     |       |               | 7          |                    |       |                     | 186,647    |   |   |   | 9 | % |   |
| Total                          |       |               | 76         |                    |       |                     | $          | 2,186,884 |   |   |   | 100 | % |   |
| Weighted average  maturity(1)  |       |               |       |                    |       |                     | 2.1 years  |   |   |   |   |   |   |

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(1)          The calculation ofweighted average maturity is based upon the initial term of the investment anddoes not include option or extension periods or the ability to prepay theinvestment after a negotiated lock-out period, which may be available to theborrower.

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Combinedaggregate principal maturities of our consolidated CDOs, repurchase facilities,trust preferred securities, proportionately consolidated mortgage note payablerelated to our TIC interest in 55 Corporate Drive, and unsecured revolvingcredit facility as of December 31, 2006 are as follows:

| ** ** | ** ** | ** ** | ** ** | ** **     | ** ** | ** **     | ** ** | ** **   | ** ** | **Unsecured** | ** ** | ** ** | ** ** |
|------------|------------|------------|------------|----------------|------------|----------------|------------|--------------|------------|---------------|------------|------------|------------|
| ** ** | ** ** | ** ** | ** ** | ** **     | ** ** | **Trust**      | ** ** | **Mortgage** | ** ** | **Revolving** | ** ** | ** ** | ** ** |
| ** ** | ** ** | ** ** | ** ** | **Repurchase** | ** ** | **Preferred**  | ** ** | **Note**     | ** ** | **Credit**    | ** ** | ** ** | ** ** |
| ** ** | ** ** | **CDOs**   | ** ** | **Facilities** | ** ** | **Securities** | ** ** | **Payable**  | ** ** | **Facility**  | ** ** | **Total**  | ** ** |
| 2007       |       | $          | —     |           |       | $              | —     |         |       | $             | —     |       |       | $ | — |   |   |   | $ | — |   |   | $ | — |   |
| 2008       |       | —     |       |           | —     |           |       | —       |       |          | —     |       |       |   | — |   |   | — |   |
| 2009       |       | —     |       |           | 277,412    |           |       | —       |       |          | —     |       |       |   | 15,000 |   |   | 292,412 |   |
| 2010       |       | —     |       |           | —     |           |       | —       |       |          | —     |       |       |   | — |   |   | — |   |
| 2011       |       | —     |       |           | —     |           |       | —       |       |          | —     |       |       |   | — |   |   | — |   |
| Thereafter |       | 1,714,250  |       |           | —     |           |       | 150,000      |       |          | 94,525     | (1)        |       |   | — |   |   | 1,958,775 |   |
| Total      |       | $          | 1,714,250  |           |       | $              | 277,412    |         |       | $             | 150,000    |       |       | $ | 94,525 |   |   |   | $ | 15,000 |   |   | $ | 2,251,187 |   |

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(1)          Wehave a 49.75% interest in the mortgage note.

Thefollowing table summarizes the notional and fair value of our derivativefinancial instrument at December 31, 2006. The notional value is anindication of the extent of our involvement in this instrument at that time,but does not represent exposure to credit, interest rate or market risks:

| ** **         | ** ** | **Benchmark Rate** | ** ** | **Notional  Value** | ** ** | **Strike  Rate** | ** ** | **Effective  Date** | ** ** | **Expiration  Date** | ** ** | **Fair  Value** | ** ** |
|--------------------|------------|-------------------------|------------|---------------------|------------|------------------|------------|---------------------|------------|----------------------|------------|-----------------|------------|
| Interest Rate Swap |       | 1 month LIBOR           |       | $                   | 168,300    |             | 4.973      | %                   |       | 1/2007               |       |            |       | 1/2017 |   |   | $ | 836 |   |
| Interest Rate Swap |       | 1 month LIBOR           |       | 64,076              |       | 4.990            | %          |                | 1/2007     |                 |       |            | 1/2017     |   |   | 248 |   |
| Interest Rate Swap |       | 1 month LIBOR           |       | 42,718              |       | 4.990            | %          |                | 1/2007     |                 |       |            | 1/2017     |   |   | 162 |   |
| Interest Rate Swap |       | 3 month LIBOR           |       | 39,683              |       | 4.420            | %          |                | 7/2005     |                 |       |            | 2/2014     |   |   | 1,293 |   |
| Interest Rate Swap |       | 1 month LIBOR           |       | 36,500              |       | 4.837            | %          |                | 12/2006    |                 |       |            | 11/2009    |   |   | 120 |   |
| Interest Rate Swap |       | 1 month LIBOR           |       | 31,686              |       | 3.855            | %          |                | 7/2005     |                 |       |            | 11/2009    |   |   | 943 |   |
| Interest Rate Swap |       | 3 month LIBOR           |       | 24,940              |       | 5.445            | %          |                | 8/2006     |                 |       |            | 7/2016     |   |   | (728 | ) |
| Interest Rate Cap  |       | 3 month LIBOR           |       | 23,713              |       | 5.700            | %          |                | 11/2005    |                 |       |            | 12/2007    |   |   | 2 |   |
| Interest Rate Cap  |       | 1 month LIBOR           |       | 20,000              |       | 6.000            | %          |                | 4/2006     |                 |       |            | 4/2007     |   |   | — |   |
| Interest Rate Swap |       | 3 month LIBOR           |       | 12,000              |       | 9.850            | %          |                | 8/2006     |                 |       |            | 8/2011     |   |   | (93 | ) |
| Basis Swap         |       | 1 month PRIME           |       | 9,363               |       | 722 bps          |       |                | 8/2006     |                 |       |            | 12/2007    |   |   | (29 | ) |
| Interest Rate Swap |       | 1 month LIBOR           |       | 6,339               |       | 4.760            | %          |                | 1/2006     |                 |       |            | 3/2015     |   |   | 97 |   |
| Interest Rate Swap |       | 1 month LIBOR           |       | 3,960               |       | 4.959            | %          |                | 12/2005    |                 |       |            | 12/2015    |   |   | 16 |   |
| Interest Rate Swap |       | 1 month LIBOR           |       | 3,465               |       | 4.280            | %          |                | 7/2005     |                 |       |            | 12/2009    |   |   | 64 |   |
| Interest Rate Swap |       | 3 month LIBOR           |       | 3,465               |       | 5.178            | %          |                | 4/2006     |                 |       |            | 3/2010     |   |   | (21 | ) |
| Total              |       |                    |       | $                   | 490,208    |             |       |                |       |                 |       |            |       |   |   |   | $ | 2,910 |   |

 

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**ITEM 8.**                FINANCIALSTATEMENTS AND SUPPLEMENTARY DATA

**Indexto Financial Statements and Schedules**

| **GRAMERCY CAPITAL CORP.**                                                                                                                                                                     | ** ** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|
|                                                                                                                                                                                           |       |       |
| Report of Independent  Registered Public Accounting Firm                                                                                                                                       |       | 75         |
| Consolidated Balance  Sheets as of December 31, 2006 and 2005                                                                                                                             |       | 77         |
| Consolidated Statements  of Income for the years ended December 31, 2006 and 2005 and the period  from April 12, 2004 (formation) through December 31, 2004                     |       | 78         |
| Consolidated Statements  of Stockholders’ Equity for the years ended December 31, 2006 and 2005  and the period from April 12, 2004 (formation) through December 31,  2004 |       | 79         |
| Consolidated Statements  of Cash Flows for the years ended December 31, 2006 and 2005 and the  period from April 12, 2004 (formation) through December 31, 2004                 |       | 80         |
| Notes to Consolidated  Financial Statements                                                                                                                                                    |       | 82         |
| **Schedules**                                                                                                                                                                                  |       |       |
| Schedule IV Mortgage Loans on Real Estate as of  December 31, 2006                                                                                                                   |       | 115        |

 

All other schedules are omitted because they are notrequired or the required information is shown in the financial statements ornotes thereto.

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**Reportof Independent Registered Public Accounting Firm**

The Board of Directors and Stockholders of GramercyCapital Corp.

We have audited the accompanying consolidated balancesheets of Gramercy Capital Corp. as of December 31, 2006 and 2005, and therelated consolidated statements of income, stockholders’ equity and cash flowsfor the years ended December 31, 2006 and 2005 and for the period from April 12,2004 (formation) through December 31, 2004. Our audits also included thefinancial statement schedule listed in the Index as Item 15(a)(2). Thesefinancial statements and schedule are the responsibility of GramercyCapital Corp.’s management. Our responsibility is to express an opinion onthese financial statements and schedule based on our audits.

We conducted our audits in accordance with thestandards of the Public Company Accounting Oversight Board (United States). Thosestandards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. An audit includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements. An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statement presentation.We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred toabove present fairly, in all material respects, the consolidated financialposition of Gramercy Capital Corp. at December 31, 2006 and 2005, and theconsolidated results of its operations and its cash flows for the years ended December 31,2006 and 2005 and for the period from April 12, 2004 (formation) through December 31,2004, in conformity with U.S. generally accepted accounting principles. Also,in our opinion, the related financial statement schedule, when considered inrelation to the basic financial statements taken as a whole, presents fairly inall material respects, the information set forth therein.

As discussed in Note 2 to the consolidated financialstatements, Gramercy Capital Corp. adopted Statement of Financial AccountingStandards No. 123(R), “Share-Based Payment.”

We also have audited, in accordance with the standardsof the Public Company Accounting Oversight Board (United States), theeffectiveness of Gramercy Capital Corp.’s internal control over financialreporting as of December 31, 2006, based on criteria established inInternal Control-Integrated Framework issued by the Committee of SponsoringOrganizations of the Treadway Commission and our report dated February 28,2007 expressed an unqualified opinion thereon.
| /s/ Ernst & Young  LLP |   |
|---------------------------------|--------|

 

New York, New York

February 28, 2007

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**Reportof Independent Registered Public Accounting Firm**

**The Board of Directors and Stockholdersof Gramercy Capital Corp.**

We have audited management’sassessment, included in the accompanying Item 9A. Controls and Procedures - “Management’sReport on Internal Control over Financial Reporting,” that Gramercy CapitalCorp. maintained effective internal control over financial reporting as of December 31,2006, based on criteria established inInternal Control—Integrated Framework issued by the Committee of SponsoringOrganizations of the Treadway Commission (the COSO criteria). GramercyCapital Corp.’s management is responsible for maintaining effective internalcontrol over financial reporting and for its assessment of the effectiveness ofinternal control over financial reporting. Our responsibility is to express anopinion on management’s assessment and an opinion on the effectiveness of thecompany’s internal control over financial reporting based on our audit.

We conducted our audit inaccordance with the standards of the Public Company Accounting Oversight Board(United States). Those standards require that we plan and perform the audit toobtain reasonable assurance about whether effective internal control overfinancial reporting was maintained in all material respects. Our audit includedobtaining an understanding of internal control over financial reporting,evaluating management’s assessment, testing and evaluating the design andoperating effectiveness of internal control, and performing such otherprocedures as we considered necessary in the circumstances. We believe that ouraudit provides a reasonable basis for our opinion.

A company’s internalcontrol over financial reporting is a process designed to provide reasonableassurance regarding the reliability of financial reporting and the preparationof financial statements for external purposes in accordance with generallyaccepted accounting principles. A company’s internal control over financialreporting includes those policies and procedures that (1) pertain to themaintenance of records that, in reasonable detail, accurately and fairlyreflect the transactions and dispositions of the assets of the company; (2) providereasonable assurance that transactions are recorded as necessary to permitpreparation of financial statements in accordance with generally acceptedaccounting principles, and that receipts and expenditures of the company arebeing made only in accordance with authorizations of management and directorsof the company; and (3) provide reasonable assurance regarding preventionor timely detection of unauthorized acquisition, use, or disposition of thecompany’s assets that could have a material effect on the financial statements.

Because of its inherentlimitations, internal control over financial reporting may not prevent ordetect misstatements. Also, projections of any evaluation of effectiveness tofuture periods are subject to the risk that controls may become inadequatebecause of changes in conditions, or that the degree of compliance with thepolicies or procedures may deteriorate.

In our opinion, management’sassessment that Gramercy Capital Corp. maintained effective internal controlover financial reporting as of December 31, 2006, is fairly stated, in allmaterial respects, based on the COSO criteria. Also, in our opinion, GramercyCapital Corp. maintained, in all material respects, effective internal controlover financial reporting as of December 31, 2006, based on****theCOSO criteria**.**

We also have audited, in accordance with the standardsof the Public Company Accounting Oversight Board (United States), theconsolidated balance sheets of Gramercy Capital Corp. as of December 31,2006 and 2005, and the related consolidated statements of income, stockholders’equity and cash flows for the years ended December 31, 2006 and 2005 andfor the period from April 12, 2004 (formation) through December 31,2004 of Gramercy Capital Corp. and our report dated February 28, 2007expressed an unqualified opinionthereon.
| /s/ Ernst & Young  LLP |   |
|---------------------------------|--------|

 

New York, New York

February 28, 2007

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

| ** **                                                                                                                                                                                 | ** ** | **December 31,** | ** ** | **December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                 | ** ** | **2006**              | ** ** | **2005**              | ** ** |
| **Assets:**                                                                                                                                                                                |       |                  |       |                  |       |   |   |   |   |
| Cash and cash  equivalents                                                                                                                                                                 |       |                  | $          | 19,314                |       |   |   | $ | 70,576 |   |   |
| Restricted cash                                                                                                                                                                            |       |                  | 354,283    |                  |       |   | 53,833 |   |   |
| Loans and other  lending investments, net                                                                                                                                                  |       |                  | 2,144,151  |                  |       |   | 1,163,745 |   |   |
| Investment in  unconsolidated joint ventures                                                                                                                                               |       |                  | 57,567     |                  |       |   | 58,040 |   |   |
| Loans held for  sale, net                                                                                                                                                                  |       |                  | 42,733     |                  |       |   | 42,000 |   |   |
| Commercial real  estate, net                                                                                                                                                               |       |                  | 99,821     |                  |       |   | 51,173 |   |   |
| Accrued interest                                                                                                                                                                           |       |                  | 12,092     |                  |       |   | 7,187 |   |   |
| Deferred  financing costs                                                                                                                                                                  |       |                  | 27,456     |                  |       |   | 17,488 |   |   |
| Deferred costs                                                                                                                                                                             |       |                  | 1,271      |                  |       |   | 1,894 |   |   |
| Derivative  instruments, at fair value                                                                                                                                                     |       |                  | 2,910      |                  |       |   | 2,271 |   |   |
| Other assets                                                                                                                                                                               |       |                  | 4,515      |                  |       |   | 1,603 |   |   |
| Total assets                                                                                                                                                                               |       |                  | $          | 2,766,113             |       |   |   | $ | 1,469,810 |   |   |
| **Liabilities  and Stockholders’ Equity:**                                                                                                                                            |       |                  |       |                  |       |   |   |   |   |
| Repurchase  agreements                                                                                                                                                                     |       |                  | $          | 277,412               |       |   |   | $ | 117,366 |   |   |
| Credit facilities                                                                                                                                                                          |       |                  | 15,000     |                  |       |   |   |   |   |
| Collateralized  debt obligations                                                                                                                                                           |       |                  | 1,714,250  |                  |       |   | 810,500 |   |   |
| Mortgage note  payable                                                                                                                                                                     |       |                  | 94,525     |                  |       |   | 41,000 |   |   |
| Management fees  payable                                                                                                                                                                   |       |                  | 2,093      |                  |       |   | 1,329 |   |   |
| Incentive fee  payable                                                                                                                                                                     |       |                  | 1,195      |                  |       |   | 1,237 |   |   |
| Dividends payable                                                                                                                                                                          |       |                  | 14,419     |                  |       |   | 10,726 |   |   |
| Accounts payable  and accrued expenses                                                                                                                                                     |       |                  | 24,750     |                  |       |   | 11,561 |   |   |
| Other liabilities                                                                                                                                                                          |       |                  | 11,809     |                  |       |   | 3,687 |   |   |
| Junior  subordinated deferrable interest debentures held by trusts that issued trust  preferred securities                                                                                 |       |                  | 150,000    |                  |       |   | 100,000 |   |   |
| Total liabilities                                                                                                                                                                          |       |                  | 2,305,453  |                  |       |   | 1,097,406 |   |   |
| Commitments and contingencies                                                                                                                                                              |       |                  | —     |                  |       |   | — |   |   |
| **Stockholders’  Equity:**                                                                                                                                                            |       |                  |       |                  |       |   |   |   |   |
| Preferred stock,  par value $0.001, 25,000,000 shares authorized, no shares issued or  outstanding                                                                                         |       |                  | —     |                  |       |   | — |   |   |
| Common stock, par  value $0.001, 100,000,000 shares authorized, 25,878,391and 22,802,642 shares issued and outstanding  at December 31, 2006 and December 31, 2005, respectively |       |                  | 26         |                  |       |   | 22 |   |   |
| Additional  paid-in-capital                                                                                                                                                                |       |                  | 453,766    |                  |       |   | 369,529 |   |   |
| Accumulated other  comprehensive income                                                                                                                                                    |       |                  | 2,890      |                  |       |   | 2,851 |   |   |
| Retained earnings                                                                                                                                                                          |       |                  | 3,978      |                  |       |   | 2 |   |   |
| Total stockholders’ equity                                                                                                                                                            |       |                  | 460,660    |                  |       |   | 372,404 |   |   |
| Total liabilities and  stockholders’ equity                                                                                                                                           |       |                  | $          | 2,766,113             |       |   |   | $ | 1,469,810 |   |   |

 

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

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**Gramercy CapitalCorp.Consolidated Statements of Income(Amounts in thousands, except per share data)**

| ** **                                                                                                            | ** ** | **Year Ended  December 31,** | ** ** | **Period from  April 12, 2004  (formation)  through  December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------|------------|-----------------------------------------------------------------------------------------|------------|
| ** **                                                                                                            | ** ** | **2006**                               | ** ** | **2005**                                                                                | ** ** | **2004** | ** ** |
| **Revenues**                                                                                                          | ** ** | ** **                             | ** ** | ** **                                                                              | ** ** |   | ** ** | ** ** |   |
| Investment income                                                                                                     |       | $                                      | 176,421    |                                                                                    | $          | 73,302 |   |   | $ | 6,841 |   |   |
| Rental revenue, net                                                                                                   |       | 2,402                                  |       | 1,219                                                                                   |       |   | — |   |   |
| Gain on sales and other income                                                                                        |       | 19,392                                 |       | 13,564                                                                                  |       |   | 310 |   |   |
| Total revenues                                                                                                        |       | 198,215                                |       | 88,085                                                                                  |       |   | 7,151 |   |   |
| **Expenses**                                                                                                          | ** ** | ** **                             | ** ** | ** **                                                                              | ** ** |   | ** ** | ** ** |   |
| Interest expense                                                                                                      |       | 98,299                                 |       | 33,771                                                                                  |       |   | 1,463 |   |   |
| Management fees                                                                                                       |       | 16,668                                 |       | 9,600                                                                                   |       |   | 1,965 |   |   |
| Incentive fee                                                                                                         |       | 7,609                                  |       | 2,276                                                                                   |       |   | — |   |   |
| Depreciation and amortization                                                                                         |       | 1,582                                  |       | 672                                                                                     |       |   | 38 |   |   |
| Marketing, general and administrative                                                                                 |       | 11,957                                 |       | 6,976                                                                                   |       |   | 1,358 |   |   |
| Provision for loan loss                                                                                               |       | 1,430                                  |       | 1,030                                                                                   |       |   | — |   |   |
| Total expenses                                                                                                        |       | 137,545                                |       | 54,325                                                                                  |       |   | 4,824 |   |   |
| Income from continuing operations before equity in  net loss of unconsolidated joint ventures and provision for taxes |       | 60,670                                 |       | 33,760                                                                                  |       |   | 2,327 |   |   |
| Equity in net loss of unconsolidated joint ventures                                                                   |       | (2,960                                 | )          | (1,489                                                                                  | )          |   | — |   |   |
| Income from continuing operations before provision  for taxes                                                         |       | 57,710                                 |       | 32,271                                                                                  |       |   | 2,327 |   |   |
| Provision for taxes                                                                                                   |       | (1,808                                 | )          | (900                                                                                    | )          |   | — |   |   |
| GKK formation costs                                                                                                   |       | —                                 |       | —                                                                                  |       |   | (275 | ) |   |
| Net income available to common stockholders                                                                           |       | $                                      | 55,902     |                                                                                    | $          | 31,371 |   |   | $ | 2,052 |   |   |
| **Basic  earnings per share:**                                                                                        | ** ** | ** **                             | ** ** | ** **                                                                              | ** ** |   | ** ** | ** ** |   |
| Net income available to common stockholders                                                                           |       | $                                      | 2.26       |                                                                                    | $          | 1.57 |   |   | $ | 0.15 |   |   |
| **Diluted earnings per share:**                                                                                       | ** ** | ** **                             | ** ** | ** **                                                                              | ** ** |   | ** ** | ** ** |   |
| Net income available to common stockholders                                                                           |       | $                                      | 2.15       |                                                                                    | $          | 1.51 |   |   | $ | 0.15 |   |   |
| Dividends per common share                                                                                            |       | $                                      | 2.08       |                                                                                    | $          | 1.495 |   |   | $ | 0.15 |   |   |
| Basic weighted average common shares outstanding                                                                      |       | 24,722                                 |       | 20,027                                                                                  |       |   | 13,348 |   |   |
| Diluted weighted  average common shares and common share equivalents outstanding                                      |       | 26,009                                 |       | 20,781                                                                                  |       |   | 13,411 |   |   |

 

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

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**Gramercy Capital Corp.Consolidated Statement ofStockholders’ Equity(Amounts in thousands, except share data)**

| ** **                                                                                                                            | ** ** | ** **            | ** ** | ** **         | ** ** | ** **        | ** ** | **Accumulated** | ** ** | ** **   | ** ** | ** **        | ** ** | ** ** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|--------------------|------------|-------------------|------------|-----------------|------------|--------------|------------|-------------------|------------|------------|------------|
| ** **                                                                                                                            | ** ** | ** **            | ** ** | ** **         | ** ** | **Additional**    | ** ** | **Other**       | ** ** | ** **   | ** ** | ** **        | ** ** | ** ** | ** ** |
| ** **                                                                                                                            | ** ** | **Common Stock** | ** ** | **Paid**           | ** ** | **Comprehensive** | ** ** | **Retained**    | ** ** | ** **   | ** ** | **Comprehensive** | ** ** |
| ** **                                                                                                                            | ** ** | **Shares**            | ** ** | **Par Value** | ** ** | **In-Capital**    | ** ** | **Income**      | ** ** | **Earnings** | ** ** | **Total**         | ** ** | **Income** | ** ** |
| **Balance  at April 12, 2004 (formation)**                                                                                       |       |                  | 500        |               |       |              | $          | 1               |       |         |       | $                 | 199        |       |       |   | $ | — |   |   |   | $ | — |   |   | $ | 200 |   |   | $ | — |   |   |
| Net income                                                                                                                            |       |                  |       |               |       |              |       |            |       |         |       |              |       |       |       |   |   |   | 2,052 |   |   | 2,052 |   |   | 2,052 |   |   |
| Net unrealized  gain on derivative instruments                                                                                        |       |                  |       |               |       |              |       |            |       |         |       |              |       |       | 282        |   |   |   |   |   |   | 282 |   |   | 282 |   |   |
| Net proceeds from  common stock offerings                                                                                             |       |                  | 18,000     |               |       |              | 18         |            |       |         | 267,955    |              |       |       |       |   |   |   |   |   |   | 267,973 |   |   |   |   |   |
| Stock-based  compensation—fair value                                                                                             |       |                  |       |               |       |              |       |            |       |         | 404        |              |       |       |       |   |   |   |   |   |   | 404 |   |   |   |   |   |
| Deferred  compensation plan, net                                                                                                      |       |                  | 313        |               |       |              | —     |            |       |         |       |              |       |       |       |   |   |   |   |   |   | — |   |   |   |   |   |
| Cash distributions  declared ($0.15 per common share of which none represented a return of  capital for federal income tax purposes)  |       |                  |       |               |       |              |       |            |       |         |       |              |       |       |       |   |   |   | (1,952 | ) |   | (1,952 | ) |   |   |   |   |
| **Balance  at December 31, 2004**                                                                                                |       |                  | 18,813     |               |       |              | 19         |            |       |         | 268,558    |              |       |       | 282        |   |   |   | 100 |   |   | 268,959 |   |   | $ | 2,334 |   |   |
| Net income                                                                                                                            |       |                  |       |               |       |              |       |            |       |         |       |              |       |       |       |   |   |   | 31,371 |   |   | 31,371 |   |   | $ | 31,371 |   |   |
| Net unrealized  gain on derivative instruments                                                                                        |       |                  |       |               |       |              |       |            |       |         |       |              |       |       | 2,569      |   |   |   |   |   |   | 2,569 |   |   | 2,569 |   |   |
| Net proceeds from  common stock offerings                                                                                             |       |                  | 3,833      |               |       |              | 3          |            |       |         | 96,028     |              |       |       |       |   |   |   |   |   |   | 96,031 |   |   |   |   |   |
| Stock-based  compensation—fair value                                                                                             |       |                  |       |               |       |              |       |            |       |         | 1,798      |              |       |       |       |   |   |   |   |   |   | 1,798 |   |   |   |   |   |
| Proceeds from  stock option exercises                                                                                                 |       |                  | 131        |               |       |              | —     |            |       |         | 1,970      |              |       |       |       |   |   |   |   |   |   | 1,970 |   |   |   |   |   |
| Deferred  compensation plan, net                                                                                                      |       |                  | 26         |               |       |              | —     |            |       |         | 1,175      |              |       |       |       |   |   |   |   |   |   | 1,175 |   |   |   |   |   |
| Cash distributions  declared ($1.495 per common share of which none represented a return of  capital for federal income tax purposes) |       |                  |       |               |       |              |       |            |       |         |       |              |       |       |       |   |   |   | (31,469 | ) |   | (31,469 | ) |   |   |   |   |
| **Balance  at December 31, 2005**                                                                                                |       |                  | 22,803     |               |       |              | 22         |            |       |         | 369,529    |              |       |       | 2,851      |   |   |   | 2 |   |   | 372,404 |   |   | $ | 33,940 |   |   |
| Net income                                                                                                                            |       |                  |       |               |       |              |       |            |       |         |       |              |       |       |       |   |   |   | 55,902 |   |   | 55,902 |   |   | $ | 55,902 |   |   |
| Net unrealized  gain on derivative instruments                                                                                        |       |                  |       |               |       |              |       |            |       |         |       |              |       |       | 39         |   |   |   |   |   |   | 39 |   |   | 39 |   |   |
| Proceeds from  common stock offerings                                                                                                 |       |                  | 3,000      |               |       |              | 3          |            |       |         | 79,787     |              |       |       |       |   |   |   |   |   |   | 79,790 |   |   |   |   |   |
| Stock-based  compensation—fair value                                                                                             |       |                  |       |               |       |              |       |            |       |         | 2,259      |              |       |       |       |   |   |   |   |   |   | 2,259 |   |   |   |   |   |
| Proceeds from  stock option exercises                                                                                                 |       |                  | 63         |               |       |              | 1          |            |       |         | 1,017      |              |       |       |       |   |   |   |   |   |   | 1,018 |   |   |   |   |   |
| Deferred  compensation plan, net                                                                                                      |       |                  | 12         |               |       |              | —     |            |       |         | 1,174      |              |       |       |       |   |   |   |   |   |   | 1,174 |   |   |   |   |   |
| Cash distributions  declared ($2.08 per common share of which none represented a return of  capital for federal income tax purposes)  |       |                  |       |               |       |              |       |            |       |         |       |              |       |       |       |   |   |   | (51,926 | ) |   | (51,926 | ) |   |   |   |   |
| **Balance at December 31,  2006**                                                                                                |       |                  | 25,878     |               |       |              | $          | 26              |       |         |       | $                 | 453,766    |       |       |   | $ | 2,890 |   |   |   | $ | 3,978 |   |   | $ | 460,660 |   |   | $ | 55,941 |   |   |

 

The accompanyingnotes are an integral part of these financial statements

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**Gramercy Capital Corp.**Consolidated Statements of Cash Flows(Amounts in thousands)

| ** **                                                                                                           | ** ** | **Year Ended   December 31,** | ** ** | **Period from   April 12, 2004   (formation)   through   December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------|------------|---------------------------------------------------------------------------------------------|------------|
| ** **                                                                                                           | ** ** | **2006**                                | ** ** | **2005**                                                                                    | ** ** | **2004** | ** ** |
| **Operating  Activities**                                                                                            | ** ** | ** **                              | ** ** | ** **                                                                                  | ** ** |   | ** ** | ** ** |   |
| Net income  available to common stockholders                                                                         |       | $                                       | 55,902     |                                                                                        | $          | 31,371 |   |   | $ | 2,052 |   |   |
| Adjustments to reconcile  net income available to common stockholders to net cash provided by operating  activities: |       |                                    | ** ** | ** **                                                                                  |       |   |   |   |   |
| Depreciation and amortization                                                                                        |       | 6,042                                   |       | 3,448                                                                                       |       |   | 38 |   |   |
| Amortization of discount, premium and other fees on  investments                                                     |       | (12,956                                 | )          | (1,810                                                                                      | )          |   | 253 |   |   |
| Deferred rents receivable                                                                                            |       | (1,488                                  | )          | —                                                                                      |       |   | — |   |   |
| Equity in net loss of unconsolidated joint ventures                                                                  |       | 2,960                                   |       | 1,489                                                                                       |       |   | — |   |   |
| Gain on sale of securities                                                                                           |       | (6,362                                  | )          | —                                                                                      |       |   | — |   |   |
| Amortization of stock compensation                                                                                   |       | 3,433                                   |       | 2,569                                                                                       |       |   | — |   |   |
| Provision for loan loss                                                                                              |       | 1,430                                   |       | 1,030                                                                                       |       |   | — |   |   |
| Net realized gain on loan held for sale                                                                              |       | (4,713                                  | )          | —                                                                                      |       |   | — |   |   |
| Changes in operating  assets and liabilities:                                                                        |       |                                    | ** ** | ** **                                                                                  |       |   |   |   |   |
| New investments in loans held for sale                                                                               |       | (104,931                                | )          | (182,431                                                                                    | )          |   | — |   |   |
| Proceeds from sale of loans held for sale                                                                            |       | 175,050                                 |       | 140,431                                                                                     |       |   | — |   |   |
| Accrued interest                                                                                                     |       | (4,905                                  | )          | (4,266                                                                                      | )          |   | (2,921 | ) |   |
| Other assets                                                                                                         |       | 12,034                                  |       | (1,364                                                                                      | )          |   | (628 | ) |   |
| Management fees payable                                                                                              |       | 764                                     |       | 913                                                                                         |       |   | 416 |   |   |
| Incentive fee payable                                                                                                |       | (42                                     | )          | 1,237                                                                                       |       |   | — |   |   |
| Settlement of derivative instruments                                                                                 |       | 534                                     |       | —                                                                                      |       |   | — |   |   |
| Accounts payable, accrued expenses and other  liabilities                                                            |       | 31,955                                  |       | 9,543                                                                                       |       |   | 1,935 |   |   |
| Net cash provided  by operating activities                                                                           |       | 154,707                                 |       | 2,160                                                                                       |       |   | 1,145 |   |   |
| **Investing  Activities**                                                                                            |       |                                    | ** ** | ** **                                                                                  |       |   |   |   |   |
| New investment  originations and funded commitments                                                                  |       | (1,847,976                              | )          | (1,030,149                                                                                  | )          |   | (407,603 | ) |   |
| Principal  collections on investments                                                                                |       | 810,947                                 |       | 273,897                                                                                     |       |   | 736 |   |   |
| Investment in  commercial real estate and securities                                                                 |       | (113,644                                | )          | (50,616                                                                                     | )          |   | — |   |   |
| Net proceeds from  the sale of securities                                                                            |       | 14,812                                  |       | —                                                                                      |       |   | — |   |   |
| Investment in  joint venture                                                                                         |       | 75                                      |       | (59,529                                                                                     | )          |   | — |   |   |
| Change in  restricted cash from investing activities                                                                 |       | (11,900                                 | )          | —                                                                                      |       |   | — |   |   |
| Settlement of  derivative instruments                                                                                |       | —                                  |       | 106                                                                                         |       |   | — |   |   |
| Deferred  investment costs                                                                                           |       | (1,840                                  | )          | (1,704                                                                                      | )          |   | (189 | ) |   |
| Net cash used in  investing activities                                                                               |       | (1,149,526                              | )          | (867,995                                                                                    | )          |   | (407,056 | ) |   |
| **Financing  Activities**                                                                                            |       |                                    | ** ** | ** **                                                                                  |       |   |   |   |   |
| Proceeds from  repurchase facilities                                                                                 |       | 1,381,582                               |       | 815,151                                                                                     |       |   | 238,885 |   |   |
| Repayments of  repurchase facilities                                                                                 |       | (1,206,537                              | )          | (936,670                                                                                    | )          |   | — |   |   |
| Proceeds from  issuance of collateralized debt obligation                                                            |       | 903,750                                 |       | 810,500                                                                                     |       |   | — |   |   |
| Proceeds from  mortgage note payable                                                                                 |       | 94,525                                  |       | 41,000                                                                                      |       |   | — |   |   |
| Change in  restricted cash from financing activities                                                                 |       | (304,567                                | )          | (50,935                                                                                     | )          |   | — |   |   |
|                                                                                                                      |            |                                         |            |                                                                                             |            |  |  |  |  |  |  |  |

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

81

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| Settlement of  derivative instruments                  |   | 730     |       | 375        |   |   | —  |   |   |
|--------------------------------------------------------|--------|---------|------------|------------|--------|--------|---------|--------|--------|
| Proceeds from  stock options exercised                 |   | 1,018   |       | 1,970      |   |   | —  |   |   |
| Net proceeds from  sale of common stock                |   | 79,790  |       | 156,848    |   |   | 268,409 |   |   |
| Stock  subscription receivable                         |   | —  |       | —     |   |   | (60,445 | )      |   |
| Issuance of trust  preferred securities                |   | 50,000  |       | 100,000    |   |   | —  |   |   |
| Deferred  financing costs and other liabilities        |   | (8,494  | )          | (18,227    | )      |   | (2,044  | )      |   |
| Dividends paid                                         |   | (48,240 | )          | (22,695    | )      |   | —  |   |   |
| Net cash provided  by financing activities             |   | 943,557 |       | 897,317    |   |   | 444,805 |   |   |
| Net decrease in  cash and cash equivalents             |   | (51,262 | )          | 31,482     |   |   | 38,894  |   |   |
| Cash and cash  equivalents at beginning of period      |   | 70,576  |       | 39,094     |   |   | 200     |   |   |
| Cash and cash  equivalents at end of period            |   | $       | 19,314     |       | $      | 70,576 |    |   | $      | 39,094 |   |   |
| **Non-cash  activity**                                 |   |    | ** ** | ** ** |   |   |    |   |   |
| Change in investment in unconsolidated joint  ventures |   | 1,814   |       | —     |   |   | —  |   |   |
| Deferred gains on derivative instruments               |   | 237     |       | 2,569      |   |   | 282     |   |   |
| **Supplemental  cash flow disclosures**                |   |    | ** ** | ** ** |   |   |    |   |   |
| Interest paid                                          |   | 80,956  |       | 22,440     |   |   | 558     |   |   |
| Income taxes paid                                      |   | 1,888   |       | 828        |   |   | —  |   |   |
|                                                        |        |         |            |            |        |        |         |        |        |  |  |  |

 

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

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**Gramercy Capital Corp. Notes To Consolidated Financial Statements (Continued) (Amounts in thousands, except share and per share data) December 31, 2006**

**1.**   Organization

Gramercy Capital Corp. (the “Company” or “Gramercy”)is a commercial real estate specialty finance company that focuses on thedirect origination and acquisition of whole loans, subordinate interests inwhole loans, mezzanine loans, preferred equity, and net lease investmentsinvolving commercial properties throughout the United States. When evaluatingtransactions, we assess our risk-adjusted return and target transactions withyields that seek to provide excess returns for the risks being taken.

Substantially all of our operations are conductedthrough GKK Capital LP, a Delaware limited partnership, or our OperatingPartnership. We, as the sole general partner of, and currently the holder of100% of the common units of, our Operating Partnership, have responsibility anddiscretion in the management and control of our Operating Partnership, and thelimited partners of our Operating Partnership, in such capacity, have noauthority to transact business for, or participate in the management activitiesof, our Operating Partnership. Accordingly, we consolidate the accounts of ourOperating Partnership.

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

As of December 31,2006, we held loans and other lending investments of $2,186,884 net of fees,discounts, and unfunded commitments with an average spread to LIBOR of 384basis points for our floating rate investments, and an average yield of 10.04%for our fixed rate investments. As of December 31, 2006, we also heldinterests in four credit tenant lease, or CTL, investments comprised of a49.75% tenancy-in-common, or TIC, interest in 55 Corporate Drive inBridgewater, New Jersey, and three joint venture investments.

**2.**   SignificantAccounting Policies

**Principles ofConsolidation**

The consolidated financialstatements include our accounts and those of our subsidiaries which arewholly-owned or controlled by us, or entities which are variable interestentities in which we are the primary beneficiaries under FASB Interpretation No. 46,or FIN 46, “Consolidation of Variable Interest Entities.”  FIN 46 requires a variable interest entity,or VIE, to be consolidated by its primary beneficiary. The primary beneficiaryis the party that absorbs a majority of the VIE’s anticipated losses and/or amajority of the expected returns. We have evaluated our investments forpotential classification as variable interests by evaluating the sufficiency ofthe entities’ equity investment at risk to absorb losses, and determined thatwe are not the primary beneficiary for any of our investments. Entities whichwe do not control and entities which are VIE’s, but where we are not theprimary beneficiary, are accounted for under the equity method. Wheninvestments are made through a TIC structure, we report our pro rata share ofthe assets, liabilities, revenues, and expenses of the investment in ourfinancial statements. All significant intercompany balances and transactionshave been eliminated.

83

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**Gramercy Capital Corp. Notes To Consolidated Financial Statements (Continued) (Amounts in thousands, except share and per share data) December 31, 2006**

**Cash and CashEquivalents**

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

**Restricted Cash**

Restricted cash at December 31,2006 consists primarily of $322,167 on deposit with the trustee of ourcollateralized debt obligations, or CDOs, a portion of which representsproceeds from our second CDO issuance that will be used to fund futureinvestments that will be acquired by the CDO trust. Also included are theproceeds of repayments from loans serving as collateral in our CDOs, which willbe used to fund investments to replace those trust assets which are repaid orsold by the trust, interest payments received by the trustee on investmentsthat serve as collateral for our CDOs, which are remitted to us on a quarterlybasis in the month following the end of our fiscal quarter, and future fundingobligations on certain investments. The remaining balance consists of interestreserves held on behalf of borrowers and $18,201 representing our proportionateshare of the reserves of 55 Corporate Drive.

**Loans andInvestments and Loans Held for Sale**

Loans held for investment are intended to be held tomaturity and, accordingly, are carried at cost, net of unamortized loanorigination fees, discounts, repayments, sales of partial interests in loans,and unfunded commitments unless such loan or investment is deemed to beimpaired. Loans held for sale are carried at the lower of cost or market valueusing available market information obtained through consultation with dealersor other originators of such investments. We may originate or acquire preferredequity interests that allow us to participate in a percentage of the underlyingproperty’s cash flows from operations and proceeds from a sale or refinancing.Should we make such a preferred equity investment, we must determine whetherthat investment should be accounted for as a loan, joint venture or as aninterest in real estate.

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

If upon completion of the valuation, the fair value ofthe underlying collateral securing the impaired loan is less than the netcarrying value of the loan, an allowance is created with a corresponding chargeto the provision for loan losses. The allowance for each loan is maintained ata level we believe is adequate to absorb probable losses. We maintained areserve of $2,460 and $1,030 at December 31, 2006 and December 31,2005, respectively.

Our Manager evaluates ourassets on a regular basis to determine if they continue to satisfy ourinvestment criteria. Subject to certain restrictions, our Manager may cause usto sell our investments 

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**Gramercy Capital Corp. Notes To Consolidated Financial Statements (Continued) (Amounts in thousands, except share and per share data) December 31, 2006**

opportunisticallyand use the proceeds of any such sale for debt reduction, additionalacquisitions or working capital purposes.

**Classifications ofMortgage-Backed Securities**

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

**Valuations ofMortgage-Backed Securities**

All MBS are carried on the balance sheet at fairvalue. We determine the fair value of MBS based on the types of securities inwhich we have invested. For liquid, investment-grade securities, we consultwith dealers of such securities to periodically obtain updated market pricingfor the same or similar instruments. For non-investment grade securities, weactively monitor the performance of the underlying properties and loans andupdate our pricing model to reflect changes in projected cash flows. The valueof the securities is derived by applying discount rates to such cash flowsbased on current market yields. The yields employed are obtained from our ownexperience in the market, advice from dealers and/or information obtained inconsultation with other investors in similar instruments. Because fair valueestimates may vary to some degree, we must make certain judgments andassumptions about the appropriate price to use to calculate the fair values forfinancial reporting purposes. Different judgments and assumptions could resultin different presentations of value.

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

**Credit Tenant LeaseInvestments**

Consolidated CTL investments are recorded at cost lessaccumulated depreciation. Costs directly related to the acquisition of suchinvestments are capitalized. Certain improvements are capitalized when they aredetermined to increase the useful life of the building. Capitalized items aredepreciated using the straight-line method over the shorter of the useful livesof the capitalized item or 40 years for buildings or facilities, the remaininglife of the facility for facility improvements, four to seven years forpersonal property and equipment, and the shorter of the remaining lease term orthe expected life for tenant improvements.

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**Gramercy Capital Corp. Notes To Consolidated Financial Statements (Continued) (Amounts in thousands, except share and per share data) December 31, 2006**

Consolidated depreciation expense for the years ended December 31,2006 and 2005 were $614 and $324, respectively. We did not have anyconsolidated CTL investments during the period from April 12, 2004(formation) through December 31, 2004.

Results of operations of properties acquired areincluded in the Statement of Income from the date of acquisition.

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

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

**Investments inUnconsolidated Joint Ventures**

We account for ourinvestments in unconsolidated joint ventures under the equity method ofaccounting since we exercise significant influence, but do not unilaterallycontrol, the entities and are not considered to be the primary beneficiaryunder FIN 46. In the joint ventures, the rights of the other investor areprotective and participating. Unless we are determined to be the primarybeneficiary, these rights preclude us from consolidating the investments. Theinvestments are recorded initially at cost as an investment in unconsolidatedjoint ventures, and subsequently are adjusted for equity in net income (loss) andcash contributions and distributions. Any difference between the carryingamount of the investments on our balance sheet and the underlying equity in netassets is amortized as an adjustment to equity in net income (loss) ofunconsolidated joint ventures over the lesser of the joint venture term or 40years. None of the joint venture debt is recourse to us. As of December 31,2006 and 2005, we had investments of $57,567 and $58,040 in unconsolidatedjoint ventures, respectively.

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**Gramercy Capital Corp. Notes To Consolidated Financial Statements (Continued) (Amounts in thousands, except share and per share data) December 31, 2006**

**Revenue Recognition**

Interest income on debt investments is recognized overthe life of the investment using the effective interest method and recognizedon the accrual basis. Fees received in connection with loan commitments aredeferred until the loan is funded and are then recognized over the term of theloan using the effective interest method. Anticipated exit fees, whosecollection is expected, are also recognized over the term of the loan as anadjustment to yield. Fees on commitments that expire unused are recognized atexpiration. Fees received in exchange for the credit enhancement of anotherlender, either subordinate or senior to us, in the form of a guarantee arerecognized over the term of that guarantee using the straight-line method.

Income recognition is generally suspended for debtinvestments at the earlier of the date at which payments become 90 days pastdue or when, in our opinion, a full recovery of income and principal becomesdoubtful. Income recognition is resumed when the loan becomes contractuallycurrent and performance is demonstrated to be resumed.

In some instances we may sell all or a portion of ourinvestments to a third party. To the extent the fair value received for aninvestment exceeds the amortized cost of that investment and FASB Statement No. 140,or SFAS 140, “Accounting for Transfers and Servicing of Financial Assets andExtinguishments of Liabilities,” criteria is met, under which control of theasset that is sold is surrendered making it a “true sale,” a gain on the salewill be recorded through earnings as other income. To the extent an investmentthat is sold has a discount or fees, which were deferred at the time theinvestment was made and were being recognized over the term of the investment,the unamortized portion of the discount or fees are recognized at the time ofsale and recorded as a gain on the sale of the investment through other income.For the years ended December 31, 2006 and 2005, we recognized $5,349 and$10,474 in net gains from the sale of debt investments or commitments. We didnot recognize any such gains for the period from April 12, 2004(formation) through December 31, 2004.

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

In addition to base rent,the tenants in our CTL investments also pay all operating costs of ownedproperty including real estate taxes.

**Reserve forPossible Loan Losses**

The expense for possibleloan losses in connection with debt investments is the charge to earnings toincrease the allowance for possible loan losses to the level that managementestimates to be adequate considering delinquencies, loss experience andcollateral quality. Other factors considered relate to geographic trends andproject diversification, the size of the portfolio and current economicconditions. Based upon these factors, we may establish the provision forpossible loan losses by individual asset or category of asset. When it is probablethat we will be unable to collect all amounts contractually due, the account isconsidered impaired.

Where impairment isindicated, a valuation write-down or write-off is measured based upon theexcess of the recorded investment amount over the net fair value of thecollateral, as reduced by selling costs. Any 

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**Gramercy Capital Corp. Notes To Consolidated Financial Statements (Continued) (Amounts in thousands, except share and per share data) December 31, 2006**

deficiencybetween the carrying amount of an asset and the net sales price of foreclosedcollateral is charged to the allowance for loan losses. We maintained a reservefor possible loan losses of $2,460 against investments with a carrying value of$131,427 as of December 31, 2006, and a reserve for possible loan lossesof $1,030 against investments with a carrying value of $68,293 as of December 31,2005.

**Deferred Costs**

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

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

**Deferred Financing Costs**

Deferred financing costsrepresent commitment fees, legal and other third party costs associated withobtaining commitments for financing which result in a closing of suchfinancing. These costs are amortized over the terms of the respectiveagreements and the amortization is reflected in interest expense. Unamortizeddeferred financing costs are expensed when the associated debt is refinanced orrepaid before maturity. Costs incurred in seeking financing transactions, whichdo not close, are expensed in the period in which it is determined that thefinancing will not close.

**Stock Based Compensation Plans**

We have a stock-basedcompensation plan, described more fully in Note 14. We account for this planusing the fair value recognition provisions of FASB Statement 123(R), “Share-BasedPayment, a revision of FASB Statement No. 123, Accounting for Stock-BasedCompensation.”

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

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

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

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**Gramercy Capital Corp. Notes To Consolidated Financial Statements (Continued) (Amounts in thousands, except share and per share data) December 31, 2006**

 

| ** **                       | ** ** | **2006**  | ** ** | **2005**  | ** ** |
|----------------------------------|------------|-----------|------------|-----------|------------|
| Dividend yield                   |       | 8.0       | %          | 8.4       | %          |
| Expected life of  option         |       | 6.7 years |       | 6.9 years |       |
| Risk-free  interest rate         |       | 4.14      | %          | 4.16      | %          |
| Expected stock price  volatility |       | 21.0      | %          | 19.1      | %          |

 

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

The Class B limitedpartner interests are entitled to receive an incentive return equal to 25% ofthe amount by which funds from operations, or FFO plus certain accounting gains(as defined in the partnership agreement of our Operating Partnership which wasamended and restated in April 2006) exceed the product of our weightedaverage stockholders equity (as defined in the amended and restated partnershipagreement of our Operating Partnership) multiplied by 9.5% (divided by 4 toadjust for quarterly calculations). We will record any distributions on the Class Blimited partner interests as an incentive distribution expense in the periodwhen earned and when payment of such amounts has become probable and reasonablyestimable in accordance with the partnership agreement. These cashdistributions will reduce the amount of cash available for distribution to ourcommon unitholders in our Operating Partnership and to common stockholders. Weincurred approximately $7,609 and $2,276 with respect to such Class Blimited partner interests for the years ended December 31, 2006 and 2005,respectively. We did not recognize such an expense for the period from April 12,2004 (formation) through December 31, 2004.

**Derivative Instruments**

In the normal course ofbusiness, we use a variety of derivative instruments to manage, or hedge,interest rate risk. We require that hedging derivative instruments be effectivein reducing the interest rate risk exposure that they are designated to hedge.This effectiveness is essential for qualifying for hedge accounting. Somederivative instruments are associated with an anticipated transaction. In thosecases, hedge effectiveness criteria also require that it be probable that theunderlying transaction occurs. Instruments that meet these hedging criteria areformally designated as hedges at the inception of the derivative contract.

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

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**Gramercy Capital Corp. Notes To Consolidated Financial Statements (Amounts in thousands, except share and per share data) December 31, 2006**

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

We use a variety of commonlyused derivative products that are considered plain vanilla derivatives. Thesederivatives typically include interest rate swaps, caps, collars and floors. Wealso use total rate of return swaps, or TROR swaps, which are tied to theLehman Brothers CMBS index. We expressly prohibit the use of unconventionalderivative instruments and using derivative instruments for trading orspeculative purposes. Further, we have a policy of only entering into contractswith major financial institutions based upon their credit ratings and otherfactors.

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

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

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

**Income Taxes**

We elected to be taxed asa REIT, under Sections 856 through 860 of the Internal Revenue Code, beginningwith our taxable year ending December 31, 2004. To qualify as a REIT, wemust meet certain organizational and operational requirements, including arequirement to distribute at least 90% of our ordinary taxable income tostockholders. As a REIT, we generally will not be subject to federal income taxon taxable income that we distribute to our stockholders. If we fail to qualifyas a REIT in any taxable year, we will then be subject to federal income taxeson our taxable income at regular corporate rates and we will not be permittedto qualify for treatment as a REIT for federal income tax purposes for fouryears following the year during which qualification is lost unless the InternalRevenue Service grants us relief 

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**Gramercy Capital Corp. Notes To Consolidated Financial Statements (Amounts in thousands, except share and per share data) December 31, 2006**

undercertain statutory provisions. Such an event could materially adversely affectour net income and net cash available for distributions to stockholders. However,we believe that we will be organized and operate in such a manner as to qualifyfor treatment as a REIT and we intend to operate in the foreseeable future insuch a manner so that we will qualify as a REIT for federal income tax purposes.We may, however, be subject to certain state and local taxes.

Our TRSs are subject tofederal, state and local taxes.

**Underwriting Commissions and Costs**

Underwriting commissionsand costs incurred in connection with our stock offerings are reflected as areduction of additional paid-in-capital.

**Formation Costs**

Costs incurred to organizeGramercy in 2004 were expensed as incurred.

**Earnings Per Share**

We present both basic anddiluted earnings per share, or EPS. Basic EPS excludes dilution and is computedby dividing net income available to common stockholders by the weighted averagenumber of common shares outstanding during the period. Diluted EPS reflects thepotential dilution that could occur if securities or other contracts to issuecommon stock were exercised or converted into common stock, where such exerciseor conversion would result in a lower EPS amount.

**Use of Estimates**

The preparation offinancial statements in conformity with GAAP requires management to makeestimates and assumptions that affect the amounts reported in the financialstatements and accompanying notes. Actual results could differ from thoseestimates.

**Concentrations of Credit Risk**

Financial instruments thatpotentially subject us to concentrations of credit risk consist primarily ofcash investments, debt investments and accounts receivable. Gramercy places itscash investments in excess of insured amounts with high quality financial institutions.Our Manager performs ongoing analysis of credit risk concentrations in our debtinvestment portfolio by evaluating exposure to various markets, underlyingproperty types, investment structure, term, sponsors, tenants and other creditmetrics. Four investments accounted for more than 21% of the total carryingvalue of our debt investments as of December 31, 2006 and 20% of the totalcarrying value of our debt investments as of December 31, 2005. Sixinvestments accounted for approximately 22% of the revenue earned on our debtinvestments for the year ended December 31, 2006, compared to threeinvestments which accounted for approximately 25% of 

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**Gramercy Capital Corp. Notes To Consolidated Financial Statements (Amounts in thousands, except share and per share data) December 31, 2006**

therevenue earned on our debt investments for the year ended December 31,2005 and two investments which accounted for approximately 58% of the revenueearned on our debt investments for the period from April 12, 2004(formation) through December 31, 2004.

**Recently Issued Accounting Pronouncements**

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

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

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

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**Gramercy Capital Corp. Notes To Consolidated Financial Statements (Amounts in thousands, except share and per share data) December 31, 2006**

In July 2006, theFASB issued Interpretation No. 48, or FIN 48, “Accounting for Uncertaintyin Income Taxes.” This interpretation, among other things, creates a two-stepapproach for evaluating uncertain tax positions. Recognition (step one) occurswhen an enterprise concludes that a tax position, based solely on its technicalmerits, is more-likely-than-not to be sustained upon examination. Measurement(step two) determines the amount of benefit that more-likely-than-not will berealized upon settlement. Derecognition of a tax position that was previouslyrecognized would occur when a company subsequently determines that a taxposition no longer meets the more-likely-than-not threshold of being sustained.FIN 48 specifically prohibits the use of a valuation allowance as a substitutefor derecognition of tax positions, and it has expanded disclosure requirements.FIN 48 is effective for fiscal years beginning after December 15, 2006, inwhich the impact of adoption should be accounted for as a cumulative-effectadjustment to the beginning balance of retained earnings. We are currently evaluatingthe effect, if any, that this pronouncement will have on our future financialposition or results of operations.

In September 2006,the FASB issued Statement No. 157, Fair Value Measurements, or SFAS No. 157.SFAS No. 157 provides guidance for using fair value to measure assets andliabilities. This statement clarifies the principle that fair value should bebased on the assumptions that market participants would use when pricing theasset or liability. SFAS No. 157 establishes a fair value hierarchy,giving the highest priority to quoted prices in active markets and the lowestpriority to unobservable data. SFAS No. 157 applies whenever otherstandards require assets or liabilities to be measured at fair value. Thisstatement is effective in fiscal years beginning after November 15, 2007.We believe that the adoption of this standard on January 1, 2008 will nothave a material effect on our financial position or results of operations.

In September 2006,the Securities and Exchange Commission issued Staff Accounting Bulletin No. 108,or SAB 108, which becomes effective beginning on January 1, 2007. SAB 108provides guidance on the consideration of the effects of prior periodmisstatements in quantifying current year misstatements for the purpose of a materialityassessment. SAB 108 provides for the quantification of the impact of correctingall misstatements, including both the carryover and reversing effects of prioryear misstatements, on the current year financial statements. If a misstatementis material to the current year financial statements, the prior year financialstatements should also be corrected, even though such revision was, andcontinues to be, immaterial to the prior year financial statements. Correctingprior year financial statements for immaterial errors would not requirepreviously filed reports to be amended. Such correction should be made in thecurrent period filings. We believe that the adoption of this standard will nothave a material effect on our financial position or results of operations.

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**Gramercy Capital Corp. Notes To Consolidated Financial Statements (Amounts in thousands, except share and per share data) December 31, 2006**

**3.   Loansand Other Lending Investments**

Theaggregate carrying values, allocated by product type and weighted averagecoupons of our loans and other lending investments as of December 31, 2006and December 31, 2005 were as follows: 

| ** **                                           | ** ** | **Carrying Value(1)  ($ in thousands)** | ** ** | **Allocation by  Investment Type** | ** ** | **Fixed Rate:  Average Yield** | ** ** | **Floating Rate:  Average Spread over LIBOR(2)** | ** ** |
|------------------------------------------------------|------------|--------------------------------------------------------|------------|----------------------------------------------|------------|------------------------------------------|------------|----------------------------------------------------------------------|------------|
| ** **                                           | ** ** | **2006**                                               | ** ** | **2005**                                     | ** ** | **2006**                                 | ** ** | **2005**                                                             | ** ** | **2006** | ** ** | **2005** | ** ** | **2006** | ** ** | **2005** | ** ** |
| Whole loans,  floating rate                          |       | $                                                      | 1,372,316  |                                         | $          | 561,388                                  |       |                                                                 | 63         | % |   |   | 46 | % |   | — |   | — |   | 327 bps |   | 325 bps |   |
| Whole loans,  fixed rate                             |       | 42,376                                                 |       | 94,448                                       |       |                                     | 2          | %                                                                    |       |   | 8 | % |   | 11.69 | % | 10.67 | % | — |   | — |   |
| Subordinate  interests in whole loans, floating rate |       | 236,308                                                |       | 362,983                                      |       |                                     | 11         | %                                                                    |       |   | 30 | % |   | — |   | — |   | 445 bps |   | 443 bps |   |
| Subordinate  interests in whole loans, fixed rate    |       | 48,769                                                 |       | 37,104                                       |       |                                     | 2          | %                                                                    |       |   | 3 | % |   | 8.54 | % | 8.80 | % | — |   | — |   |
| Mezzanine loans, floating rate                       |       | 226,675                                                |       | 82,793                                       |       |                                     | 10         | %                                                                    |       |   | 7 | % |   | — |   | — |   | 665 bps |   | 858 bps |   |
| Mezzanine loans,  fixed rate                         |       | 216,216                                                |       | 43,352                                       |       |                                     | 10         | %                                                                    |       |   | 4 | % |   | 9.92 | % | 8.51 | % | — |   | — |   |
| Preferred equity, floating rate                      |       | —                                                 |       | 11,795                                       |       |                                     | —     |                                                                 |       |   | 1 | % |   | — |   | — |   | 900 bps |   | 900 bps |   |
| Preferred equity,  fixed rate                        |       | 44,224                                                 |       | 11,882                                       |       |                                     | 2          | %                                                                    |       |   | 1 | % |   | 10.68 | % | 10.27 | % | — |   | — |   |
| Total / Weighted  average                            |       | $                                                      | 2,186,884  |                                         | $          | 1,205,745                                |       |                                                                 | 100        | % |   |   | 100 | % |   | 10.04 | % | 9.78 | % | 384 bps |   | 417 bps |   |

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

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

The carrying value of ourloans and other lending investments is net of unamortized fees and discounts of$35,500 and $13,336 at December 31, 2006 and 2005, respectively, andunfunded commitments of $289,153 and $107,281 at December 31, 2006 and2005, respectively.

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

| **Year of Maturity** | ** ** | ** ** | ** ** | **Number of  Investments  Maturing** | ** ** | **Current  Carrying Value  (In thousands)** | ** ** | **% of Total** | ** ** |
|--------------------------------|------------|------------|------------|-------------------------------------------|------------|-------------------------------------------------------|------------|--------------------------|------------|
| 2007                           |       |       | 26         |                                      |       |                                                  | $          | 608,009                  |       |   |   | 28 | % |   |
| 2008                           |       |       | 23         |                                      |       |                                                  | 990,814    |                     |       |   | 45 | % |   |
| 2009                           |       |       | 16         |                                      |       |                                                  | 337,856    |                     |       |   | 15 | % |   |
| 2010                           |       |       | 2          |                                      |       |                                                  | 6,638      |                     |       |   | — |   |   |
| 2011                           |       |       | 2          |                                      |       |                                                  | 56,920     |                     |       |   | 3 | % |   |
| Thereafter                     |       |       | 7          |                                      |       |                                                  | 186,647    |                     |       |   | 9 | % |   |
| Total                          |       |       | 76         |                                      |       |                                                  | $          | 2,186,884                |       |   |   | 100 | % |   |
| Weighted average  maturity(1)  |       |       |       |                                      |       |                                                  | 2.1 years  |                     |       |   |   |   |   |

 

94

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**Gramercy Capital Corp. Notes To Consolidated Financial Statements (Amounts in thousands, except share and per share data) December 31, 2006**

----

(1)          The calculation ofweighted average maturity is based upon the initial term of the investment anddoes not include option or extension periods or the ability to prepay theinvestment after a negotiated lock-out period, which may be available to theborrower.

Forthe years ended December 31, 2006 and 2005 and the period from April 12,2004 (formation) through December 31, 2004 the Company’s investment incomefrom debt investments was generated by the following investment types:

| ** **                            | ** ** | **For the Year Ended  December 31, 2006** | ** ** | **For the Year Ended  December 31, 2005** | ** ** | **For the Period From  April 12, 2004  (formation) through  December 31, 2004** | ** ** |
|---------------------------------------|------------|--------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------|------------|
| **Investment Type**              | ** ** | ** **                                                         | ** ** | **Investment  Income**                                             | ** ** | **% of  Total**                                                                                                    | ** ** | **Investment  Income** | ** ** | **% of  Total** | ** ** | **Investment  Income** | ** ** | **% of  Total** | ** ** |
| Whole loans                           |       |                                                               | $          | 107,074                                                            |       |                                                                                                                    |       | 60 | % |   |   | $ | 30,331 |   |   |   | 41 | % |   |   | $ | 782 |   |   |   | 11 | % |   |
| Subordinate  interests in whole loans |       |                                                               | 42,506     |                                                               |       |                                                                                                                    | 24         | % |   |   | 29,630 |   |   |   | 41 | % |   |   | 5,499 |   |   |   | 80 | % |   |
| Mezzanine loans                       |       |                                                               | 22,353     |                                                               |       |                                                                                                                    | 13         | % |   |   | 10,356 |   |   |   | 14 | % |   |   | — |   |   |   | — |   |   |
| Preferred equity                      |       |                                                               | 4,488      |                                                               |       |                                                                                                                    | 3          | % |   |   | 1,574 |   |   |   | 2 | % |   |   | — |   |   |   | — |   |   |
| CMBS                                  |       |                                                               | —     |                                                               |       |                                                                                                                    | —     |   |   |   | 1,411 |   |   |   | 2 | % |   |   | 560 |   |   |   | 9 | % |   |
| Total                                 |       |                                                               | $          | 176,421                                                            |       |                                                                                                                    |       | 100 | % |   |   | $ | 73,302 |   |   |   | 100 | % |   |   | $ | 6,841 |   |   |   | 100 | % |   |
|                                       |            |                                                                    |            |                                                                    |            |                                                                                                                         |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

At December 31,2006 and December 31, 2005, our debt investment portfolio had thefollowing geographic diversification:

| ** ** | ** ** | **2006**   | ** ** | **2005**            | ** ** |
|------------|------------|------------|------------|---------------------|------------|
| **Region** | ** ** | ** ** | ** ** | **Carrying  Value** | ** ** | **% of  Total** | ** ** | **Carrying  Value** | ** ** | **% of  Total** | ** ** |
| Northeast  |       | $          | 1,169,790  |                |       | 53 | % |   | $ | 464,054 |   |   | 39 | % |   |
| West       |       | 579,568    |       |                | 27         | % |   | 378,040 |   |   | 31 | % |   |
| South      |       | 310,909    |       |                | 14         | % |   | 258,511 |   |   | 21 | % |   |
| Midwest    |       | 41,894     |       |                | 2          | % |   | 74,949 |   |   | 6 | % |   |
| Various    |       | 84,723     |       |                | 4          | % |   | 30,191 |   |   | 3 | % |   |
| Total      |       | $          | 2,186,884  |                |       | 100 | % |   | $ | 1,205,745 |   |   | 100 | % |   |
|            |            |            |            |                     |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

For the year ended December 31, 2006, werecognized $5,349 in gains from the sale or syndication of debt investmentstotaling $173,391, of which $313 represents the recognition of unamortizeddiscounts or fees at the time of sale. For the year ended December 31,2005, we recognized $10,474 in gains from the sale or syndication of debtinvestments totaling $182,035, of which $1,849 represented the recognition ofunamortized discounts or fees at the time of sale.

We maintained a reserve for possible loan losses of$2,460 against investments with a carrying value of $131,427 as of December 31,2006, and a reserve for possible loan losses of $1,030 against investments witha carrying value of $68,293 as of December 31, 2005, respectively. Duringthe year ended December 31, 2006, we recorded additional reserves for loanlosses of $1,930 through our results of operations, offset by a reversal of$500, which had been reserved against an investment that repaid in full. For theperiod during 

95

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**Gramercy Capital Corp. Notes To Consolidated Financial Statements (Amounts in thousands, except share and per share data) December 31, 2006**

which a reserve wascarried, these investments generated interest income of $9,377 and $2,413 in2006 and 2005, respectively, and income recognition remained current. We didnot maintain a reserve during 2004.

In connection with apreferred equity investment, which was repaid in October 2006, we haveguaranteed a portion of the outstanding principal balance of the first mortgageloan that is a financial obligation of the entity in which we have invested inthe event of a borrower default under such loan. The loan matures in 2032. Thisguarantee is considered to be an off-balance-sheet arrangement and will surviveuntil the repayment of the first mortgage loan. As compensation, we received acredit enhancement fee of $125 from the borrower, which is recognized as thefair value of the guarantee and has been recorded on our balance sheet as aliability. The liability will be amortized over the life of the guarantee usingthe straight-line method and corresponding fee income will be recorded. Ourmaximum exposure under this guarantee is approximately $1,441 as of December 31,2006. Under the terms of the guarantee, the investment sponsor is required toreimburse us for the entire amount paid under the guarantee until the guaranteeexpires.

**4.   PropertyAcquisitions**

*55 Corporate Drive*

On June 7, 2006 we closed on the acquisition of a49.75% TIC interest in 55 Corporate Drive, located in Bridgewater, New Jersey,with a 0.25% interest to be acquired in the future. The property is comprisedof three buildings totaling 670,000 square feet which is 100% net leased to anentity whose obligations are guaranteed by Sanofi-Aventis Group through April 2023.The transaction was valued at $236,000 and was financed with a $190,000, 10-year,fixed rate first mortgage loan. The remaining 50% of the property is owned as aTIC interest by an affiliate of SL Green.  Upon closing the acquisition of the property,the $90,000 whole loan previously held by us was repaid in full using proceedsfrom the new mortgage financing. Following its acquisition, all income andexpenses at this property were capitalized and were not recognized in ourresults from operations as the property was being redeveloped. The property isaccounted for as an operating property beginning in the three months ended December 31,2006.

Thefollowing is a schedule of our proportionate share of future minimum rentpayments to be received under the lease at 55 Corporate Drive:

| ** ** | ** ** | **Rent Payments** | ** ** |
|------------|------------|------------------------|------------|
| 2007       |       |                   | $          | 2,428 |   |   |
| 2008       |       |                   | 6,140      |   |   |
| 2009       |       |                   | 7,996      |   |   |
| 2010       |       |                   | 7,996      |   |   |
| 2011       |       |                   | 8,107      |   |   |
| Thereafter |       |                   | 100,925    |   |   |
|       |       |                   | $          | 133,592 |   |   |

 

96

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**Gramercy Capital Corp. Notes To Consolidated Financial Statements (Amounts in thousands, except share and per share data) December 31, 2006**

**5.   Dispositionof Security Interests in Property**

*200 Franklin Square Drive*

On September 6, 2005,we closed on the acquisition of a 100% fee interest in 200 Franklin SquareDrive, located in Somerset, New Jersey. The property is a 200,000 square footbuilding which is 100% net leased to Philips Holding USA Inc., a wholly-ownedsubsidiary of Royal Philips Electronics, through December 2021. Theproperty was acquired for a purchase price of $50,250, excluding closing costs,and financed with a $41,000, 10-year, fixed-rate first mortgage loan.

On March 31, 2006,following the conversion of the entity that owns 200 Franklin Square Drive intoa Delaware statutory trust, or DST, we sold approximately 29.3% of our securityinterests in the DST to a third party. Subsequently, we sold an additional45.7% of our security interests in the DST to the same party, reducing ourfinal ownership interest to 25.0%. We received total cash consideration of$12,800 for these interests and the buyer assumed 75% of the DST’s underlyingmortgage debt. The disposition resulted in a net gain of $4,530, aftertransaction costs. As a result of the disposition, this investment is nowclassified as an investment in joint venture and accounted for using the equitymethod. As of December 31, 2006, the investment has a carrying value of$2,519. We recorded our pro rata share of net income of the joint venture of$109 for the year ended December 31, 2006.

**6.   Investmentsin Unconsolidated Joint Ventures**

*South Building at One Madison Avenue, New York, NewYork*

On April 29, 2005, weclosed on a $57,503 initial investment in a joint venture with SL Green toacquire, own and operate the South Building located at One Madison Avenue, NewYork, New York, or the South Building. The joint venture is owned 45% by awholly-owned subsidiary and 55% by a wholly-owned subsidiary of SL Green. Thejoint venture interests are *pari passu*.Also on April 29, 2005, the joint venture completed the acquisition of theSouth Building from Metropolitan Life Insurance Company for the purchase priceof approximately $802,800 plus closing costs, financed in part through a$690,000 first mortgage loan on the South Building. The first mortgage isnon-recourse to us. The South Building comprises approximately 1.2 millionsquare feet and is almost entirely net leased to Credit Suisse Securities (USA)LLC, or CS, pursuant to a lease with a 15-year remaining term. As of December 31,2006 the investment has a carrying value of $55,168. We recorded our pro ratashare of net losses of the joint venture of $1,728 and $1,358 for the yearsended December 31, 2006 and 2005, respectively.

*101 S. Marengo Avenue, Pasadena, California*

On November 29, 2005,we closed on the purchase of a 50% interest in an office building in Pasadena,CA. We also acquired an interest in certain related assets as part of thetransaction. The 345,000 square foot office property, which is net leased toBank of America through September 2015, assuming the exercise of options,and related collateral were acquired for $52,000 plus closing costs, using anon-recourse, $50,000, 10-year fixed-rate first mortgage loan. For theyears ended December 31, 2006 and 2005, we recorded our pro rata share ofnet losses of the joint ventures of $1,341 and $131, respectively.

97

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**Gramercy Capital Corp. Notes To Consolidated Financial Statements (Amounts in thousands, except share and per share data) December 31, 2006**

**7.   JuniorSubordinated Debentures**

On January 27, 2006,we completed a third issuance of $50,000 in unsecured trust preferredsecurities through a separate newly formed DST, Gramercy Capital Trust III, orGCTIII, that is a wholly-owned subsidiary of our Operating Partnership. Thesecurities bear interest at a fixed rate of 7.65% for the first ten yearsending January 2016, with an effective rate of 7.43% when giving effect tothe swap arrangement previously entered into in contemplation of this financing.Thereafter, the interest rate will float based on the three-month LIBOR plus270 basis points.

In May and August 2005,we completed issuances of $50,000 each in unsecured trust preferred securitiesthrough two DSTs, Gramercy Capital Trust I, or GCTI, and Gramercy Capital TrustII, or GCTII, that are also wholly-owned subsidiaries of our OperatingPartnership. The securities issued in May 2005 bear interest at a fixedrate of 7.57% for the first ten years ending June 2015 and the securitiesissued in August 2005 bear interest at a fixed rate of 7.75% for the firstten years ending October 2015. Thereafter the rates will float based onthe three-month LIBOR plus 300 basis points.

All issuances of trustpreferred securities require quarterly interest distributions; however, paymentsmay be deferred while the interest expense is accrued for a period of up tofour consecutive quarters if our Operating Partnership exercises its right todefer such payments. The trust preferred securities are redeemable, at theoption of our Operating Partnership, in whole or in part, with no prepaymentpremium any time after June 30, 2010, October 30, 2010 or January 30,2011 for the securities issued by GCTI, GCTII and GCTIII, respectively.

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

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

**8. Collateralized Debt Obligations**

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

98

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**Gramercy Capital Corp. Notes To Consolidated Financial Statements (Continued) (Amounts in thousands, except share and per share data) December 31, 2006**

On August 24, 2006, we issued an additionalapproximately $1,000,000 of CDOs through two newly-formed indirectsubsidiaries, Gramercy Real Estate CDO 2006-1 Ltd., or the 2006Issuer, and Gramercy Real Estate CDO 2006-1 LLC, or the 2006 Co-Issuer.The CDO consists of $903,750 of investment grade notes, $38,750 ofnon-investment grade notes, which were co-issued by the 2006 Issuer and the2006 Co-Issuer, and $57,500 of preferred shares, which were issued by the 2006Issuer. The investment grade notes were issued with floating rate coupons witha combined weighted average rate of three-month LIBOR plus 0.37%. We incurredapproximately $11,273 of costs related to Gramercy Real Estate CDO 2006-1,which are amortized on a level yield basis over the average life of the CDO.

We retained allnon-investment grade securities, the preferred shares and the common shares inthe Issuer of each CDO. The Issuer in each CDO holds assets, consistingprimarily of whole loans, subordinate interests in whole loans, mezzanine loansand preferred equity investments, which serve as collateral for the CDO. EachCDO may be replenished, pursuant to certain rating agency guidelines relatingto credit quality and diversification, with substitute collateral for loansthat are repaid during the first five years of the CDO. Thereafter, the CDOsecurities will be retired in sequential order from senior-most to junior-mostas loans are repaid. The financial statements of the Issuer of each CDO areconsolidated in our financial statements. The investment grade notes aretreated as a secured financing, and are non-recourse to us. Proceeds from thesale of the investment grade notes issued in each CDO were used to repaysubstantially all outstanding debt under our repurchase agreements and to fundadditional investments.

**9.  Debt Obligations**

**RepurchaseFacilities**

We have two repurchase facilities, one with WachoviaCapital Markets, LLC or one or more of its affiliates, or Wachovia, and onewith Goldman Sachs Mortgage Company, or Goldman.

The repurchase facility with Wachovia is a $500,000facility. This facility was initially established as a $250,000 facility, wasincreased to $350,000 from $250,000 effective January 3, 2005, and wassubsequently increased to $500,000 effective April 22, 2005. On March 21,2006, we further modified the facility by reducing the interest spreads. As aresult of the modifications, the $500,000 facility bears interest at spreads of1.00% to 2.50% over one-month LIBOR and, based on our expected investmentactivities, provides for advance rates that vary from 60% to 100% based uponthe collateral provided under a borrowing base calculation. On October 13,2006, we extended the facility’s maturity date until October 2009. Thelender has a consent right with respect to the inclusion of investments in thisfacility, determines periodically the market value of the investments, and hasthe right to require additional collateral if the estimated market value of theincluded investments declines. We had no accrued interest and borrowings of$151,403 at a weighted average spread to LIBOR of 1.86% as of December 31,2006, and no accrued interest and borrowings of $67,717 at a weighted averagespread to LIBOR of 1.50%, as of December 31, 2005.

99

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**Gramercy Capital Corp. Notes To Consolidated Financial Statements (Continued) (Amounts in thousands, except share and per share data) December 31, 2006**

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

| ** **                            | ** ** | **Carrying Value(1)** | ** ** |
|---------------------------------------|------------|----------------------------|------------|
| **Investment Type**              | ** ** | ** **                 | ** ** | **2006** | ** ** | **2005** | ** ** |
| Whole loans                           |       | $                          | 117,328    |   | $ | 33,223 |   |
| Subordinate  interests in whole loans |       | —                     |       | 74,689 |   |
| Mezzanine loans                       |       | 139,680                    |       | — |   |
| Preferred equity                      |       | 14,955                     |       | — |   |
| CDO securities(2)                     |       | —                     |       | 49,500 |   |
| Total                                 |       | $                          | 271,963    |   | $ | 157,412 |   |
|                                       |            |                            |            |  |  |  |  |  |  |

 

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(1)         Approximates fair value.

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

We also have a repurchase facility with Goldman. On October 13,2006 we increased this facility from $200,000 to $400,000 and extended itsmaturity date until September 2009. On March 21, 2006, we modifiedthe pricing on this facility by reducing the interest spreads. As a result ofthe modifications, the facility bears interest at spreads of 1.00% to 2.25%over one-month LIBOR and, based on our expected investment activities, providesfor advance rates that vary from 40% to 85% based upon the collateral providedunder a borrowing base calculation. As with the Wachovia facility, the lenderhas a consent right to the inclusion of investments in this facility,determines periodically the market value of the investments, and has the rightto require additional collateral if the estimated market value of the includedinvestments declines. We had accrued interest of $261 and borrowings of$126,009 at a weighted average spread to LIBOR of 1.51% as of December 31,2006, and accrued interest of $163 and borrowings of $49,649 at a weightedaverage spread to LIBOR of 1.71% under this facility at December 31, 2005.

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

| ** **               | ** ** | **Carrying Value(1)** | ** ** |
|--------------------------|------------|----------------------------|------------|
| **Investment Type** | ** ** | ** **                 | ** ** | **2006** | ** ** | **2005** | ** ** |
| Whole loans              |       | $                          | 97,795     |   | $ | 59,457 |   |
| Mezzanine loans          |       | 71,798                     |       | — |   |
| Total                    |       | $                          | 169,593    |   | $ | 157,412 |   |
|                          |            |                            |            |  |  |  |  |  |  |

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(1)         Approximates fair value.

The terms of our repurchase facilities (together withany related guarantees) include covenants that****(a) limit our maximum total indebtedness to no more than 85% oftotal assets under the Wachovia facility or a debt to equity ratio less than orequal to 5:1 under the Goldman facility, (b) require us to maintainminimum liquidity of at least $10,000 for the first two years and $15,000thereafter under the Goldman facility, and at least $15,000 under the Wachoviafacility, (c) require our fixed charge coverage ratio to be 

100

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**Gramercy Capital Corp. Notes To Consolidated Financial Statements (Continued) (Amounts in thousands, except share and per share data) December 31, 2006**

at no time less than 1.50to 1.00, (d) require our minimum interest coverage ratio to be at no timeless than 1.75 to 1.00 under the Wachovia facility, (e) require us tomaintain minimum tangible net worth of not less than (i) $129,750, plus (ii) 75%of the net proceeds of our subsequent equity issuances following our initialpublic offering under the Goldman facility and not less than (i) $400,000,plus (ii) 75% of the proceeds of our subsequent equity issuances followingthe date of the October 2006 amendment under the Wachovia facility and (f) restrictthe maximum amount of our total indebtedness. The covenants also restrict usfrom making distributions in excess of a maximum of 100% of our FFO (as definedtherein) under the Wachovia facility, except that we may in any case paydistributions necessary to maintain our REIT status. An event of default can be triggered on our repurchase facilities if, amongother things, GKK Manager LLC is terminated as our Manager. As of December 31,2006 and 2005, we were in compliance with all such covenants.

The repurchase facilities require that we pay downborrowings under these facilities as principal payments on the loans andinvestments pledged to these facilities are received. Assets pledged as collateral under thesefacilities may include stabilized and transitional whole loans, subordinateinterests in whole loans, mezzanine loans, and rated CMBS or commercial realestate CDO securities originated or acquired by us.

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

**Unsecured RevolvingCredit Facility**

In May 2006, we closed on a $100,000 seniorunsecured revolving credit facility with KeyBank National Association, orKeyBank, with an initial term of three years and a one-year extension option. Thefacility is supported by a negative pledge of an identified asset base withadvance rates that vary from 30% to 90% of the asset value provided under aborrowing base calculation. The lender also has consent rights to the inclusionof assets in the borrowing base calculation. The facility bears interest at1.90% over one-month LIBOR to the extent our leverage ratio, defined as totalliabilities to total assets, including our proportionate share of theliabilities and assets of our unconsolidated subsidiaries, is less than 80% and2.10% over one-month LIBOR to the extent out leverage ratio is equal to orgreater than 80%. We had 

101

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**Gramercy Capital Corp. Notes To Consolidated Financial Statements (Continued) (Amounts in thousands, except share and per share data) December 31, 2006**

accrued interest of $75and borrowings of $15,000 at a spread to LIBOR of 2.10% against this facilityas of December 31, 2006.

The terms of the unsecured revolving credit facilityinclude covenants that****(a) limitour maximum total indebtedness to no more than 85% of total assets, (b) requireour fixed charge coverage ratio to be at no time less than 1.50, (c) requireour minimum interest coverage ratio to be at no time less than 1.70, (d) requireus to maintain minimum tangible net worth of not less than $370,000 plus 75% ofthe net proceeds from equity offerings completed after the closing of thefacility and (e) restrict the maximum amount of our total indebtedness. Thecovenants also restrict us from making distributions in excess of a maximum of100% of our FFO (as defined by the National Association of Real EstateInvestment Trusts, or NAREIT), except that we may in any case pay distributionsnecessary to maintain our REIT status. Anevent of default can be triggered on our unsecured revolving credit facilityif, among other things, GKK Manager LLC is terminated as our Manager. As of December 31,2006, we were in compliance with all such covenants.

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

**Mortgage Loan**

We have one proportionately consolidated interest-onlymortgage loan related to 55 Corporate Drive in an amount equal to our ownershippercentage in the entity multiplied by the outstanding principal balance of themortgage loan, which loan financed the acquisition of 55 Corporate Drive in June 2006.The mortgage has an outstanding principal balance of $190,000, of which we haveconsolidated 49.75% or $94,525, with an effective interest rate of 5.75% and aterm of ten years. Interest on this mortgage was capitalized for a portion ofthe year ended December 31, 2006 as the property was redeveloped. Capitalizedinterest was $1,841 for the year ended December 31, 2006.

Combinedaggregate principal maturities of our consolidated CDOs, repurchase facilities,trust preferred securities, proportionately consolidated mortgage note payablerelated to our TIC interest in 55 Corporate Drive, and unsecured revolvingcredit facility as of December 31, 2006 are as follows:

| ** ** | ** ** | ** ** | ** ** | ** **     | ** ** | ** **     | ** ** | ** **   | ** ** | **Unsecured** | ** ** | ** ** | ** ** |   |
|------------|------------|------------|------------|----------------|------------|----------------|------------|--------------|------------|---------------|------------|------------|------------|--------|
| ** ** | ** ** | ** ** | ** ** | ** **     | ** ** | **Trust**      | ** ** | **Mortgage** | ** ** | **Revolving** | ** ** | ** ** | ** ** |   |
| ** ** | ** ** | ** ** | ** ** | **Repurchase** | ** ** | **Preferred**  | ** ** | **Note**     | ** ** | **Credit**    | ** ** | ** ** | ** ** |   |
| ** ** | ** ** | **CDOs**   | ** ** | **Facilities** | ** ** | **Securities** | ** ** | **Payable**  | ** ** | **Facility**  | ** ** | **Total**  | ** ** |   |
| 2007       |       | $          | —     |           |       | $              | —     |         |       | $             | —     |       |       | $      | — |   |   |   | $ | — |   |   | $ | — |   |
| 2008       |       | —     |       |           | —     |           |       | —       |       |          | —     |       |       |   | — |   |   | — |   |
| 2009       |       | —     |       |           | 277,412    |           |       | —       |       |          | —     |       |       |   | 15,000 |   |   | 292,412 |   |
| 2010       |       | —     |       |           | —     |           |       | —       |       |          | —     |       |       |   | — |   |   | — |   |
| 2011       |       | —     |       |           | —     |           |       | —       |       |          | —     |       |       |   | — |   |   | — |   |
| Thereafter |       | 1,714,250  |       |           | —     |           |       | 150,000      |       |          | 94,525     | (1)        |       |   | — |   |   | 1,958,775 |   |
| Total      |       | $          | 1,714,250  |           |       | $              | 277,412    |         |       | $             | 150,000    |       |       | $      | 94,525 |   |   |   | $ 15,000 |   |   | $ | 2,251,187 |   |
|            |            |            |            |                |            |                |            |              |            |               |            |            |            |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

----

(1)          Wehave a 49.75% interest in the mortgage note.

102

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**Gramercy Capital Corp. Notes To Consolidated Financial Statements (Continued) (Amounts in thousands, except share and per share data) December 31, 2006**

**10. OperatingPartnership Agreement / Manager**

At December 31, 2006, we owned all of the Class Alimited partnership interests in our Operating Partnership. At December 31,2006, the majority of the Class B limited partnership interests were ownedby our Manager and SL Green Operating Partnership, L.P. Interests were alsoheld by certain officers and employees of SL Green, including some of whom are ourexecutive officers, certain of which interests are subject to performancethresholds.

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

**11. Related PartyTransactions**

In connection with our initial public offering, weentered into a management agreement with our Manager, which was subsequentlyamended and restated in April 2006. The amended and restated managementagreement provides for a term through December 2009 with automaticone-year extension options and is subject to certain termination rights. We payour Manager an annual management fee equal to 1.75% of our gross stockholdersequity (as defined in the amended and restated management agreement) inclusiveof our trust preferred securities. We incurred expense to our Manager underthis agreement of an aggregate of $10,147, $6,337 and $1,349 for the yearsended December 31, 2006 and 2005 and the period from April 12, 2004(formation) through December 31, 2004, respectively.

To provide an incentive to enhance the value of ourcommon stock, the holders of the Class B limited partner interests of ourOperating Partnership are entitled to an incentive return equal to 25% of theamount by which FFO plus certain accounting gains and losses (as defined in theamended and restated partnership agreement of our Operating Partnership) exceedthe product of our weighted average stockholders equity (as defined in theamended and restated partnership agreement of our Operating Partnership)multiplied by 9.5% (divided by 4 to adjust for quarterly calculations). We willrecord any distributions on the Class B limited partner interests as anincentive distribution expense in the period when earned and when payments ofsuch amounts have become probable and reasonably estimable in accordance withthe partnership agreement. We incurred $7,609 and $2,276 with respect to such Class Blimited partner interests for the years ended December 31, 2006 and 2005.

We are obligated to reimburse our Manager for itscosts incurred under an asset servicing agreement between our Manager and an affiliateof SL Green Operating Partnership, L.P. and a separate outsourcing agreementbetween our Manager and SL Green Operating Partnership, L.P. The assetservicing agreement, which was amended and restated in April 2006,provides for an annual fee payable to SL Green Operating Partnership, L.P. byus of 0.05% of the book value of all credit tenant lease assets andnon-investment grade bonds and 0.15% of the book value of all other assets. Theasset servicing fee is reduced by SL Green Operating Partnership, L.P. for feespaid directly to outside servicers by us. The outsourcing agreement currentlyprovides for an annual fee payable by us, which fee is currently $1,326 peryear, increasing 3% annually over the prior year on the anniversary date of theoutsourcing agreement in August of each year. For the years ended December 31,2006 and 2005 and the period from April 12, 2004 (formation) through December 31,2004, we realized expense of $1,304, $1,266 and $521, respectively, to 

103

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**Gramercy Capital Corp. Notes To Consolidated Financial Statements (Continued) (Amounts in thousands, except share and per share data) December 31, 2006**

our Manager under theoutsourcing agreement. For the years ended December 31, 2006 and 2005 andthe period from April 12, 2004 (formation) through December 31, 2004,we realized expense of $2,349, $1,037 and $95, respectively, to our Managerunder the asset servicing agreement.

In connection with the closing of our first CDO in July 2005,the Issuer, Gramercy Real Estate CDO 2005-1 Ltd., entered into acollateral management agreement with our Manager. Pursuant to the collateralmanagement agreement, our Manager has agreed to provide certain advisory andadministrative services in relation to the collateral debt securities and othereligible investments securing the CDO notes. The collateral managementagreement provides for a senior collateral management fee, payable quarterly inaccordance with the priority of payments as set forth in the indenture, equalto 0.15% per annum of the net outstanding portfolio balance, and a subordinatecollateral management fee, payable quarterly in accordance with the priority ofpayments as set forth in the indenture, equal to 0.25% per annum of the netoutstanding portfolio balance. Net outstanding portfolio balance is the sum ofthe (i) aggregate principal balance of the collateral debt securities,excluding defaulted securities, (ii) aggregate principal balance of allprincipal proceeds held as cash and eligible investments in certain accounts,and (iii) with respect to the defaulted securities, the calculation amountof such defaulted securities. As compensation for the performance of its obligationsas collateral manager under the first CDO, our Board of Directors has allocatedto our Manager the subordinate collateral management fee paid on securities notheld by us. At December 31, 2006 we owned all of the non-investment gradebonds, preferred equity and equity in both CDOs. The senior collateral management fee andbalance of the subordinate collateral management fee is allocated to us. Forthe years ended December 31, 2006 and 2005, we realized expense of $2,065and $944, respectively, to our Manager under such collateral managementagreement.

Collateral manager fees paid on our CDO that closed inAugust 2006 are governed by the amended and restated management agreementas a “transitional managed” CDO, as defined in the amended and restatedmanagement agreement, consisting primarily of debt investments secured bynon-stabilized real estate. The amended and restated management agreementprovides that in connection with formations of collateralized debt obligationsor other securitization vehicles after the execution of the amended andrestated management agreement, if a collateral manager is retained, our Manageror an affiliate will be the collateral manager and will receive the followingfees:  (i) 0.25% per annum of the book value of the assets owned for “transitionalmanaged” CDOs, (ii) 0.15% per annum of the book value of the assets ownedfor “non-transitional managed” CDOs, (iii) 0.10% per annum of the bookvalue of the assets owned for static CDOs that own primarily non-investmentgrade bonds, and (iv) 0.05% per annum of the book value of the assetsowned for static CDOs that own primarily investment grade bonds; limited ineach instance by the fees that are paid to the collateral manager. The balanceof the fees paid by the CDOs for collateral management services are paid to us.For the year ended December 31,2006 we realized expense of $803 to our Manager under this agreement.

In connection with the 5,500,000 shares of commonstock that were sold on December 3, 2004 and settled on December 31,2004 and January 3, 2005 in a private placement, we agreed to pay ourManager a fee of $1,000 as compensation for financial advisory, structuring andcosts incurred on our behalf.  This feewas recorded as a reduction in the proceeds of the private placement. Apartfrom legal fees and stock clearing charges totaling $245, no other fees werepaid by us to an investment bank, broker/dealer or other 

104

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**Gramercy Capital Corp. Notes To Consolidated Financial Statements (Continued) (Amounts in thousands, except share and per share data) December 31, 2006**

financial advisor inconnection with the private placement, resulting in total costs of 1.3% oftotal gross proceeds.

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

On June 7, 2006, we closed on the acquisition ofa 49.75% TIC interest in 55 Corporate Drive, located in Bridgewater, New Jerseywith a 0.25% interest to be acquired in the future. The remaining 50% of theproperty is owned as a TIC interest by an affiliate of SL Green OperatingPartnership, L.P. The property is comprised of three buildings totalingapproximately six hundred and seventy thousand square feet which is 100% netleased to an entity whose obligations are guaranteed by Sanofi-Aventis Groupthrough April 2023. The transaction was valued at $236,000 and wasfinanced with a $190,000, 10-year, fixed-rate first mortgage loan.

Commencing May 1, 2005 we are party to a leaseagreement with SLG Graybar Sublease LLC, an affiliate of SL Green, for ourcorporate offices at 420 Lexington Avenue, New York, New York. The lease is forapproximately five thousand square feet with an option to lease an additionalapproximately two thousand square feet and carries a term of ten years withrents on the entire seven thousand square feet of approximately $249 per annumfor year one rising to $315 per annum in year ten. For the years ended December 31,2006 and 2005, we paid $252 and $90 under this lease, respectively.

Bright Star Couriers LLC, or Bright Star, providesmessenger services to us. Bright Star is owned by Gary Green, a son of StephenL. Green, our Chairman. The aggregate amount of fees paid by us for suchservices for the years ended December 31, 2006 and 2005 and the periodfrom April 12, 2004 (formation) through December 31, 2004 was $7, $3and less than $1, respectively.

SL Green Operating Partnership, L.P. is an equityholder in the joint venture that is the borrower on an investment with a bookvalue of $29,026 as of December 31, 2005. This investment was repaid in August 2006.

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

On February 27, 2006, we closed on the purchaseof a $90,000 whole loan, which bears interest at one-month LIBOR plus 2.15%, toa joint venture in which SL Green is an equity holder. The loan is secured by55 Corporate Drive in Bridgewater, New Jersey. The loan was repaid in full in June 2006with the proceeds 

105

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**Gramercy Capital Corp. Notes To Consolidated Financial Statements (Continued) (Amounts in thousands, except share and per share data) December 31, 2006**

from new mortgagefinancing obtained in connection with the sale of the property, 49.75% of whichis now owned by us through a TIC structure.

On March 17, 2006, we closed on the purchase of a$25,000 mezzanine loan, which bears interest at one-month LIBOR plus 8.00%, toa joint venture in which SL Green is an equity holder. The loan was repaid infull on May 9, 2006, when we originated a $90,287 whole loan, which bearsinterest at one-month LIBOR plus 2.75%, to the joint venture. The loan issecured by office and industrial properties in northern New Jersey and has abook value of $90,049 as of December 31, 2006.

On August 1, 2006, we acquired from a financialinstitution a 50% pari-passu interest in a $65,000 preferred equity investmentsecured by an office property in New York, New York. An affiliate of SL Greensimultaneously acquired and owns the other 50% pari-passu interest. Theinvestment bears interest at a blended fixed rate of 10.52%.

On December 20, 2006, we acquired from afinancial institution a pari-passu interest of $125,000 in a $200,000 mezzanineloan, which bears interest at 6.384% and is secured by a multi-family portfolioin New York, New York. An affiliate of SL Green simultaneously acquired theremaining $75,000 pari-passu interest in the mezzanine loan.

During the year ended December 31, 2006, weearned fees of $163 from SL Green representing SL Green’s proportionate shareof fees for financing and structural advisory services related to a specificpotential transaction.

**12. Deferred Costs**

Deferredcosts at December 31, 2006 and December 31, 2005 consisted of thefollowing:

| ** **                     | ** ** | **2006** | ** ** | **2005** | ** ** |
|--------------------------------|------------|----------|------------|----------|------------|
| Deferred  financing            |       | $        | 35,103     |     | $          | 20,553 |   |
| Deferred  acquisition          |       | 2,195    |       | 2,210    |       |
|                           |       | 37,298   |       | 22,763   |       |
| Less accumulated  amortization |       | (8,571   | )          | (3,381   | )          |
|                           |       | $        | 28,727     |     | $          | 19,382 |   |

 

Deferred financing costsrelate to our existing repurchase facilities with Wachovia and Goldman, ourunsecured revolving credit facility with KeyBank, our CDOs and the trustpreferred securities. These costs are amortized on a straight-line basis tointerest expense based on the remaining term of the related financing.

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

**13. Fair Value of Financial Instruments**

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

106

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**Gramercy Capital Corp. Notes To Consolidated Financial Statements (Amounts in thousands, except share and per share data) December 31, 2006**

Cash equivalents, accrued interest, and accountspayable balances reasonably approximate their fair values due to the shortmaturities of these items. The carrying value of our CDOs, repurchasefacilities and unsecured revolving credit facility approximate fair valuebecause they bear interest at floating rates, which we believe, for facilitieswith a similar risk profile, reasonably approximate market rates. Our juniorsubordinated debentures reasonably approximate fair value based upon the amountat which similarly issued instruments would be issued in the current market. Based on the borrowing rates currentlyavailable to the Company for bank loans with similar terms and averagematurities, the fair value of our fixed rate mortgage payable approximates itscarrying value. Loans are carried at amounts, which reasonablyapproximate their fair value as determined by our Manager.

Thefair value of our fixed-rate debt investments as determined by our Manager inconsultation with market dealers of such instruments as of December 31,2006 are as follows:

| ** **                   | ** ** | **Carrying  Value** | ** ** | **Fair   Value** | ** ** |
|------------------------------|------------|---------------------|------------|-----------------------|------------|
| Fixed-rate debt  investments |       | $                   | 351.585    |                  | $          | 351,585 |   |
|                              |            |                     |            |                       |            |  |  |

 

Disclosure about fairvalue of financial instruments is based on pertinent information available tous at December 31, 2006. Although we are not aware of any factors thatwould significantly affect the reasonable fair value amounts, such amounts havenot been comprehensively revalued for purposes of these financial statementssince that date and current estimates of fair value may differ significantlyfrom the amounts presented herein.

**14. Stockholders’Equity**

**Common Stock**

Our authorized capital stock consists of 125,000,000shares, $0.001 par value, of which we have authorized the issuance of up to100,000,000 shares of common stock, $0.001 par value per share, and 25,000,000shares of preferred stock, par value $0.001 per share.

As of the date of our formation, April 12, 2004,we had 500,000 shares of common stock outstanding valued at approximately $200.On August 2, 2004 we completed our initial public offering of 12,500,000shares of common stock resulting in net proceeds of approximately $172,900,which was used to fund investments and commence our operations. As of December 31,2006, 350,000 restricted shares had also been issued under our 2004 EquityIncentive Plan, or the Equity Incentive Plan. These shares have a vestingperiod of three to four years and are not entitled to receive distributionsdeclared by us on our common stock until such time as the shares have vested,or the shares have been designated to receive dividends by the CompensationCommittee of our Board of Directors.

On December 3, 2004, we sold 5,500,000 shares ofour common stock, at a price of $17.27 per share, resulting in net proceeds ofapproximately $93,740 under a private placement exemption from the registrationrequirements of Section 5 of the Securities Act of 1933, as amended. Wesubsequently registered the resale of these shares under the Securities Act in August 2005.A total of 4,225,000 shares were sold to various institutional investors and anadditional 1,275,000 shares were sold to SL Green Operating Partnership, L.P.pursuant to its contractual right to choose to maintain a 25% ownership 

107

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**Gramercy Capital Corp. Notes To Consolidated Financial Statements (Amounts in thousands, except share and per share data) December 31, 2006**

interest in the outstandingshares of our common stock. Of the 5,500,000 shares sold, 2,000,000 shares weresettled on December 31, 2004 and the remaining 3,500,000 shares weresettled on January 3, 2005.

On September 14, 2005, we sold 3,833,333 sharesof our common stock, at a price of $25.80 per share, resulting in net proceedsof approximately $97,830. A total of 2,875,000 shares were sold through apublic offering and an additional 958,333 shares were sold to SL GreenOperating Partnership, L.P. pursuant to its contractual right to choose tomaintain a 25% ownership interest in our outstanding shares of common stock. Netproceeds were used for loan acquisitions and originations, repayment ofoutstanding principal under one of our repurchase facilities and generalcorporate purposes.

On May 16, 2006, we sold 3,000,000 shares of ourcommon stock, at a price of $26.75 per share, resulting in net proceeds ofapproximately $79,787. A total of 2,250,000 shares were sold through a publicoffering and an additional 750,000 shares were sold to SL Green OperatingPartnership, L.P. pursuant to its contractual right to choose to maintain a 25%ownership interest in the outstanding shares of our common stock. After thisoffering, SL Green Operating Partnership, L.P. owned 6,418,333 shares of ourcommon stock. Net proceeds were used for loan acquisitions and originations,repayment of outstanding principal under our repurchase facilities and generalcorporate purposes.

In August 2005 our $350,000 shelf registrationstatement was declared effective by the Securities and Exchange Commission, orSEC. This registration statement provides us with the ability to issue commonand preferred stock, depository shares and warrants. We currently have $170,850available under the shelf.

As of December 31, 2006,25,878,391 shares of our common stock and no shares of our preferred stock wereissued and outstanding.

**Equity IncentivePlan**

As part of our initial public offering, we institutedour Equity Incentive Plan. The Equity Incentive Plan, as amended, authorizes (i) thegrant of stock options that qualify as incentive stock options under Section 422of the Internal Revenue Code of 1986, as amended, or ISOs, (ii) the grantof stock options that do not qualify, or NQSOs, (iii) the grant of stockoptions in lieu of cash directors’ fees and (iv) grants of shares ofrestricted and unrestricted common stock. The exercise price of stock optionswill be determined by the compensation committee, but may not be less than 100%of the fair market value of the shares of common stock on the date of grant. AtDecember 31, 2006, approximately 1,212,840 shares of common stock wereavailable for issuance under the Equity Incentive Plan.

Management and outsourcing fees paid to our Managerand SL Green Operating Partnership, L.P. are sufficient to reimburse ourManager and SL Green Operating Partnership, L.P. for the applicablecompensation, including payroll taxes, of the employees who provide services toGramercy pursuant to the confirmatory addendum to the Management Agreement betweenGramercy, our Manager and our Operating Partnership. These awardees areconsidered co-leased employees. Options granted under the Equity Incentive Planto recipients who are co-leased employees of Gramercy are exercisable at thefair market value on the date of grant and, subject to termination ofemployment, expire ten years from the date of grant, are not transferable otherthan on death, and are exercisable in three to four annual installmentscommencing one year from the date of grant. In some instances, options may begranted under the Equity Incentive Plan to persons who provide significantservices to us or our affiliates, but are not considered co-leased employeesbecause compensation for their services is not covered by our 

108

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**Gramercy Capital Corp. Notes To Consolidated Financial Statements (Amounts in thousands, except share and per share data) December 31, 2006**

management agreement oroutsourcing agreement. Options granted to recipients that are not co-leasedemployees have the same terms as those issued to co-leased employees except asit relates to any performance-based provisions within the grant. To the extentthere are performance provisions associated with a grant to a recipient who isnot a co-leased employee, an estimated expense related to these options isrecognized over the vesting period and the final expense is reconciled at thepoint performance has been met, or the measurement date. If no performancebased provision exists, the fair value of the options is calculated on aquarterly basis and the related expense is recognized over the vesting period.

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

| ** **                    | ** ** | **2006**                 | ** ** | **2005**                               | ** ** |
|-------------------------------|------------|--------------------------|------------|----------------------------------------|------------|
| ** **                    | ** ** | **Options  Outstanding** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Options  Outstanding** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
| Balance at  beginning of year |       |                     | 733,584    |                                   |       |   | $ | 16.47 |   |   |   | 640,500 |   |   |   | $ | 15.05 |   |   |
| Granted                       |       |                     | 197,500    |                                   |       |   | $ | 23.49 |   |   |   | 236,000 |   |   |   | $ | 19.62 |   |   |
| Exercised                     |       |                     | (63,749    | )                                      |       |   | $ | 15.95 |   |   |   | (131,249 | ) |   |   | $ | 15.01 |   |   |
| Lapsed or  cancelled          |       |                     | (37,334    | )                                      |       |   | $ | 20.18 |   |   |   | (11,667 | ) |   |   | $ | 18.20 |   |   |
| Balance at end of period      |       |                     | 830,001    |                                   |       |   | $ | 18.02 |   |   |   | 733,584 |   |   |   | $ | 16.47 |   |   |

 

All options were granted within a price range of$15.00 to $26.79. The remaining weighted average contractual life of theoptions was 8.10 years. Compensation expense of $432 will be recorded over thecourse of the next 15 months, representing the remaining weighted averagevesting period of the option awards as of December 31, 2006. Compensationexpense of $324, $172 and $23 was recorded for the years ended December 31,2006 and 2005 and for the period from April 12, 2004 (formation) through December 31,2004, respectively, related to the issuance of stock options.

Through December 31,2006, 350,000 restricted shares had been issued under the Equity IncentivePlan, of which 62% have vested.  Theunvested shares are not currently entitled to receive distributions declared byus on our common stock until such time as the shares have vested. Unvestedshares may be entitled to receive dividends at the discretion of theCompensation Committee of our Board of Directors. Holders of restricted sharesare prohibited from selling such shares until they vest but are provided theability to vote such shares beginning on the date of grant. Compensationexpense of $163 will be recorded over the course of the next 9 months,representing the remaining weighted average vesting period of the restrictedstock awards as of December 31, 2006. Compensation expense of $1669,$1,577 and $381 was recorded for the years ended December 31, 2006 and2005 and for the period from April 12, 2004 (formation) through December 31,2004, respectively, related to the issuance of restricted shares.

**Outperformance Plan**

In June 2005, thecompensation committee of our board of directors approved a long-term incentivecompensation program, the 2005 Outperformance Plan. Participants in the 2005Outperformance Plan, all of whom are co-leased employees, will share in a “performancepool” if our total return to stockholders for the period from June 1, 2005through May 31, 2008 exceeds a cumulative total return to stockholders of30% during the measurement period over a base share price of $20.21 per share. Thesize of the pool will 

109

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**Gramercy Capital Corp. Notes To Consolidated Financial Statements (Amounts in thousands, except share and per share data) December 31, 2006**

be 10%of the outperformance amount in excess of the 30% benchmark, subject to amaximum limit equal to the lesser of 4% of our outstanding shares and units oflimited partnership interest as of the end of the performance period, or1,200,000 shares. If our total return to stockholders from June 1, 2005 toany subsequent date exceeds 80% and remains at that level or higher for 30consecutive days, then a minimum performance pool will be established. In theevent the potential performance pool reaches the maximum dilution cap before May 31,2008 and remains at that level or higher for 30 consecutive days, theperformance period will end early and the pool will be formed on the last dayof such 30-day period. Each participant’s award under the 2005Outperformance Plan is designated as a specified percentage of the aggregateperformance pool to be allocated to such participant assuming the 30% benchmarkis achieved. Individual awards under the 2005 Outperformance Plan will be madein the form of partnership units, or LTIP Units, that may ultimately becomeexchangeable for shares of our common stock or cash, at our election. Under the2005 Outperformance Plan, LTIP Units have been granted and additional LTIPUnits may be granted in the future prior to the determination of theperformance pool; however, these LTIP Units will only vest upon satisfaction ofperformance and other thresholds, and will not be entitled to distributionsuntil after the performance pool, or minimum performance pool, is established. The2005 Outperformance Plan provides that if a pool is established, eachparticipant will also be entitled to the distributions that would have beenpaid on the number of LTIP Units earned, had they been issued at the beginningof the performance period. Those distributions will be paid in the form ofadditional LTIP Units. Once a performance pool has been established, the earnedLTIP Units will receive regular quarterly distributions on a per unit basisequal to the dividends per share paid on our common stock, whether or not theyare vested. Any LTIP Units that are not earned upon the establishment of theperformance pool will be automatically forfeited, and the LTIP Units that areearned will be subject to time-based vesting, with 50% of the LTIP Units earnedvesting in May 2009 and the balance vesting one year later based oncontinued employment with our Manager or SL Green.  We will record the expense of the restrictedstock award in accordance with FASB Statement No. 123(R). Compensationexpense of $1,174 was recorded for the years ended December 31, 2006 and2005 related to the 2005 Outperformance Plan.

**Deferred StockCompensation Plan for Directors**

Under our Independent Director’s Deferral Program,which commenced April 2005, our independent directors may elect to deferup to 100% of their annual retainer fee, chairman fees and meeting fees. Unlessotherwise elected by a participant, fees deferred under the program shall becredited in the form of phantom stock units. The phantom stock units areconvertible into an equal number of shares of common stock upon such directors’termination of service from the Board of Directors or a change in control byus, as defined by the program. Phantom stock units are credited to eachindependent director quarterly using the closing price of our common stock onthe applicable dividend record date for the respective quarter. Eachparticipating independent director who elects to receive fees in the form ofphantom stock units has the option to have their account credited for anequivalent amount of phantom stock units based on the dividend rate for eachquarter or have dividends paid in cash.

As of December 31,2006, there were approximately 15,301 phantom stock units outstanding, of which11,301 units are vested.

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**Gramercy Capital Corp. Notes To Consolidated Financial Statements (Amounts in thousands, except share and per share data) December 31, 2006**

**Earnings per Share**

Earningsper share for the years ended December 31, 2006 and 2005 and for theperiod from April 12, 2004 (formation) through December 31, 2004 iscomputed as follows:

| ** **                                  | ** ** | **For the Year  Ended   December 31,  2006** | ** ** | **For the Year  Ended  December 31,  2005** | ** ** | **For the period  from April 12,  2004  (formation)   through   December 31,  2004** | ** ** |
|---------------------------------------------|------------|------------------------------------------------------------------|------------|------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------|------------|
| **Numerator  (Income)**                     |       |                                                             |       |                                                       |       |                                                                                                                    |       |   |   |   |   |   |   |
| Basic Earnings:                             |       |                                                             |       |                                                       |       |                                                                                                                    |       |   |   |   |   |   |   |
| Net income available to common stockholders |       |                                                             | $          | 55,902                                                     |       |                                                                                                                    |       | $ | 31,371 |   |   |   | $ | 2,052 |   |   |
| Effect of  dilutive securities              |       |                                                             | —     |                                                       |       |                                                                                                                    | —     |   |   |   | — |   |   |
| Diluted Earnings:                           |       |                                                             |       |                                                       |       |                                                                                                                    |       |   |   |   |   |   |   |
| Net income available to common stockholders |       |                                                             | $          | 55,902                                                     |       |                                                                                                                    |       | $ | 31,371 |   |   |   | $ | 2,052 |   |   |
| **Denominator  (Weighted Average Shares)**  |       |                                                             |       |                                                       |       |                                                                                                                    |       |   |   |   |   |   |   |
| Basic                                       |       |                                                             |       |                                                       |       |                                                                                                                    |       |   |   |   |   |   |   |
| Shares available to common stockholders     |       |                                                             | 24,722     |                                                       |       |                                                                                                                    | 20,027     |   |   |   | 13,348 |   |   |
| Effect of Diluted  Securities:              |       |                                                             |       |                                                       |       |                                                                                                                    |       |   |   |   |   |   |   |
| Stock-based compensation plans              |       |                                                             | 1,272      |                                                       |       |                                                                                                                    | 752        |   |   |   | 63 |   |   |
| Phantom stock units                         |       |                                                             | 15         |                                                       |       |                                                                                                                    | 2          |   |   |   | — |   |   |
| Diluted Shares                              |       |                                                             | 26,009     |                                                       |       |                                                                                                                    | 20,781     |   |   |   | 13,411 |   |   |

 

**15. Benefit Plans**

We do not maintain adefined benefit pension plan, post-retirement health and welfare plan, 401(k) planor other benefits plans as we do not have any employees. These benefits areprovided to its employees by our Manager, a majority-owned subsidiary of SLGreen.

**16.** Commitments and Contingencies

We and our Operating Partnership are not presentlyinvolved in any material litigation nor, to our knowledge, is any materiallitigation threatened against us or our investments, other than routinelitigation arising in the ordinary course of business. Management believes thecosts, if any, incurred by our Operating Partnership and us related tolitigation will not materially affect our financial position, operating resultsor liquidity.

Our corporate offices at 420 Lexington Avenue, NewYork, New York are subject to an operating lease agreement with SLG GraybarSublease LLC, an affiliate of SL Green, effective May 1, 2005. The leaseis for approximately five thousand square feet with an option to lease anadditional approximately two thousand square feet and carries a term of tenyears with rents on the entire seven thousand square feet of approximately $249per annum for year one rising to $315 per annum in year ten.

111

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**Gramercy Capital Corp. Notes To Consolidated Financial Statements (Amounts in thousands, except share and per share data) December 31, 2006**

Thefollowing is a schedule of future minimum lease payments under our operatinglease as of December 31, 2006.

| ** **                    | ** ** | **Operating   Lease** | ** ** |
|-------------------------------|------------|----------------------------|------------|
| 2007                          |       |                       | $          | 256 |   |   |
| 2008                          |       |                       | 261        |   |   |
| 2009                          |       |                       | 265        |   |   |
| 2010                          |       |                       | 283        |   |   |
| 2011                          |       |                       | 297        |   |   |
| Thereafter                    |       |                       | 1,054      |   |   |
| Total minimum  lease payments |       |                       | $          | 2,416 |   |   |

 

**17. FinancialInstruments: Derivatives and Hedging**

FASB No. 133, or SFAS 133, “Accounting forDerivative Instruments and Hedging Activities,” which became effective January 1,2001, requires Gramercy to recognize all derivatives on the balance sheet at fairvalue. Derivatives that are not hedges must be adjusted to fair value throughincome. If a derivative is a hedge, depending on the nature of the hedge,changes in the fair value of the derivative will either be offset against thechange in fair value of the hedged asset, liability, or firm commitment throughearnings, or recognized in other comprehensive income until the hedged item isrecognized in earnings. The ineffective portion of a derivative’s change infair value will be immediately recognized in earnings. SFAS 133 may increase ordecrease reported net income and stockholders’ equity prospectively, dependingon future levels of LIBOR interest rates and other variables affecting the fairvalues of derivative instruments and hedged items, but will have no effect oncash flows, provided the contract is carried through to full term.

112

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**Gramercy Capital Corp. Notes To Consolidated Financial Statements (Continued) (Amounts in thousands, except share and per share data) December 31, 2006**

Thefollowing table summarizes the notional and fair value of our derivativefinancial instrument at December 31, 2006. The notional value is anindication of the extent of our involvement in this instrument at that time,but does not represent exposure to credit, interest rate or market risks:

| ** **         | ** ** | **Benchmark Rate** | ** **     | **Notional  Value** | ** ** | **Strike  Rate** | ** ** | **Effective  Date**       | ** ** | **Expiration  Date** | ** ** | **Fair  Value** | ** ** |
|--------------------|------------|-------------------------|----------------|---------------------|------------|------------------|------------|---------------------------|------------|----------------------|------------|-----------------|------------|
| Interest Rate Swap |       |                    | 1  month LIBOR |                |       | $                | 168,300    |                      | 4.973      | %                    |       | 1/2007          |       |   |   | 1/2017 |   |   | $ | 836 |   |
| Interest Rate Swap |       |                    | 1  month LIBOR |                |       | 64,076           |       | 4.990                     | %          |                 | 1/2007     |            |       |   | 1/2017 |   |   | 248 |   |
| Interest Rate Swap |       |                    | 1  month LIBOR |                |       | 42,718           |       | 4.990                     | %          |                 | 1/2007     |            |       |   | 1/2017 |   |   | 162 |   |
| Interest Rate Swap |       |                    | 3  month LIBOR |                |       | 39,683           |       | 4.420                     | %          |                 | 7/2005     |            |       |   | 2/2014 |   |   | 1,293 |   |
| Interest Rate Swap |       |                    | 1  month LIBOR |                |       | 36,500           |       | 4.837                     | %          |                 | 12/2006    |            |       |   | 11/2009 |   |   | 120 |   |
| Interest Rate Swap |       |                    | 1  month LIBOR |                |       | 31,686           |       | 3.855                     | %          |                 | 7/2005     |            |       |   | 11/2009 |   |   | 943 |   |
| Interest Rate Swap |       |                    | 3  month LIBOR |                |       | 24,940           |       | 5.445                     | %          |                 | 8/2006     |            |       |   | 7/2016 |   |   | (728 | ) |
| Interest Rate Cap  |       |                    | 3  month LIBOR |                |       | 23,713           |       | 5.700                     | %          |                 | 11/2005    |            |       |   | 12/2007 |   |   | 2 |   |
| Interest Rate Cap  |       |                    | 1  month LIBOR |                |       | 20,000           |       | 6.000                     | %          |                 | 4/2006     |            |       |   | 4/2007 |   |   | — |   |
| Interest Rate Swap |       |                    | 3  month LIBOR |                |       | 12,000           |       | 9.850                     | %          |                 | 8/2006     |            |       |   | 8/2011 |   |   | (93 | ) |
| Basis Swap         |       |                    | 1  month PRIME |                |       | 9,363            |       | 722 bps    |       | 8/2006               |       |            |       | 12/2007 |   |   | (29 | ) |
| Interest Rate Swap |       |                    | 1  month LIBOR |                |       | 6,339            |       | 4.760                     | %          |                 | 1/2006     |            |       |   | 3/2015 |   |   | 97 |   |
| Interest Rate Swap |       |                    | 1  month LIBOR |                |       | 3,960            |       | 4.959                     | %          |                 | 12/2005    |            |       |   | 12/2015 |   |   | 16 |   |
| Interest Rate Swap |       |                    | 1  month LIBOR |                |       | 3,465            |       | 4.280                     | %          |                 | 7/2005     |            |       |   | 12/2009 |   |   | 64 |   |
| Interest Rate Swap |       |                    | 3  month LIBOR |                |       | 3,465            |       | 5.178                     | %          |                 | 4/2006     |            |       |   | 3/2010 |   |   | (21 | ) |
| Total              |       |                    |           |                |       | $                | 490,208    |                      |       |                 |       |            |       |   |   |   |   |   | $ | 2,910 |   |

 

At December 31, 2006, derivative instruments werereported at their fair value as assets of $3,782 and liabilities of $872. Offsettingadjustments are represented as deferred gains in Accumulated OtherComprehensive Income of $2,890. For the year ended December 31, 2006 werecognized in interest expense $1 attributable to the ineffective component ofour derivative instruments designated as cash flow hedges. For the same periodwe reclassified through earnings (i) $1,815 representing the gains andlosses previously reported in Accumulated Other Comprehensive Income, whichwere reclassified into earnings at the same time that the forecastedtransactions affect earnings, and (ii) a $994 reduction in earningsrepresenting the change in value of undesignated derivatives which are notspeculative for economic purposes. Currently, all derivative instruments aredesignated as cash flow hedging instruments with the exception of a $20,000notional cap, a $9,363 notional Prime-LIBOR basis swap, and a $168,300 notionalswap, which are effective economic hedges but have not been designated. Overtime, the realized and unrealized gains and losses held in Accumulated OtherComprehensive Income will be reclassified into earnings in the same periods inwhich the hedged interest payments affect earnings. We estimate thatapproximately $943 of the current balance held in Accumulated OtherComprehensive Income will be reclassified into earnings within the next 12months.

We are hedging exposure tovariability in future interest payments on our debt facilities and cash flowsfor future transactions except in the case of swaps we may enter into from timeto time, including TROR swaps, which are intended to hedge our exposure tovariability in the rate of return in excess of anticipated future interestpayments on that portion of our debt facilities used to fund fixed ratemortgage loan assets held as available for sale.

113

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**Gramercy Capital Corp. Notes To Consolidated Financial Statements (Continued) (Amounts in thousands, except share and per share data) December 31, 2006**

**18. Income Taxes**

We have elected to be taxed as a REIT, under Sections856 through 860 of the Internal Revenue Code beginning with our taxable yearending December 31, 2004. To qualify as a REIT, we must meet certainorganizational and operational requirements, including a requirement todistribute at least 90% of our ordinary taxable income to stockholders. As aREIT, we generally will not be subject to federal income tax on taxable incomethat we distribute to our stockholders. If we fail to qualify as a REIT in anytaxable year, we will then be subject to federal income taxes on our taxableincome at regular corporate rates and we will not be permitted to qualify fortreatment as a REIT for federal income tax purposes for four years followingthe year during which qualification is lost unless the Internal Revenue Servicegrants us relief under certain statutory provisions. Such an event couldmaterially adversely affect our net income and net cash available fordistributions to stockholders. However, we believe that we are organized andwill operate in such a manner as to qualify for treatment as a REIT and weintend to operate in the foreseeable future in such a manner so that we willqualify as a REIT for federal income tax purposes. We may, however, be subjectto certain state and local taxes.

For the years ended December 31,2006 and 2005, we recorded $1,808 and $900 of income tax expense, respectively,in income from continuing operations for income attributable to ourwholly-owned taxable REIT subsidiaries. We have assumed an effective tax ratefor the year ended December 31, 2006 of 48% taking into consideration theanticipated applicable U.S. federal statutory tax rate at December 31,2006 of 34% and state and local taxes.

**19. EnvironmentalMatters**

Our management believes weare in compliance in all material respects with applicable Federal, state andlocal ordinances and regulations regarding environmental issues. Our managementis not aware of any environmental liability that it believes would have amaterially adverse impact on our financial position, results of operations orcash flows.

**20. SegmentReporting**

Statement of FinancialAccounting Standard No. 131, or “SFAS No. 131,” establishes standardsfor the way that public entities report information about operating segments intheir annual financial statements. We are a REIT focused primarily onoriginating and acquiring loans and securities related to real estate and underthe provisions of SFAS No. 131 currently operate in only one segment.

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

Following the conversion of the entity that owns 200Franklin Square Drive into a DST, we sold approximately 75% of our securityinterests in the DST to a third party, reducing our final ownership interest to25.0%. We received total cash consideration of $12,800 for these interests andthe buyer assumed 75% of the DST’s underlying mortgage debt. As a result of thetransaction, the property is no longer consolidated onto our balance sheet, butinstead is accounted for as an equity method investment.

114

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**Gramercy Capital Corp. Notes To Consolidated Financial Statements (Continued) (Amounts in thousands, except share and per share data) December 31, 2006**

The following tablerepresents non-cash activities recognized in other comprehensive income:

| ** **                                | ** ** | **2006**   | ** ** | **2005** | ** ** | **2004** | ** ** |
|-------------------------------------------|------------|------------|------------|----------|------------|----------|------------|
| Deferred gains on  derivative instruments |       | $ 237 |       | $        | 2,569      |     | $          | 282 |   |
|                                           |            |            |            |          |            |          |            |  |  |

 

**22. QuarterlyFinancial Data (unaudited)**

Quarterlydata for the last two years is presented below (in thousands).

| **2006 Quarter  Ended**                                                                                                | ** ** | ** ** | ** ** | **December 31** | ** ** | **September 30** | ** ** | **June 30** | ** ** | **March 31** | ** ** |
|------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|----------------------|------------|-----------------------|------------|------------------|------------|-------------------|------------|
| Total revenues                                                                                                         |       |       | $          | 67,264               |       |                  |       | $                | 50,455     |              |       | $ | 43,505 |   |   | $ | 36,990 |   |   |
| Income from  continuing operations before equity in net loss of unconsolidated joint  ventures and provision for taxes |       |       | 19,495     |                 |       |                  | 16,065     |             |       | 13,782            |       |   | 11,328 |   |   |
| Equity in net  loss of unconsolidated joint ventures                                                                   |       |       | (870       | )                    |       |                  | (734       | )                |       | (630              | )          |   | (727 | ) |   |
| Income from  continuing operations before provision for taxes and GKK formation costs                                  |       |       | 18,625     |                 |       |                  | 15,331     |             |       | 13,152            |       |   | 10,601 |   |   |
| Provision /  (recovery) for taxes                                                                                      |       |       | (630       | )                    |       |                  | (795       | )                |       | (335              | )          |   | (47 | ) |   |
| Net income  available to common stockholders                                                                           |       |       | $          | 17,995               |       |                  |       | $                | 14,536     |              |       | $ | 12,817 |   |   | $ | 10,554 |   |   |
| Net income per  common share - Basic                                                                                   |       |       | $          | 0.70                 |       |                  |       | $                | 0.56       |              |       | $ | 0.53 |   |   | $ | 0.46 |   |   |
| Net income per common  share - Diluted                                                                                 |       |       | $          | 0.66                 |       |                  |       | $                | 0.54       |              |       | $ | 0.50 |   |   | $ | 0.44 |   |   |

 

| **2005 Quarter  Ended**                                                                                                | ** ** | ** ** | ** ** | **December 31** | ** ** | **September 30** | ** ** | **June 30** | ** ** | **March 31** | ** ** |
|------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|----------------------|------------|-----------------------|------------|------------------|------------|-------------------|------------|
| Total revenues                                                                                                         |       |       | $          | 32,045               |       |                  |       | $                | 26,592     |              |       | $ | 18,758 |   |   | $ | 10,690 |   |   |
| Income from  continuing operations before equity in net loss of unconsolidated joint  ventures and provision for taxes |       |       | 11,247     |                 |       |                  | 9,587      |             |       | 8,361             |       |   | 4,566 |   |   |
| Equity in net  loss of unconsolidated joint ventures                                                                   |       |       | (575       | )                    |       |                  | (510       | )                |       | (404              | )          |   | —- |   |   |
| Income from  continuing operations before provision for taxes and GKK formation costs                                  |       |       | 10,672     |                 |       |                  | 9,077      |             |       | 7,957             |       |   | 4,566 |   |   |
| Provision /  (recovery) for taxes                                                                                      |       |       | 100        |                 |       |                  | (500       | )                |       | (500              | )          |   | —- |   |   |
| Net income  available to common stockholders                                                                           |       |       | $          | 10,772               |       |                  |       | $                | 8,577      |              |       | $ | 7,457 |   |   | $ | 4,566 |   |   |
| Net income per  common share - Basic                                                                                   |       |       | $          | 0.47                 |       |                  |       | $                | 0.44       |              |       | $ | 0.40 |   |   | $ | 0.24 |   |   |
| Net income per common  share - Diluted                                                                                 |       |       | $          | 0.45                 |       |                  |       | $                | 0.41       |              |       | $ | 0.39 |   |   | $ | 0.24 |   |   |

 

**23. SubsequentEvents**

On January 10, 2007 we originated two mezzanineloans totaling $169,700, which bear interest at one-month LIBOR plus 600 basispoints. The mezzanine loan with a principal amount of $42,400 is secured byinterests in an office building in New York, New York. The first mortgage onthis property was defeased in February 2007, at which time our investmentwas converted to a first mortgage lien. The mezzanine loan with a principalamount of $127,300 is secured by interests in a residential property portfoliowith locations primarily in the northeast United States. An affiliate of SLGreen simultaneously originated pari-passu interests in the mezzanine loans of$30,300.

115

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**GramercyCapital Corp.Schedule IV—Mortgage Loans on Real EstateDecember 31, 2006(Dollars in thousands)**

| **Description**                               | ** ** | **Location**        | ** ** | **Interest Rate(1)**             | ** ** | **Final  Maturity  Date(2)**               | ** ** | **Periodic  Payment  Terms** | ** ** | **Prior  Liens** | ** ** | **Face  Amount  of Loans** | ** ** | **Carrying  Amount of  Loans(3)** | ** ** |
|-----------------------------------------------|------------|---------------------|------------|---------------------------------------|------------|--------------------------------------------|------------|------------------------------|------------|------------------|------------|---------------------------------|------------|----------------------------------------|------------|
| Whole Loans:                                  |       |                |       |                                  |       |                                       |       |                         |       |             |       |                            |       |                                   |       |   |   |
| Office                                        |       | Washington,  DC     |       | LIBOR  + 2.50%                        |       | July 2008                             |       | Interest only                |       | $                | —     |                            | $          | 163,000                                |       |   | $ | 162,250 |   |   |
| Retail                                        |       | Cupertino,  CA      |       | LIBOR  + 4.10%                        |       | June 2008                             |       | Interest only                |       | —           |       | 118,790                         |       |                                   | 117,328    |   |   |
| Office                                        |       | Various  cities, NJ |       | LIBOR  + 2.75%                        |       | May 2008                              |       | Interest only                |       | —           |       | 90,287                          |       |                                   | 90,048     |   |   |
| Multi-family                                  |       | New  York, NY       |       | LIBOR  + 3.50%                        |       | February 2008                         |       | Interest only                |       | —           |       | 84,735                          |       |                                   | 84,519     |   |   |
| Multi-family                                  |       | Various  cities, FL |       | LIBOR  + 3.00%                        |       | September 2008                        |       | Interest only                |       | —           |       | 77,478                          |       |                                   | 76,709     |   |   |
| Hotel                                         |       | Las  Vegas, NV      |       | LIBOR  + 2.60%                        |       | June 2008                             |       | Interest only                |       | —           |       | 67,529                          |       |                                   | 67,529     |   |   |
| Whole loans < 3%                           |       | Various             |       | 8.57%  - 14.95%  LIBOR + 1.50%-6.00%  |       | January 2007  -   October 2009   |       |                         |       | —           |       | 824,007                         |       |                                   | 816,309    |   |   |
|                                          |       |                |       |                                  |       |                                       |       |                         |       | —           |       | 1,425,826                       |       |                                   | 1,414,692  |   |   |
| Subordinate interests  in whole loans < 3% |       | Various             |       | 5.00%  - 13.14%  LIBOR + 1.06%-12.50% |       | January 2007  -   September 2016 |       |                         |       | 1,641,503        |       | 291,588                         |       |                                   | 285,077    |   |   |
| Mezzanine Loans:                              |       |                |       |                                  |       |                                       |       |                         |       |             |       |                            |       |                                   |       |   |   |
| Multi-family(4)                               |       | New  York, NY       |       | 6.384%                                |       | December 2016                         |       | Interest only                |       | 4,200            |       | 125,000                         |       |                                   | 106,832    |   |   |
| Mezzanine  loans < 3%                      |       | Various             |       | 8.47%  - 13.24%  LIBOR + 4.25%-10.00% |       | April 2007  -   July 2016        |       |                         |       | 2,001,589        |       | 335,878                         |       |                                   | 336,059    |   |   |
|                                          |       |                |       |                                  |       |                                       |       |                         |       | 2,005,789        |       | 460,878                         |       |                                   | 442,891    |   |   |
| Preferred equity < 3%                      |       | Various             |       | 10.18%  - 10.87%  LIBOR + 9.00%       |       | July 2007  -   August 2011       |       |                         |       | 875,686          |       | 44,500                          |       |                                   | 44,222     |   |   |
|                                          |       |                |       |                                  |       |                                       |       |                         |       | $                | 4,522,978  |                            | $          | 2,222,792                              |       |   | $ | 2,186,884 |   |   |

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(1)                All variable-rate loans are based on one-month LIBORand reprice monthly.

(2)                Reflects the initial maturity of the investment anddoes not consider any options to extend that are at the discretion of theborrower.

(3)                No mortgage loans are delinquent with respect toprincipal or interest.

(4)                An SL Green affiliate holds a pari-passu interest inthe investment.

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**ITEM  9.**             CHANGESIN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

**ITEM  9A.**     CONTROLSAND PROCEDURES

**Evaluation ofDisclosure Controls and Procedures**

We maintain disclosure controls and procedures thatare designed to ensure that information required to be disclosed in ourExchange Act reports is recorded, processed, summarized and reported within thetime periods specified in the SEC’s rules and forms, and that suchinformation is accumulated and communicated to our management, including ourChief Executive Officer and Chief Financial Officer, as appropriate, to allowtimely decisions regarding required disclosure based closely on the definitionof “disclosure controls and procedures” in Rule 13a-15(e). Indesigning and evaluating the disclosure controls and procedures, managementrecognized that any controls and procedures, no matter how well designed andoperated, can provide only reasonable assurance of achieving the desiredcontrol objectives, and management necessarily was required to apply itsjudgment in evaluating the cost-benefit relationship of possible controls andprocedures. Also, we have investments in certain unconsolidated entities. As wedo not control these entities, our disclosure controls and procedures withrespect to such entities are necessarily substantially more limited than thosewe maintain with respect to our consolidated subsidiaries.

As of the end of theperiod covered by this report, we carried out an evaluation, under thesupervision and with the participation of our management, including our ChiefExecutive Officer and our Chief Financial Officer, of the effectiveness of thedesign and operation of our disclosure controls and procedures. Based upon thatevaluation, our Chief Executive Officer and Chief Financial Officer concludedthat our disclosure controls and procedures were effective as of the end of theperiod covered by this report.

**Management’s AnnualReport on Internal Control over Financial Reporting**

We are responsible for establishing and maintainingadequate internal control over financial reporting, as such term is defined inExchange Act Rules 13a-15(f) and 15d-15(f). Under thesupervision and with the participation of our management, including our ChiefExecutive Officer and Chief Financial Officer, we conducted an evaluation ofthe effectiveness of our internal control over financial reporting as of December 31,2006 based on the framework in Internal Control-Integrated Framework issued bythe Committee of Sponsoring Organizations of the Treadway Commission (COSO). Basedon that evaluation, we concluded that our internal control over financialreporting was effective as of December 31, 2006.

Management’s assessment ofthe effectiveness of our internal control over financial reporting as of December 31,2006 has been audited by Ernst & Young LLP, an independent registeredpublic accounting firm, as stated in their report which is included elsewhereherein.

**Changes in InternalControl over Financial Reporting**

There have been nosignificant changes in our internal control over financial reporting during theyear ended December 31, 2006 that has materially affected, or isreasonably likely to materially affect, our internal control over financialreports.

**ITEM  9B.**    OTHERINFORMATION

None.

117

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**PART III**

**ITEM 10.**         DIRECTORS,EXECUTIVE OFFICERS OF THE REGISTRANT AND CORPORATE GOVERNANCE

The information requiredby Item 10 will be set forth in our Definitive Proxy Statement for our2007 Annual Meeting of Stockholders, to be filed pursuant to Regulation 14Aunder the Securities and Exchange Act of 1934, as amended, prior to April 30,2006 (the “2007 Proxy Statement”), and is incorporated herein by reference.

**ITEM 11.**         EXECUTIVEAND DIRECTOR COMPENSATION

The information requiredby Item 11 will be set forth in the 2007 Proxy Statement and isincorporated herein by reference.

**ITEM 12.**         SECURITYOWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDERMATTERS

The information requiredby Item 12 will be set forth in the 2007 Proxy Statement and isincorporated herein by reference.

**ITEM 13.**         CERTAINRELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE

The information requiredby Item 13 will be set forth in the 2007 Proxy Statement and is incorporatedherein by reference.

**ITEM 14.**         PRINCIPALACCOUNTING FEES AND SERVICES

The information regarding principal accounting feesand services and the audit committee’s pre-approval policies and proceduresrequired by this Item 14 is incorporated herein by reference to the 2007 ProxyStatement.

118

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**PART IV**

**ITEM 15. EXHIBITS,FINANCIAL STATEMENTS AND SCHEDULES, AND REPORTS ON FORM 8-K**

(a)(1)            Consolidated Financial Statements

|   | **GRAMERCY CAPITAL CORP.**                                                                                                                                                                     |   |   |
|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------|
|   | ** **                                                                                                                                                                                     |   |   |
|   | Report of Independent  Registered Public Accounting Firm                                                                                                                                       |   | 75     |
|   | Consolidated Balance  Sheets as of December 31, 2006 and 2005                                                                                                                             |   | 77     |
|   | Consolidated Statements  of Income for the years ended December 31, 2006 and 2005 and the period  from April 12, 2004 (formation) through December 31, 2004                     |   | 78     |
|   | Consolidated Statements  of Stockholders’ Equity for the years ended December 31, 2006 and 2005  and the period from April 12, 2004 (formation) through December 31,  2004 |   | 79     |
|   | Consolidated Statements  of Cash Flows for the years ended December 31, 2006 and 2005 and the  period from April 12, 2004 (formation) through December 31, 2004                 |   | 80     |
|   | Notes to Consolidated  Financial Statements                                                                                                                                                    |   | 82     |
|   | (a)(2) Financial  Statement Schedules                                                                                                                                                     |   |   |
|   | Schedule IV-Mortgage  Loans on Real Estate as of December 31, 2006                                                                                                                   |   | 115    |
|   | Schedules other than  those listed are omitted as they are not applicable or the required or  equivalent information has been included in the financial statements or notes  thereto.          |   |   |

 

(a)(3)            Exhibits

See Index to Exhibits on following page

119

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** **

**INDEX TO EXHIBITS**
| Exhibit No. | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                                    | ** ** | ** ** |
|------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|
| 3.1              |       | Articles of  Incorporation of the Company, incorporated by reference to the Company’s  Registration Statement on Form S-11 (No. 333-114673),  declared effective by the Commission on July 27, 2004.                                                                                                                                                                           |
| 3.2              |       | Bylaws of the Company,  incorporated by reference to the Company’s Registration Statement on  Form S-11 (No. 333-114673), declared effective by the  Commission on July 27, 2004.                                                                                                                                                                                              |
| 4.1

       |       | Specimen Common Stock  Certificate, incorporated by reference to the Company’s Registration  Statement on Form S-11 (No. 333-114673), declared  effective by the Commission on July 27, 2004.                                                                                                                                                                                  |
| 10.1             |       | Third Amended and  Restated Agreement of Limited Partnership of GKK Capital LP, dated  April 19, 2006, incorporated by reference to the Company’s Current  Report on Form 8-K, dated April 19, 2006, filed with the  Commission on April 20, 2006.                                                                                                                        |
| 10.2             |       | Form of Amended and  Restated Management Agreement by and between the Company and GKK Manager LLC,  incorporated by reference to the Company’s Current Report on Form 8-K,  dated April 19, 2006, filed with the Commission on April 20, 2006.                                                                                                                            |
| 10.3             |       | Form of Amended and  Restated Origination Agreement by and between the Company and SL Green Realty  Corp., incorporated by reference to the Company’s Current Report on  Form 8-K, dated April 19, 2006, filed with the Commission on  April 20, 2006.                                                                                                                    |
| 10.4             |       | Form of Amended and  Restated Asset Servicing Agreement by and between GKK Manager LLC and SLG  Gramercy Services LLC, incorporated by reference to the Company’s Current  Report on Form 8-K, dated April 19, 2006, filed with the  Commission on April 20, 2006.                                                                                                        |
| 10.5             |       | Form of Amended and  Restated Outsource Agreement by and between GKK Manager LLC and SLG Operating  Partnership, L.P., incorporated by reference to the Company’s Quarterly  Report on Form 10-Q for the fiscal quarter ended March 31,  2006.                                                                                                                                 |
| 10.6             |       | Form of Collateral  Management Agreement by and between Gramercy Real Estate CDO 2005-1,  Ltd., as issuer and GKK Manager LLC, as collateral manager, incorporated by  reference to the Company’s Quarterly Report on Form 10-Q for the  fiscal quarter ended June 30, 2005.                                                                                                   |
| 10.7             |       | Collateral Management  Agreement, dated as of August 24, 2006, by and between Gramercy Real  Estate CDO 2006-1, Ltd., as issuer and GKK Manager LLC, as collateral  manager, incorporated by reference to the Company’s Quarterly Report on  Form 10-Q for the fiscal quarter ended September 30, 2006.                                                                        |
| 10.8             |       | Amended and Restated  Master Repurchase Agreement, dated as of  October 13, 2006, by and among Gramercy Warehouse Funding II LLC,  GKK Trading Warehouse II LLC and Goldman Sachs Mortgage Company (incorporated  by reference to Exhibit 10.1 of the Company’s Current Report on  Form 8-K, dated October 13, 2006, filed with the Commission  on October 19, 2006. |
| 10.9             |       | Annex I to Amended and  Restated Master Repurchase Agreement,  dated as of October 13, 2006, by and among Gramercy Warehouse  Funding II LLC, GKK Trading Warehouse II LLC and Goldman Sachs Mortgage  Company, incorporated by reference to the Company’s Current Report on  Form 8-K, dated October 13, 2006, filed with the Commission  on October 19, 2006.           |

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| 10.10 |   | Amended and Restated Master Repurchase Agreement, dated as of October 13, 2006, by and  among Gramercy Warehouse Funding I LLC, GKK Trading Warehouse I LLC,  GKK 450 LEX LLC, and the additional sellers from time to time parties  thereto, the buyers from time to time parties thereto, Wachovia Bank,  National Association, as agent, and Wachovia Capital Markets, LLC, as the  sole lead arranger, incorporated by reference to the Company’s Current Report  on Form 8-K, filed with the Commission on October 19, 2006. |
|-------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.11 |   | Form of Credit  Agreement, by and between the Company and Wachovia Capital Markets, LLC,  incorporated by reference to the Company’s Registration Statement on  Form S-11 (No. 333-114673), declared effective by the  Commission on July 27, 2004.                                                                                                                                                                                                                                                                          |
| 10.12 |   | Form of Indenture  by and among Gramercy Real Estate CDO 2005-1, Ltd., as issuer, Gramercy  Real Estate CDO 2005-1 LLC, as co-issuer, GKK Liquidity LLC, as advancing  agent and Wells Fargo Bank, National Association, as trustee, paying agent,  calculation agent, transfer agent, custodial securities intermediary, backup  advancing agent, notes registrar, incorporated by reference to the Company’s  Quarterly Report on Form 10-Q for the fiscal quarter ended  June 30, 2005.                                        |
| 10.13 |   | Form of 2004 Equity  Incentive Plan, incorporated by reference to the Company’s Registration  Statement on Form S-11 (No. 333-114673), declared  effective by the Commission on July 27, 2004.                                                                                                                                                                                                                                                                                                                               |
| 10.14 |   | Form of Gramercy  Capital Corp. Director’s Deferral Program, incorporated by reference to the  Company’s Quarterly Report on Form 10-Q/A for the fiscal quarter  ended June 30, 2005.                                                                                                                                                                                                                                                                                                                                        |
| 10.15 |   | Form of Gramercy  Capital Corp. 2005 Long-Term Outperformance Program Award Agreement,  incorporated by reference to the Company’s Form 8-K, dated  December 14, 2005, filed with the Commission on December 20, 2005.                                                                                                                                                                                                                                                                                                       |
| 10.16 |   | Form of Employment  Agreement by and between Hugh Hall and GKK Manager LLC, incorporated by  reference to the Company’s Annual Report on Form 10-K for the  fiscal year ended December 31, 2004.                                                                                                                                                                                                                                                                                                                                  |
| 10.17 |   | Form of Employment  Agreement by and between Robert R. Foley and GKK Manager LLC, incorporated by  reference to the Company’s Annual Report on Form 10-K for the  fiscal year ended December 31, 2004.                                                                                                                                                                                                                                                                                                                            |
| 10.18 |   | Form of Second  Amended and Restated Registration Rights Agreement by and between the Company  and SL Green Operating Partnership, L.P., incorporated by reference to the  Company’s Form 8-K, dated April 19, 2006, filed with the  Commission on April 20, 2006.                                                                                                                                                                                                                                                           |
| 10.19 |   | Form of  Registration Rights Agreement, by and between various holders of the  Company’s common stock and the Company, incorporated by reference to the  Company’s Form 8-K, dated December 9, 2004, filed with the  Commission on December 9, 2004.                                                                                                                                                                                                                                                                    |
| 10.20 |   | Form of Purchase  Agreement, by and among the Company and various investors in the Company’s  common stock, incorporated by reference to the Company’s Form 8-K,  dated December 3, 2004 filed with the Commission on December 3,  2004.                                                                                                                                                                                                                                                                                |
| 10.21 |   | Form of Amended and  Restated Trust Agreement by and among GKK Capital LP, as depositor, JPMorgan  Chase Bank, National Association, as property trustee, Chase Bank USA,  National Association, as Delaware trustee, and the administrative trustees  named therein, incorporated by reference to the Company’s Quarterly Report on  Form 10-Q for the fiscal quarter ended June 30, 2005.                                                                                                                                       |
| 10.22 |   | Form of Junior  Subordinated Indenture between GKK Capital LP and JPMorgan Chase Bank,  National Association, as trustee, incorporated by reference to the Company’s  Quarterly Report on Form 10-Q for the fiscal quarter ended  June 30, 2005.                                                                                                                                                                                                                                                                                  |

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| 10.23 |   | Form of Amended and  Restated Trust Agreement among GKK Capital LP, as depositor, JPMorgan Chase  Bank, National Association, as property trustee, Chase Bank USA, National  Association, as Delaware trustee, and the administrative trustees named  therein, incorporated by reference to the Company’s Quarterly Report on  Form 10-Q for the fiscal quarter ended September 30, 2005.                                                                                                                                 |
|-------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.24 |   | Form of Junior  Subordinated Indenture between GKK Capital LP and JPMorgan Chase Bank,  National Association, as trustee, incorporated by reference to the Company’s  Quarterly Report on Form 10-Q for the fiscal quarter ended  September 30, 2005.                                                                                                                                                                                                                                                                     |
| 10.25 |   | Form of Amended and  Restated Trust Agreement among GKK Capital LP, as depositor, JPMorgan Chase  Bank, National Association, as property trustee, Chase Bank USA, National  Association, as Delaware trustee, and the administrative trustees named  therein, dated January 27, 2006, incorporated by reference to the  Company’s Annual Report on Form 10-K for the fiscal year ended  December 31, 2005.                                                                                                          |
| 10.26 |   | Form of Junior  Subordinated Indenture between GKK Capital LP and JPMorgan Chase Bank,  National Association, as trustee, dated January 27, 2006, incorporated  by reference to the Company’s Annual Report on Form 10-K for the  fiscal year ended December 31, 2005.                                                                                                                                                                                                                                               |
| 10.27 |   | Indenture, dated as of  August 24, 2006, by and among Gramercy Real Estate CDO 2006-1,  Ltd., as issuer, Gramercy Real Estate CDO 2006-1 LLC, as co-issuer, GKK  Liquidity LLC, as advancing agent, and Wells Fargo Bank, National  Association, as trustee, paying agent, calculation agent, transfer agent,  custodial securities intermediary, backup advancing agent and notes  registrar, incorporated by reference to the Company’s Quarterly Report on  Form 10-Q for the fiscal quarter ended September 30, 2006. |
| 10.28 |   | Form of  Underwriting Agreement among Gramercy Capital Corp., GKK Capital LP, GKK  Manager LLC and Wachovia Capital Markets, LLC, as underwriter, dated  May 11, 2006, incorporated by reference to the Company’s Form 8-K,  dated May 16, 2006, filed with the Commission on May 17, 2006.                                                                                                                                                                                                                     |
| 10.29 |   | Form of LLC  Agreement, by and between GKK Madison Investment LLC, a wholly-owned  subsidiary of the Company, and SLG Madison Investment LLC, a wholly-owned  subsidiary of SL Green Realty Corp., incorporated by reference to the  Company’s Quarterly Report on Form 10-Q for the fiscal quarter  ended March 31, 2005.                                                                                                                                                                                                |
| 10.30 |   | Form of Sales  Agreement, dated May 10, 2006, by and among the Company, GKK Capital LP,  GKK Manager LLC and Cantor Fitzgerald & Co., incorporated by  reference to the Company’s Quarterly Report on Form 10-Q for the  fiscal quarter ended March 31, 2006.                                                                                                                                                                                                                                               |
| 10.31 |   | Form of Sales  Agreement, dated May 10, 2006, by and among the Company, GKK Capital LP  and Merrill Lynch & Co., Merrill Lynch, Pierce Fenner &  Smith Incorporated, incorporated by reference to the Company’s Quarterly  Report on Form 10-Q for the fiscal quarter ended March 31,  2006.                                                                                                                                                                                                       |
| 21.1  |   | Subsidiaries of the  Registrant, filed herewith.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 23.1  |   | Consent of Independent  Registered Public Accounting Firm, filed herewith.                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 24.1  |   | Power of Attorney  (included on signature page).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 31.1  |   | Certification by the  Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley  Act of 2002, filed herewith.                                                                                                                                                                                                                                                                                                                                                                                                                |
| 31.2  |   | Certification by the  Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley  Act of 2002, filed herewith.                                                                                                                                                                                                                                                                                                                                                                                                                |
| 32.1  |   | Certification by the  Chief Executive Officer pursuant to 18 U.S.C. section 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, filed  herewith.                                                                                                                                                                                                                                                                                                                                                                |
| 32.2  |   | Certification by the Chief Financial Officer  pursuant to 18 U.S.C. section 1350, as adopted pursuant to Section 906  of the Sarbanes-Oxley Act of 2002, filed herewith.                                                                                                                                                                                                                                                                                                                                                                 |

 

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**SIGNATURES**

Pursuantto the requirements of Section 13 or 15(d) of the Securities ExchangeAct of 1934, the registrant has duly caused this report to be signed on itsbehalf by the undersigned, thereunto duly authorized.

|                               | GRAMERCY CAPITAL CORP. |
|-------------------------------|------------------------|
|                          |                   |   |
| Dated: February 28, 2006 | By:                    | /s/ Robert R. Foley |
|                          |                   | Robert R. Foley |
|                          |                   | Chief Financial Officer |

 

KNOW ALL MEN BY THESE PRESENTS, that we, theundersigned officers and directors of Gramercy Capital Corp. hereby severallyconstitute Marc Holliday and Robert R. Foley, and each of them singly, our trueand lawful attorneys and with full power to them, and each of them singly, tosign for us and in our names in the capacities indicated below, the AnnualReport on Form 10-K filed herewith and any and all amendments tosaid Annual Report on Form 10-K, and generally to do all such thingsin our names and in our capacities as officers and directors to enable GramercyCapital Corp. to comply with the provisions of the Securities Exchange Act of1934, and all requirements of the Securities and Exchange Commission, herebyratifying and confirming our signatures as they may be signed by our saidattorneys, or any of them, to said Annual Report on Form 10-K andany and all amendments thereto.

Pursuantto the requirements of the Securities Exchange Act of 1934, this report hasbeen signed below by the following persons on behalf of the registrant and inthe capacities and on the dates indicated:

| Signatures              | ** ** | **Title**                            | ** ** | **Date**               |
|-------------------------|------------|--------------------------------------|------------|------------------------|
|                    |       |                                 |       |                   |
| /s/ Stephen L.  Green   |       | Chairman of the Board of Directors   |       | February 28, 2006 |
| Stephen L. Green        |       |                                 |       |                   |
|                    |       |                                 |       |                   |
| /s/ Marc Holliday       |       | Chief Executive Officer, President   |       | February 28, 2006 |
| Marc Holliday           |       | and Director                         |       |                   |
|                    |       |                                 |       |                   |
| /s/ Robert R.  Foley    |       | Chief Financial Officer              |       | February 28, 2006 |
| Robert R. Foley         |       |                                 |       |                   |
|                    |       |                                 |       |                   |
| /s/ Hugh F. Hall        |       | Chief Operating Officer and Director |       | February 28, 2006 |
| Hugh Hall               |       |                                 |       |                   |
|                    |       |                                 |       |                   |
| /s/ Allan J. Baum       |       | Director                             |       | February 28, 2006 |
| Allan J. Baum           |       |                                 |       |                   |
|                    |       |                                 |       |                   |
| /s/ Jeffrey E.  Kelter  |       | Director                             |       | February 28, 2006 |
| Jeffrey E. Kelter       |       |                                 |       |                   |
|                    |       |                                 |       |                   |
| /s/ Paul J.  Konigsberg |       | Director                             |       | February 28, 2006 |
| Paul J.  Konigsberg     |       |                                 |       |                   |
|                    |       |                                 |       |                   |
| /s/ Charles S.  Laven   |       | Director                             |       | February 28, 2006 |
| Charles S. Laven        |       |                                 |       |                   |

 

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