<PAGE>   1
                                  UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                    FORM 10-K
(mark one)

[X]   ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
      SECURITIES EXCHANGE ACT OF 1934 [FEE REQUIRED]*

                   FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
                                             -----------------
                                       OR

[ ]   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
      SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]

        FOR THE TRANSITION PERIOD FROM ..............TO..................

                          COMMISSION FILE NUMBER 0-9211

                          NATIONAL INCOME REALTY TRUST
             ------------------------------------------------------
             (Exact name of registrant as specified in its charter)

        CALIFORNIA                                          94-2537061
(State or other jurisdiction of                          (I.R.S. Employer
incorporation or organization)                           Identification No.)

280 PARK AVENUE, EAST BUILDING, 20TH FLOOR, NEW YORK, NY          10017
--------------------------------------------------------       ----------
 (Address of principal executive offices)                      (Zip Code)

Registrant's telephone number, including area code   (212) 949-5000
                                                     ---------------

          Securities registered pursuant to Section 12 (b) of the Act:

                                      NONE

          Securities registered pursuant to Section 12 (g) of the Act:

                   SHARES OF BENEFICIAL INTEREST, NO PAR VALUE

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]

As of March 13, 1998, the registrant had 3,809,829 shares of beneficial interest
outstanding. Of the total shares outstanding, 2,495,637 were held by other than
those who may be deemed to be affiliated, for an aggregate value of $43,985,602
based on the last trade as reported by the National Association of Securities
Dealers Automated Quotations System on March 13, 1998. The basis of this
calculation does not constitute a determination by the registrant that all of
such persons or entities are affiliates of the registrant as defined in rule 405
of the Securities Act of 1933, as amended.


                       DOCUMENTS INCORPORATED BY REFERENCE
                                      NONE

                                       1
<PAGE>   2

                                    INDEX TO
                           ANNUAL REPORT ON FORM 10-K


<TABLE>
<CAPTION>
                                                                                  Page
                                                                                  ----
                                     PART I
<S>  <C>                                                                           <C>
Item 1.   Business..............................................................   3

Item 2.   Properties............................................................   6

Item 3.   Legal Proceedings.....................................................  15

Item 4.   Submission of Matters to a Vote of Security Holders...................  15

                                     PART II

Item 5.   Market for Registrant's Shares of Beneficial Interest and Related
             Shareholder Matters................................................  16

Item 6.   Selected Financial Data...............................................  17

Item 7.   Management's Discussion and Analysis of Financial Condition and
             Results of Operations..............................................  20

Item 7A.  Quantitative and Qualitative Disclosures About Market Risk............  30

Item 8.   Financial Statements and Supplementary Data...........................  31

Item 9.   Changes in and Disagreements with Accountants on Accounting and
             Financial Disclosure...............................................  68

                                    PART III

Item 10.  Trustees, Executive Officers, and Advisor of the Registrant...........  68

Item 11.  Executive Compensation................................................  78

Item 12.  Security Ownership of Certain Beneficial Owners and Management........  79

Item 13.  Certain Relationships and Related Transactions........................  82

                                     PART IV

Item 14.  Exhibits, Financial Statement Schedules, and Reports on Form 8-K......  85

          Signature Page........................................................  87
</TABLE>



                                       2
<PAGE>   3


                                    PART I

ITEM 1.  BUSINESS

General

National Income Realty Trust (the "Trust") was organized as a California
business trust pursuant to a declaration of trust dated October 31, 1978, (as
amended, the "Declaration of Trust") and commenced operations on March 27, 1979.
The Trust elected to be treated as a Real Estate Investment Trust ("REIT"), as
defined under Sections 856 through 860 of the Internal Revenue Code of 1986 (the
"Code") and, in the opinion of the Trust's management, has continuously
qualified for federal taxation as a REIT.

The Trust's principal offices are located at 280 Park Avenue, East Building,
20th Floor, New York, New York 10017. The telephone number is (212) 949-5000,
and the facsimile number is (214) 949-8001. In the opinion of the Trust's
management, these offices are suitable and adequate for its present operations.

Business Plan and Investment Policy

The Trust's business and only industry segment is investing in and developing
income-producing real estate directly and through partnerships and joint
ventures. At December 31, 1997, the Trust's real estate portfolio consisted of
61 properties, including 40 multifamily properties, 14 shopping centers, three
office buildings, three parcels of land, and one single family residence,
located throughout the continental United States, with concentrations in
Florida, Texas, California, and Colorado. The Trust also held investments in
eight real estate partnerships reported on the equity method (owning three
office buildings and six apartment complexes, four of which are under
construction). Due to the nature and diversity of the Trust's properties and
tenants, the Trust's business is not significantly affected by seasonal factors.

The Trust's acquisition strategy is opportunistic but focused on acquiring
properties that add to the efficiency of the Trust's portfolio. For example, all
13 of the apartment properties purchased by the Trust since the beginning of
1995 were in markets where the Trust already had a presence. Unlike most REITs,
the Trust acquires older and often troubled properties that are not considered
of institutional quality as well as better performing, new, or high quality
properties. The Trust has a policy of continuously improving and upgrading its
older properties in order to achieve increased revenues. During 1997, $16.9
million in capital expenditures were made to the operating apartment portfolio.
In addition, $1.4 million ($177 per unit) was expensed for recurring
replacements and repairs and maintenance. Management believes that a significant
portion of such expenditures was required to remedy deferred maintenance
existing at the time of acquisition and to upgrade maintenance and curb appeal.
Accordingly, such expenses are expected to decline on a per unit basis as the
proportion of stabilized properties in the Trust's portfolio increases.

The Trust has financed acquisitions and capital improvements largely through
mortgages and internally generated funds. As a matter of policy, cash
distributions have been held to less than fifty percent of funds from operations
("FFO"), as defined by the National Association of Real Estate Investment Trusts
(see ITEM 6. "SELECTED FINANCIAL DATA - Other Data" for the definition of FFO).
Funds for investment have also been generated by property sales and from the
collection of mortgages receivable, which will not be a material future source.
Accordingly, property sales and proceeds realized from financing or refinancing
are expected to provide the bulk of funds available for investment. In this
regard, the availability and cost of long term mortgage funds are key factors in
the Trust's ability to continue to make new investments without additional
equity offerings.




                                       3
<PAGE>   4
ITEM 1.  BUSINESS (Continued)

Possible Consolidation with Tarragon Realty Investors, Inc.

On February 19, 1998, the Trust and Tarragon Realty Investors, Inc., ("TRI")
jointly announced the agreement of their respective boards to form a single
consolidated entity with TRI, for convenience, as the survivor. The surviving
consolidated entity is intended to operate as a self-administered REIT. The
consolidation transaction will be submitted to shareholders of each of the Trust
and TRI for approval at special meetings to be held during 1998. Under the
proposed agreement, each shareholder of the Trust will receive 1.97 shares of
TRI common stock for each share of beneficial interest of the Trust held. TRI,
also a REIT, has a similar opportunistic approach to real estate investment and
had total consolidated assets of approximately $37 million as of December 31,
1997. Upon the approval and consummation of the consolidation transaction by the
respective shareholders of each entity, TRI will acquire Tarragon Realty
Advisors, Inc. ("Tarragon" or the "Advisor"), the Trust's advisor since April 1,
1994, and TRI's advisor since March 1, 1994, for 100,000 shares of common stock
of TRI and options to acquire additional shares of common stock of TRI at prices
ranging between $13 and $16 per share. The resulting consolidated enterprise
with TRI as the survivor will emerge from these transactions as an integrated,
self-administered, self-managed REIT controlling approximately 14,000 apartment
units and 2.1 million square feet of retail and office space, primarily in
California, Florida, and Texas. The consolidation transaction will be accounted
for as a reverse acquisition of TRI by the Trust.

William S. Friedman, President, Chief Executive Officer, and Trustee of the
Trust, also serves as Director and Chief Executive Officer of Tarragon and as
Director, President, and Chief Executive Officer of TRI. Tarragon is owned by
Mr. Friedman and his wife, Lucy N. Friedman. The Friedman family also owns
approximately 30% of the outstanding shares of common stock of TRI and
approximately 33% of the outstanding shares of beneficial interest of the Trust.

Management of the Trust

The Board of Trustees (the "Board"), elected annually by the shareholders or
appointed by the incumbent Board until the next annual shareholder meeting, is
responsible for managing the affairs of the Trust. There are currently eight
members on the Board, seven of whom are unaffiliated with the Trust. Day-to-day
management is performed by Tarragon, which operates under the supervision of the
Board pursuant to a written advisory agreement approved by shareholders.
Tarragon's duties include, among other things, locating, investigating,
evaluating, and recommending real estate investment and sale opportunities and
financing and refinancing sources for the Trust. The Advisor also serves as a
consultant in connection with the business plan and investment policy decisions
made by the Board. A majority of the officers of the Trust are also officers of
Tarragon. The Trust has no employees. Employees of Tarragon provide executive
and administrative services to the Trust.

Tarragon also serves as the advisor to TRI. All of the officers of the Trust are
also officers of TRI. Tarragon and the Trust officers owe fiduciary duties to
TRI as well as to the Trust. Historically, in determining to which entity to
allocate a particular investment opportunity, Tarragon and the Trust officers
have considered the respective investment objectives of each entity and the
appropriateness of a particular investment in light of each entity's existing
real estate portfolio. To the extent that any particular investment opportunity
is appropriate for both entities, such investment opportunity has been allocated
to the entity which had uninvested funds for the longer period of time, or, if
appropriate, the investment has been shared between the entities. Tarragon
periodically informs the Board of real estate investments made by any of its
affiliates, and the Board periodically reviews the performance of such other
investments.




                                       4
<PAGE>   5

ITEM 1. BUSINESS (Continued)

Property Management

Since April 1, 1994, Tarragon has provided property management services to the
Trust for a fee of 4.5% of the monthly gross rents collected on multifamily
properties and 1.5% to 5% of the monthly gross rents collected on commercial
properties. Tarragon subcontracts with other entities for the provision of some
of the property-level management services to the Trust. Beginning April 1, 1996,
Tarragon Management, Inc. ("TMI"), a wholly-owned subsidiary of Tarragon,
assumed the property-level management of most of the Trust's properties for a
fee of 4.5% of the monthly gross rents collected.

Competition

The Trust has not experienced difficulty in locating investment opportunities.
Management believes that ownership of properties in which the Trust invests is
highly fragmented among individuals, partnerships, public and private
corporations, and other REITs. No single entity or person dominates the market
for such properties. At any given time, a significant number of multifamily
properties are available for purchase in the various markets where the Trust
seeks additional acquisitions. Management believes that there is and will
continue to be a strong demand for well-maintained, affordable housing in these
markets and that the factors discussed above provide a market where a sufficient
number of attractive investment opportunities will be available to allow the
Trust to continue to expand through acquisitions as well as through the
development of new properties. However, since the success of any multifamily
real estate investment is impacted by other factors outside the control of the
Trust, including general demand for apartment living, interest rates, operating
costs, and the ability to attract and retain qualified property managers, there
can be no assurances that the Trust will be successful in its plan to continue
to expand through acquisitions.

Certain Factors Associated with Real Estate and Related Investments

The Trust is subject to the risks associated with ownership, operation, and
financing of real estate. These risks include, but are not limited to, liability
for environmental hazards; changes in general or local economic conditions;
changes in interest rates and the availability of permanent mortgage financing
which may render the acquisition, sale, or refinancing of a property difficult
or unattractive and which may make debt service burdensome; changes in real
estate and zoning laws; changes in income taxes, real estate taxes, or federal
or local economic or rent controls; floods, earthquakes, and other acts of
nature; and other factors beyond the control of the Trust or Tarragon. The
illiquidity of real estate investments generally may impair the ability of the
Trust to respond promptly to changing circumstances. The Trust's management
believes that some of these risks are partially mitigated by the diversification
by geographic region and property type of the Trust's real estate. However, to
the extent new investments continue to be concentrated in any particular region
or property type, the advantages of diversification may diminish.




                                       5
<PAGE>   6
ITEM 2.  PROPERTIES

Details of the Trust's real estate portfolio at December 31, 1997, are set forth
in Schedule III to the Consolidated Financial Statements and NOTE 3. "REAL
ESTATE AND DEPRECIATION" of the Notes to Consolidated Financial Statements, both
included at ITEM 8. "FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA." The
discussion set forth below provides certain summary information concerning the
Trust's real estate. To continue to qualify for federal taxation as a REIT under
the Code, the Trust is required, among other things, to hold at least 75% of the
value of its assets in real estate assets, government securities, and cash and
cash equivalents at the close of each quarter of each taxable year. At December
31, 1997, 88% of the Trust's assets consisted of equity investments in real
estate, 5% consisted of investments in partnerships which own real estate, and
2% consisted of cash and cash equivalents. The remaining 5% of the Trust's
assets at December 31, 1997, was restricted cash and other assets. It should be
noted, however, that the percentage of the Trust's assets invested in any one
category at any particular time is subject to change, and no assurance can be
given that the composition of the Trust's assets in the future will approximate
the percentages listed above.

During 1996 and 1997, the Trust purchased seven multifamily properties and one
shopping center, added one multifamily property to its portfolio by increasing
its interest in the partnership that owns it to 90%, acquired one shopping
center through a deed in lieu of foreclosure of collateral securing a mortgage
note receivable, and sold three multifamily properties and one office building.
Its multifamily portfolio consists of 7,987 operating apartments and 1,062
apartment units under construction which are owned by unconsolidated
partnerships. At December 31, 1997, the Trust's real estate portfolio consisted
of 61 properties, 53 of which were held for investment. The remaining eight
properties, some of which were obtained through foreclosure of collateral
securing the Trust's mortgage notes receivable, were held for sale. Eleven Trust
properties with an aggregate carrying value of $27.6 million were held free and
clear. The other 50 Trust properties were pledged to secure mortgages totaling
$182.5 million at December 31, 1997.

A summary of 1997 activity in the Trust's owned real estate portfolio is as
follows:

<TABLE>
<S>                                                                               <C>
      Properties owned at January 1, 1997................................         58
      Properties purchased...............................................          6
      Property consolidated due to increased partnership interest........          1
      Properties sold....................................................         (3)
      Condemned property written off.....................................         (1)
                                                                               -----
      Properties owned at December 31, 1997..............................         61
                                                                               =====
</TABLE>












                     [This space intentionally left blank.]



                                       6
<PAGE>   7
ITEM 2.  PROPERTIES (Continued)

The Trust has divided the continental United States into the following six
geographic regions.

                                      [MAP]

[Northeast region comprised of the states of Connecticut, Delaware, Maine,
       Maryland, Massachusetts, New Hampshire, New Jersey, New York,
       Pennsylvania, Rhode Island, and Vermont and the District of Columbia.

Southeast region comprised of the states of Alabama, Florida, Georgia,
       Mississippi, North Carolina, South Carolina, Tennessee, and Virginia.

Southwest region comprised of the states of Arizona, Arkansas, Louisiana, New
       Mexico, Oklahoma, and Texas.

Midwest region comprised of the states of Illinois, Indiana, Iowa, Kansas,
       Kentucky, Michigan, Minnesota, Missouri, Nebraska, North Dakota, Ohio,
       South Dakota, West Virginia, and Wisconsin.

Mountain region comprised of the states of Colorado, Idaho, Montana, Nevada,
       Utah, and Wyoming.

Pacific region comprised of the states of California, Oregon, and Washington.]

At December 31, 1997, the Trust held investments in each of the geographic
regions of the continental United States, although its multifamily properties
were concentrated in the Southeast and Southwest, as shown more specifically in
the table below.

The following table sets forth the percentages, by property type and geographic
region, of the Trust's operating real estate (other than unimproved land and the
single-family residence) at December 31, 1997:

<TABLE>
<CAPTION>
                                          Multifamily             Commercial
               Region                     Properties              Properties
               ------                     ----------              ----------
<S>                                       <C>                    <C>
               Northeast                        5.9%                     -
               Southeast                       52.8%                   55.6%
               Southwest                         25%                   10.5%
               Midwest                          8.5%                   21.3%
               Mountain                         6.1%                    3.6%
               Pacific                          1.7%                      9%
</TABLE>

The foregoing table is based solely on the number of operating apartment units
and amount of commercial square footage owned by the Trust and does not reflect
the value of the investments in each region.

                                       7
<PAGE>   8
ITEM 2.  PROPERTIES (Continued)

Types of Real Estate Investments. The Trust's real estate consists of
multifamily and commercial properties, primarily office buildings and shopping
centers, or similar properties having established income-producing capabilities.
In selecting real estate for investment, the Trust concentrates on properties
for which intensive management coupled with capital improvements can materially
increase value. The Trust favors buying or developing properties in areas in
which the Advisor has current market knowledge. The location, age, and type of
property, gross rentals, lease terms, financial and business standing of
tenants, operating expenses, fixed charges, land values, and physical condition
are also considered. The Trust may acquire properties subject to, or assume,
existing debt and may mortgage, pledge, or otherwise obtain financing for a
portion of its real estate. The Board may alter the types of and criteria for
selecting new equity investments and for obtaining financing without a vote of
shareholders to the extent such policies are not governed by the Declaration of
Trust.

Although the Trust has traditionally invested in a wide variety of developed,
income-producing real estate, the Trust intends to invest increasing amounts in
major apartment renovations and new construction or development projects either
directly or in partnership with others. To the extent the Trust invests in
construction and development projects, it is subject to the business risks, such
as cost overruns and delays, associated with such higher risk activities. The
Trust purchased The Vistas at Lake Worth ("The Vistas") in Fort Worth, Texas, in
December 1994. The Trust has invested $13 million in the expansion and
redevelopment of this property. Operations began at this property in December
1997, and the redevelopment of The Vistas was completed in the first quarter of
1998. During 1997, the Trust acquired interests in four partnerships that were
each established to construct a luxury apartment complex.

The following table presents the properties to be constructed by each
partnership:

<TABLE>
<CAPTION>
                                                                                      Number     Estimated        Expected Date
      Partnership                       Property                    Location         of Units      Cost           of Completion
  ----------------                    -------------------------    ----------------  --------  -------------    ------------------
<S>                                   <C>                          <C>               <C>       <C>              <C>
  RI Windsor, Ltd.                    Mayfaire at Windsor Parke    Jacksonville, FL     324    $18.6 million    First Quarter 1998
  RI Panama City, Ltd.                Harbour Green                Panama City, FL      200    $10.5 million    Second Quarter 1998
  Danforth National Apartments, Ltd.  The Club at Danforth         Jacksonville, FL     288    $17.1 million    Third Quarter 1998
  Tarragon Savannah, L.P.             The Links at Georgetown      Savannah, GA         250    $14.5 million    Second Quarter 1999
</TABLE>

For more information on properties owned through partnerships, see the
discussion below under "Partnership Properties."

The following table presents certain information relating to real estate owned
and mortgage loans secured by the Trust's real estate at December 31, 1997. The
Trust also owns three parcels of land and a house held for rental which are not
included in the table.




                                       8
<PAGE>   9
                          NATIONAL INCOME REALTY TRUST
                               REAL ESTATE SUMMARY
                                DECEMBER 31, 1997
                                   (Unaudited)

<TABLE>
<CAPTION>
                                                                               Average Rent Per Sq. Ft.(a)   Current
                                                        Number                   Year Ended December 31,     Market
                                                         of         Square      --------------------------   Rent Per
Property                     Location                   Units      Footage       1997      1996      1995   Sq. Foot(b)
--------                     --------                 ---------    ---------    ------    ------    ------  ----------
<S>                          <C>                       <C>         <C>          <C>       <C>       <C>     <C>
PROPERTIES ACQUIRED PRIOR TO DECEMBER 31, 1995:
Apartments:
Acadian Place                Baton Rouge, LA                120      143,450    $ 4.04    $ 3.74    $ 3.62    $ 5.68
Bay West                     Bradenton, FL                  299      323,774      5.17      5.22      5.35      6.55
Bayfront                     Houston, TX                    200      172,720      5.61      5.56      5.92      7.56
Bryan Hill                   Bethany, OK                    232      193,500      4.77      4.59      4.36      5.55
Carlyle Towers               Detroit, MI                    163      247,850      5.41      5.39      5.27      6.42
Cornell                      Los Angeles, CA                 55       30,150     13.70     12.70     12.06     15.00
Creekwood North              Altamonte Springs, FL          180      166,500      5.99      5.56      5.07      7.07
Cross Creek                  Lexington, KY                  144      102,258      7.32      7.14      6.91      9.01
Devonshire/Dunhill/
   Sandstone                 Denver, CO                     760      317,050     11.09      9.62      8.05     13.82
Diamond Loch                 Fort Worth, TX                 138      139,354      5.78      5.57      4.96      6.84
Fenway Hall                  Los Angeles, CA                 53       27,175     11.39     11.68     11.04     12.79
Forest Oaks                  Lexington, KY                  154      132,460      5.71      5.68      5.49      6.78
Heather Hills                Temple Hills, MD               459      401,029      7.83      7.87      8.61     10.24
Kirklevington                Lexington, KY                  126       99,080      6.77      6.56      5.97      7.94
Lake Point                   Memphis, TN                    540      540,160      4.25      3.92      3.68      5.37
Marina Park                  North Miami, FL                 90       86,850      8.89      7.76      6.55     10.49
Mariposa Manor               Los Angeles, CA                 41       19,710      7.48      9.25      9.03     10.35
Martins Landing              Lakeland, FL                   236      207,704      6.49      6.41      6.15      7.10
Meadowbrook                  Baton Rouge, LA                200      127,524      7.09      6.76      6.65      8.36
Mustang Creek                Arlington, TX                  120      167,880      5.19      5.11      5.06      6.79
Palm Court                   North Miami, FL                144      125,280      7.61      7.47      7.25      8.76
Park Dale Gardens            Dallas, TX                     224      206,640      5.36      5.26      5.04      6.68
Park Norton                  Los Angeles, CA                 55       25,208      8.43      7.48      4.51     10.44
Park Place                   Los Angeles, CA                 39       15,640      8.42      8.15      2.04     11.10
Pinecrest                    Ft. Lauderdale, FL             326      226,065     12.86     12.06     11.42     14.94
Prado Bay                    N. Bay Village, FL             123      109,756      9.64      8.72      8.45     10.40
Spring Pines                 Houston, TX                    136      118,430      5.45      5.27      4.93      6.29
Summit on the Lake           Fort Worth, TX                 198      138,262      7.53      7.51      7.11      8.85
Woodcreek (CO)               Denver, CO                     120       99,622      8.64      8.36      7.97      9.46
Woodcreek (FL)               Jacksonville, FL               260      198,623      7.30      6.82      6.33      7.88
                                                      ---------    ---------    ------    ------    ------    ------
SUBTOTAL OR WEIGHTED AVERAGE (e)                          5,935    4,909,704      6.83      8.44      8.76     11.07
                                                      ---------    ---------    ------    ------    ------    ------

Office Buildings:
Emerson Center               Atlanta, GA                     --      126,979     10.13      7.51      5.47     12.81
NW O'Hare                    Des Plaines, IL                 --      105,363     12.30     11.38     10.94     15.39
Rancho Sorrento              San Diego, CA                   --      147,973      7.14      6.83      4.74      9.97
                                                      ---------    ---------    ------    ------    ------    ------
SUBTOTAL OR WEIGHTED AVERAGE (e)                             --      380,315      9.57      8.32      6.70     12.42
                                                      ---------    ---------    ------    ------    ------    ------
<CAPTION>
                                                        Economic Occupancy(c)
                                                        Year Ended December 31,          Physical
                                                        -----------------------          Occupancy
Property                     Location                    1997     1996    1995       Dec. 31, 1997 (d)
--------                     --------                    ----     ----    ----       -----------------
<S>                                                       <C>      <C>     <C>      <C>
PROPERTIES ACQUIRED PRIOR TO DECEMBER 31, 1995:
Apartments:
Acadian Place                Baton Rouge, LA              85%      84%     85%             89%
Bay West                     Bradenton, FL                90%      92%     94%             94%
Bayfront                     Houston, TX                  83%      84%     92%             94%
Bryan Hill                   Bethany, OK                  93%      93%     91%             91%
Carlyle Towers               Detroit, MI                  91%      91%     93%             94%
Cornell                      Los Angeles, CA              97%      95%     94%             96%
Creekwood North              Altamonte Springs, FL        94%      90%     89%             94%
Cross Creek                  Lexington, KY                89%      91%     90%             82%
Devonshire/Dunhill/
   Sandstone                 Denver, CO                   92%      88%     80%             95%
Diamond Loch                 Fort Worth, TX               91%      95%     91%             93%
Fenway Hall                  Los Angeles, CA              95%      97%     92%             98%
Forest Oaks                  Lexington, KY                91%      92%     93%             86%
Heather Hills                Temple Hills, MD             87%      87%     92%             93%
Kirklevington                Lexington, KY                92%      91%     91%             86%
Lake Point                   Memphis, TN                  91%      85%     83%             90%
Marina Park                  North Miami, FL              92%      88%     88%             91%
Mariposa Manor               Los Angeles, CA              81%      93%     90%            100%
Martins Landing              Lakeland, FL                 95%      95%     96%             95%
Meadowbrook                  Baton Rouge, LA              93%      94%     92%             94%
Mustang Creek                Arlington, TX                85%      89%     93%             90%
Palm Court                   North Miami, FL              91%      93%     96%             89%
Park Dale Gardens            Dallas, TX                   89%      95%     96%             95%
Park Norton                  Los Angeles, CA              90%      81%     51%             87%
Park Place                   Los Angeles, CA              87%      85%     43%             90%
Pinecrest                    Ft. Lauderdale, FL           93%      92%     90%             97%
Prado Bay                    N. Bay Village, FL           96%      92%     92%             97%
Spring Pines                 Houston, TX                  94%      95%     93%             93%
Summit on the Lake           Fort Worth, TX               93%      95%     95%             89%
Woodcreek (CO)               Denver, CO                   95%      96%     95%             99%
Woodcreek (FL)               Jacksonville, FL             95%      94%     94%             95%
                                                         ---      ---     ---             ---
SUBTOTAL OR WEIGHTED AVERAGE (e)                          91%      90%     90%             92%
                                                         ---      ---     ---             ---

Office Buildings:
Emerson Center               Atlanta, GA                  85%      65%     55%             90%
NW O'Hare                    Des Plaines, IL              89%      88%     78%             87%
Rancho Sorrento              San Diego, CA                83%      80%     63%             83%
                                                         ---      ---     ---             ---
SUBTOTAL OR WEIGHTED AVERAGE (e)                          85%      77%     65%             87%
                                                         ---      ---     ---             ---
</TABLE>


                                        9
<PAGE>   10
                          NATIONAL INCOME REALTY TRUST
                         REAL ESTATE SUMMARY (CONTINUED)
                                DECEMBER 31, 1997
                                   (Unaudited)
<TABLE>
<CAPTION>
                                                                                Average Rent Per Sq. Ft.(a)  Current
                                                           Number                Year Ended December 31,      Market
                                                            of       Square     --------------------------   Rent Per
Property                     Location                      Units     Footage     1997      1996      1995   Sq. Foot(b)
--------                     --------                       ---      -------    ------    ------    ------  -----------
<S>                                                         <C>      <C>        <C>       <C>       <C>       <C>
PROPERTIES ACQUIRED PRIOR TO DECEMBER 31,1995:
Shopping Centers:
Emerson Center               Atlanta, GA                    --       17,733    $12.86    $13.61    $12.41     $14.31
K-Mart Plaza                 Charlotte, NC (f)              --      117,200       .47      0.39      0.42       2.57
K-Mart Plaza                 Temple Terrace, FL             --       63,887      3.65      3.65      3.65       3.65
K-Mart Plaza                 Thomasville, GA (g)            --       55,552      2.96      2.96      2.96       2.96
Lakeview Mall                Manitowoc, WI                  --      214,620       .74      1.43      1.33       2.98
Midland Plaza                Midland, MI                    --       30,650      3.38      3.38      3.38       3.38
Midway Mills                 Carrollton, TX                 --       72,065      9.74      9.70      8.91      10.96
Mountain View                Las Vegas, NV                  --       20,092     10.68     10.17      9.80      10.76
Northside Mall               Gainesville, FL (h)            --      139,337      3.84      3.93      3.86       4.11
Southgate                    Waco, TX                       --       80,725      2.48      2.47      2.93       5.25
Stewart Square               Las Vegas, NV                  --       39,600      9.43      8.96      8.04      11.07
Times Square                 Lubbock, TX                    --       19,550      5.07      4.72      3.38       6.21
                                                     ---------    ---------    ------    ------    ------     ------
SUBTOTAL OR WEIGHTED AVERAGE (e)                            --      871,011      3.52      3.67      3.51       4.89
                                                     ---------    ---------    ------    ------    ------     ------

SUBTOTAL PRIOR TO ACQUISITIONS (e)                          --    6,161,030      6.58      7.75      7.89      10.28
                                                     ---------    ---------    ------    ------    ------     ------
1996 Acquisitions:
River City Landing           Jacksonville, FL              352      356,800      2.99      2.79        --       6.46
The Regent                   Jacksonville, FL (i)          304      288,320      3.74      1.74        --       6.09
Woodbrier                    Oklahoma City, OK             128      114,900      4.63      4.59        --       5.50
Jackson Square               Jackson, MS (j)                --      341,361      1.23      1.32        --       3.27
                                                     ---------    ---------    ------    ------    ------     ------
SUBTOTAL OR WEIGHTED AVERAGE (e)                           784    1,101,381      2.81      2.24        --       5.27
                                                     ---------    ---------    ------    ------    ------     ------
1997 Acquisitions:
English Village              Memphis, TN                   300      364,680      4.70        --        --       5.43
Fountainhead                 Kissimmee, FL                 184      172,578      7.78        --        --       8.85
Landmark                     Tallahassee, FL               128      113,720      3.71        --        --       6.69
Morningside                  Jacksonville, FL              112       89,200      5.90        --        --       7.09
Newport                      Plantation, FL                152      139,364      7.71        --        --       9.37
Courtyard at the Park        Miami, FL                     127      117,250      4.96        --        --       8.75
Mariner Plaza                Tallahassee, FL                --       52,288      5.34        --        --       6.01
Vistas at Lake Worth         Fort Worth, TX (k)            265      188,120       .04        --        --      13.00
                                                     ---------    ---------    ------    ------    ------     ------
SUBTOTAL OR WEIGHTED AVERAGE (e)                         1,268    1,237,200      4.81        --        --       8.08
                                                     ---------    ---------    ------    ------    ------     ------

ACQUISITIONS SUBTOTAL OR WEIGHTED AVERAGE (e)            2,052    2,338,581      3.87      2.24        --       6.76
                                                     ---------    ---------    ------    ------    ------     ------
GRAND TOTAL                                              7,987    8,499,611      5.80      6.92      7.89       9.31
                                                     =========    =========    ======    ======    ======     ======
<CAPTION>
                                                    Economic Occupancy(c)
                                                    Year Ended December 31,       Physical
                                                    -----------------------       Occupancy
Property                     Location                1997     1996    1995      Dec. 31, 1997 (d)
--------                     --------                ----     ----    -----     -----------------
<S>                                                   <C>    <C>    <C>         <C>
PROPERTIES ACQUIRED PRIOR TO DECEMBER 31,1995:
Shopping Centers:
Emerson Center               Atlanta, GA               91%    100%     96%               77%
K-Mart Plaza                 Charlotte, NC (f)         27%     21%     21%                3%
K-Mart Plaza                 Temple Terrace, FL       100%    100%    100%              100%
K-Mart Plaza                 Thomasville, GA (g)      100%    100%    100%              100%
Lakeview Mall                Manitowoc, WI             30%     43%     45%               38%
Midland Plaza                Midland, MI              100%    100%    100%              100%
Midway Mills                 Carrollton, TX            93%     99%     95%               94%
Mountain View                Las Vegas, NV            100%    100%    100%              100%
Northside Mall               Gainesville, FL (h)       94%     94%     94%               98%
Southgate                    Waco, TX                  51%     50%     64%               43%
Stewart Square               Las Vegas, NV             93%     92%     87%               94%
Times Square                 Lubbock, TX               83%     80%     59%               80%
                                                     ----    ----    ----              ----
SUBTOTAL OR WEIGHTED AVERAGE (e)                       66%     69%     70%               64%
                                                     ----    ----    ----              ----

SUBTOTAL PRIOR TO ACQUISITIONS (e)                     87%     87%     86%               88%
                                                     ----    ----    ----              ----

1996 Acquisitions:
River City Landing           Jacksonville, FL          54%     55%     --                76%
The Regent                   Jacksonville, FL (i)      67%     31%     --                88%
Woodbrier                    Oklahoma City, OK         94%     97%     --                89%
Jackson Square               Jackson, MS (j)           38%     46%     --                40%
                                                     ----    ----    ----              ----
SUBTOTAL OR WEIGHTED AVERAGE (e)                       57%     50%     --                69%
                                                     ----    ----    ----              ----
1997 Acquisitions:
English Village              Memphis, TN               95%     --      --                93%
Fountainhead                 Kissimmee, FL             96%     --      --                96%
Landmark                     Tallahassee, FL           75%     --      --                73%
Morningside                  Jacksonville, FL          93%     --      --                95%
Newport                      Plantation, FL            86%     --      --                85%
Courtyard at the Park        Miami, FL                 68%     --      --                49%
Mariner Plaza                Tallahassee, FL           90%     --      --                88%
Vistas at Lake Worth         Fort Worth, TX (k)         1%     --      --                 2%
                                                     ----    ----    ----              ----
SUBTOTAL OR WEIGHTED AVERAGE (e)                       75%     --      --                72%
                                                     ----    ----    ----              ----

ACQUISITIONS SUBTOTAL OR WEIGHTED AVERAGE (e)          66%     50%     --                71%
                                                     ----    ----    ----              ----
GRAND TOTAL                                            81%     81%     86%               83%
                                                     ====    ====    ====              ====
</TABLE>

                                       10
<PAGE>   11
                          NATIONAL INCOME REALTY TRUST
                         REAL ESTATE SUMMARY (CONTINUED)
                                DECEMBER 31, 1997
                                   (Unaudited)



(a)   Amounts represent rental revenue per square foot on an annual basis.
      Rental revenue is equal to gross potential rent after giving effect to all
      rental losses including bad debts, vacancies, and discounts and
      concessions. Gross potential rent equals actual lease rates on leased
      units/space and market rates on vacant units/space.

(b)   Represents annualized market rate per square foot at December 31, 1997,
      based upon scheduled rents at such time.

(c)   Computed as follows: [(Annual gross potential rent less annual vacancy
      losses) divided by annual gross potential rent].

(d)   Represents actual physical occupancy as of the end of the last week of the
      fiscal year ended December 31, 1997.

(e)   The weighted average rent per square foot and occupancy are based on the
      square footage in each property.

(f)   K-Mart's lease expired January 1994. At December 31, 1997, space had not
      been re-leased.

(g)   Lease expires September 2004. During the first quarter of 1995, K-Mart
      moved out and sublet the space to two tenants.

(h)   K-Mart's lease expires September 2002. K-Mart moved out in 1993 and
      continues to pay the scheduled rent on the portion of the space it has not
      sublet.

(i)   For the purpose of this schedule, this property is included with 1996
      acquisitions because operations began during 1996 although the property
      was purchased in 1995.

(j)   This property was acquired through a deed in lieu of foreclosure in
      January 1996.

(k)   For purposes of this schedule, this property is included with 1997
      acquisitions because operations began during 1997 although the property
      was purchased in 1994.

Management believes that its properties are adequately covered by liability and
casualty insurance, consistent with industry standards.






                                       11
<PAGE>   12



                          NATIONAL INCOME REALTY TRUST
                   MORTGAGE LOANS SECURED BY OWNED PROPERTIES
                                DECEMBER 31, 1997
                             (Dollars in thousands)
                                   (Unaudited)

<TABLE>
<CAPTION>
                                                                                          Stated                         Balance
                                                     Original            Balance         Interest      Maturity          Due at
Name of Property                                      Amount           Dec 31, 1997       Rate (A)      Date            Maturity
----------------                                      ------           ------------       --------      ----            --------
Residential
<S>                                                <C>                 <C>                  <C>         <C>            <C>
    Acadian Place (B) ..................           $   2,775           $   2,775            8.47%      Jun -00          $  2,775
    Bay West............................               5,100               4,841            8.89%      Jan -19                --
    Bayfront............................               2,086               2,013            8.99%      Jul -00             1,953
    Bryan Hill..........................               3,500               3,500            6.93%      Jan -08             2,998
    Carlyle Towers......................               4,500               3,844           10.19%      Mar -99             3,625
    Cornell.............................               1,623               1,490            8.50%      Jan -99             1,467
    Courtyard at the Park...............               2,973               2,953            7.38%      Dec -00             2,779
    Creekwood North.....................               3,050               3,009            8.05%      May -06             2,683
    Cross Creek.........................               2,720               2,716            7.54%      Oct -07             2,363
    Dunhill/Devonshire/Sandstone (B)....              13,200              13,200            8.47%      Jun -00            13,200
    English Village.....................               6,200               6,019            7.56%      Dec -05             4,965
    Fenway Hall.........................               1,375               1,303            8.50%      Oct -98             1,288
    Forest Oaks.........................               3,075               3,015            8.16%      Jun -06             2,501
    Fountainhead (B) ...................               5,650               5,650            8.47%      Jun -00             5,650
    Heather Hills.......................              16,790              16,865            7.88%      Jan -31               117
    Kirklevington.......................               2,470               2,415            9.00%      Nov -99             2,364
    Lake Point (B) .....................               9,000               9,000            8.47%      Jun -00             9,000
    Landmark............................               1,500               1,500            8.47%      Jun -00             1,500
    Marina Park.........................               2,500               2,403            9.00%      May -98             2,388
    Mariposa Manor......................                 784                 757            8.13%      Apr -02               703
    Martins Landing.....................               5,000               4,856            7.65%      Dec -05             4,014
    Meadowbrook (B).....................               2,513               2,513            8.47%      Jun -00             2,513
    Morningside.........................               1,641               1,623            8.35%      Apr -03             1,474
    Newport.............................               5,058               5,030            8.18%      Apr -06             4,490
    Palm Court..........................               3,000               2,901            9.67%      Dec -04             2,525
    Park Dale Gardens...................               3,000               2,904            8.30%      Jul -05             2,448
    Park Norton.........................                 564                 545            6.05%      Jun -05               473
    Pinecrest...........................              14,500              14,420            7.96%      Apr -17             8,799
    Prado Bay...........................               4,800               4,800            7.05%      Jan -08             4,124
    River City Landing(B)...............               6,100               6,100            8.47%      Jun -00             6,100
    Spring Pines (B)....................               1,300               1,300            8.47%      Jun -04             1,300
    Summit on the Lake..................               4,800               4,782            6.35%      Aug -27               -
    Woodbrier...........................               1,300               1,165            7.93%      Nov -03               872
    Woodcreek (CO)......................               3,000               2,812           10.19%      Mar -99             2,750
    Woodcreek (FL)......................               3,800               3,683            9.73%      Feb -05             3,203
                                                     -------             -------            ----                         -------
                                                     151,247             148,702            8.21%  (C)                   109,404
                                                     -------             -------            ----                         -------
</TABLE>

---------------

(A)  For loans with variable interest rates, the rate in effect for the
     month of December 1997 is presented.

(B)  Represents an advance under the $50 million revolving credit facility
     with GMAC Commercial Mortgage.

(C)  Represents weighted average interest rate for the month of December
     1997.



                                       12
<PAGE>   13

                          NATIONAL INCOME REALTY TRUST
             MORTGAGE LOANS SECURED BY OWNED PROPERTIES (Continued)
                                DECEMBER 31, 1997
                             (Dollars in thousands)
                                   (Unaudited)

<TABLE>
<CAPTION>
                                                                          Stated                           Balance
                                          Original      Balance          Interest            Maturity      Due at
Name of Property                          Amount      Dec 31, 1997       Rate (A)             Date        Maturity
----------------                          ------      ------------       --------             ----        --------

Office Buildings
<S>                                      <C>           <C>                    <C>             <C>         <C>
    Emerson Center .................     $   2,900     $   2,854              8.75%           May-99      $   2,808
    Emerson Center (B) .............         1,218           923                --            May-99            841
    Northwest O'Hare ...............         2,000           771              7.75%           Nov-98            676
    Northwest O'Hare ...............           415           227              8.75%           Feb-01            159
    Rancho Sorrento ................         3,550         2,780              9.00%           Aug-00          2,414
    Rancho Sorrento ................         2,650         2,604              8.13%           Mar-09          1,575
                                         ---------     ---------         ---------                        ---------
                                            12,733        10,159              8.57%(C)                        8,473
                                         ---------     ---------         ---------                        ---------

Shopping Centers

    Emerson Center .................         1,250         1,212              9.50%           Jul-99          1,193
    K-Mart - Charlotte .............         1,360         1,256             10.00%           Oct-98          1,238
    K-Mart - Temple Terrace ........         1,750           948              8.50%           May-05             --
    K-Mart - Temple Terrace ........           347           325             10.25%           Oct-98            321
    K-Mart - Thomasville ...........         1,300           744              9.63%           Sep-05             --
    K-Mart - Thomasville ...........           290           271             10.25%           Oct-98            268
    Midland Plaza ..................           305           283             10.00%           Oct-98            278
    Midway Mills ...................         4,200         4,101              8.64%           Dec-05          3,465
    Mountain View ..................         1,050         1,038             11.68%           Jul-06            891
    Northside Center ...............         3,100         1,710              9.00%           Nov-05             --
    Stewart Square .................         2,070         2,070              8.47%           Dec-04          1,681
                                         ---------     ---------         ---------                        ---------
                                            17,022        13,958              9.22%(C)                        9,335
                                         ---------     ---------         ---------                        ---------

Line of credit (D) .................         9,000         7,479              7.78%           Sep-98          7,407
RI Windsor, Ltd., equity loan (E) ..         2,200         2,200              8.75%           Jan-99          2,200
                                         ---------     ---------         ---------                        ---------
                                            11,200         9,679              8.00%(C)                        9,607
                                         ---------     ---------         ---------                        ---------

Total ..............................     $ 192,202     $ 182,498              8.29%(C)                    $ 136,819
                                         =========     =========         =========                        =========
</TABLE>


----------------------

(A)   For loans with variable interest rates, the rate in effect for the month
      of December 1997 is presented.

(B)   Represents non-interest bearing unsecured debt associated with the
      property payable from 30% of Excess Cash Flow, as defined, of the property
      or funds from the sale or refinance of the property.

(C)   Represents weighted average interest rate for the month of December 1997.

(D)   The line of credit is secured by mortgages on Diamond Loch Apartments,
      Mustang Creek Apartments, and The Regent Apartments.

(E)   The equity loan is secured by 352,000 shares of the Trust's shares of
      beneficial interest and is cross-collateralized with the line of credit.




                                       13
<PAGE>   14

ITEM 2. PROPERTIES (Continued)

Partnership Properties. The Trust and Continental Mortgage and Equity Trust
("CMET") own two fully leased office buildings in the vicinity of Sacramento,
California, as tenants-in-common with the Trust having a 70% undivided interest.
Under the terms of the joint tenancy agreement, the Trust and CMET must agree
over any material change in the operations of the properties, including sales,
refinancings, and changes in property management. The Trust, as a noncontrolling
partner, accounts for its investment in these properties using the equity
method.

In June 1995, the Trust acquired a 50% economic interest in an office building
located at 801 Pennsylvania Avenue, Washington, D.C., (the "Property") through
the purchase of a first lien mortgage note with a face value of $8.5 million
(the "Note") for $3 million. In accordance with the terms of the Note, the
Trust's $3 million investment, as well as any additional advances made to the
Property, is to be repaid from Property cash flow after operating expenses with
interest at the rate of 11% per annum. The $5.5 million remaining balance of the
Note plus accrued interest entitles the Trust to 50% of all funds available
after Property operating expenses plus 50% of the proceeds from any sale and any
refinancing. The Note is nonrecourse to all parties and is secured only by the
Property. The Trust accounts for this investment using the equity method.

In January 1997, the Trust acquired 50% of RI Windsor, Ltd., which completed
construction of a 324-unit luxury apartment complex in Jacksonville, Florida,
known as The Mayfaire at Windsor Parke in March 1998. Initial operations began
at the property in August 1997. A portion of the $18.6 million construction cost
was financed by a $16 million construction loan.

In June 1997, the Trust acquired 50% of RI Panama City, Ltd., which is
constructing a 200-unit apartment property known as Harbour Green in Panama
City, Florida. Construction, at a total estimated cost of $10.5 million, is
expected to be complete in the second quarter of 1998. The partnership obtained
an $8.8 million construction loan to finance a portion of the construction. The
first units became available for rent in January 1998.

In September 1997, the Trust acquired 60% of Danforth National Apartments, Ltd.,
which is constructing a 288-unit apartment complex to be known as The Club at
Danforth in Jacksonville, Florida, for a total cost of $17.1 million. The
partnership obtained a $13.7 million construction loan in January 1998. This
property is expected to be complete in the third quarter of 1998. In February
1998, the Trust purchased another partner's interest in the partnership and
currently has an 80% interest in the partnership.

In December 1997, the Trust acquired a 50% interest in Tarragon Savannah, L.P.,
which is constructing a 250-unit apartment property to be known as The Links
at Georgetown in Savannah, Georgia. Total development cost is estimated at $14.5
million, $12 million of which will be provided by a construction loan.
Construction is expected to be complete in the second quarter of 1999.

The Trust has advanced substantially all of the equity for these four
construction projects as interest-bearing priority loans to these partnerships.
Principals of the Trust's partners have personally guaranteed each of the
construction loans.

In December 1997, the Trust acquired a 70% interest in Ansonia Apartments, L.P.
("Ansonia"). This partnership purchased two operating apartment properties,
Meriden East with 66 units in Meriden, Connecticut, and Autumn Ridge with 116
units in East Haven, Connecticut, in December 1997 for an aggregate purchase
price of $3.8 million, $2.9 million of which was financed through mortgages on
each property.





                                       14
<PAGE>   15

ITEM 2. PROPERTIES (Continued)

The following table sets forth certain information relating to the operating
properties owned by Trust partnerships (including Mayfaire at Windsor Parke for
which initial operations began in August 1997) as of December 31, 1997. Although
the two properties owned by Ansonia are operating, because they were purchased
in December 1997 and have less than one month's activity during 1997, Ansonia is
excluded from the following table.

<TABLE>
<CAPTION>
                                                                            Average Rent                  Economic
                                                                         Per Square Foot (a)            Occupancy (b)
                          Property            Number        Square       -------------------        ------------------
       Partnership        Location           of Units      Footage        1997         1996          1997         1996
       -----------        --------           --------      -------       -----         -----        -----         ----
<S>                     <C>                     <C>         <C>        <C>                             <C>
   RI Windsor, Ltd.     Jacksonville, FL        324         339,886    $     .60        (C)            15%          (C)
   Sacramento Nine      Rancho Cordova, CA      -           105,249        12.97      10.76           100%          91%
   801 Pennsylvania     Washington, D.C.        -            62,229        11.63       9.32            82%          56%
</TABLE>


---------------------

(a)   Amounts represent rental revenue per square foot on an annual basis.
      Rental revenue is equal to gross potential rent after giving effect to all
      rental losses including bad debts, vacancies, and discounts and
      concessions. Gross potential rent equals actual lease rates on leased
      units/space and market rates on vacant units/space.

(b)   Computed as follows: [(Annual gross potential rent less annual vacancy
      losses) divided by annual gross potential rent].

(c)   Property was constructed and began operating during 1997. Therefore, there
      is no 1996 information.

ITEM 3.  LEGAL PROCEEDINGS

The Trust is a party to various claims and routine litigation arising in the
ordinary course of business. Management of the Trust does not believe that the
results of these claims and litigation, individually or in the aggregate, will
have a material adverse effect on its business, financial position, or results
of operations. Also, see ITEM 10. "TRUSTEES, EXECUTIVE OFFICERS, AND ADVISOR OF
THE REGISTRANT" for a description of the results of the Olive modification.

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

During the fourth quarter of the fiscal year covered by this report, no matter
was submitted to a vote of security holders.






                     [This space intentionally left blank.]


                                       15
<PAGE>   16
                                   PART II

ITEM 5.  MARKET FOR THE REGISTRANT'S SHARES OF BENEFICIAL INTEREST AND
         RELATED SHAREHOLDER MATTERS

The Trust's shares of beneficial interest, no par value (the "Shares" and each a
"Share"), are traded in the over-the-counter market of the National Association
of Securities Dealers Automated Quotation ("NASDAQ") System under the symbol
"NIRTS." The following table sets forth the high and low bid quotations of the
Shares as reported by the NASDAQ System for the periods indicated, which consist
of the last two fiscal years and the quarter ending for which this report is
filed, all after giving retroactive effect to the 10% share distributions in
September 1996 and September 1997. Over-the-counter market quotations reflect
inter-dealer prices, without retail mark-up, mark-down, or commissions, and may
not necessarily represent actual transactions.

<TABLE>
<CAPTION>
                                             1997                            1996
                                  --------------------------      ---------------------------
                                      High             Low            High            Low
                                  ----------      ----------      ----------      -----------
<S>                               <C>             <C>             <C>             <C>
      First quarter               $  13  7/8      $  11  1/8      $  11           $   9  1/8
      Second quarter                 14  1/2         13  7/8         11  5/8         11
      Third quarter                  15  5/8         14  1/8         11  5/8         11  1/8
      Fourth quarter                 17              15  1/4         11  1/4         10  7/8
</TABLE>

For the first quarter of 1998 through March 13, 1998, the high and low bid
quotations of the Shares as reported by the NASDAQ System were $18 and $15 3/4,
respectively. During this period, the Trust's Shares traded as high as $18 1/8.
According to the transfer agent's records, such shares were held by
approximately 10,100 holders, including beneficial holders.

Cash  distributions  paid to  shareholders  in 1997 and 1996 were as  follows
(restated  to give  effect to the 1997 and 1996 share distributions):

<TABLE>
<CAPTION>
                                                1997             1996
                                               -------         -------
<S>                                            <C>             <C>
                   First quarter               $   .18         $   .17
                   Second quarter                  .18             .17
                   Third quarter                   .18             .17
                   Fourth quarter                  .20             .18
</TABLE>




                     [This space intentionally left blank.]




                                       16
<PAGE>   17
ITEM 6.  SELECTED FINANCIAL DATA

The following information should be read in conjunction with all of the
financial statements and notes thereto and with the discussion set forth in
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" included elsewhere in this Form 10-K. Dollar amounts are in
thousands, except per share amounts.

<TABLE>
<CAPTION>
                                                                          For the Years Ended December 31,
                                                 -------------------------------------------------------------------------------
                                                     1997             1996             1995             1994             1993
                                                 -----------      -----------      -----------      -----------      -----------
<S>                                              <C>              <C>              <C>              <C>              <C>
OPERATING DATA

   Revenue .................................     $    52,017      $    49,962      $    45,240      $    40,135      $    36,357
   Expenses ................................         (51,749)         (49,176)         (46,214)         (40,915)         (40,370)
                                                 -----------      -----------      -----------      -----------      -----------
   Income (loss) before net gain on sale
     of real estate, gain on sale of
     investments, gain on insurance
     settlement, and extraordinary gain ....             268              786             (974)            (780)          (4,013)
   Net gain on sale of real estate .........           4,350            3,700              533              385              945
   Gain on sale of investments .............             913               --              412              141               --
   Gain on insurance settlement ............              --              451               --               --               --
                                                 -----------      -----------      -----------      -----------      -----------
   Income (loss) from continuing
     operations ............................           5,531            4,937              (29)            (254)          (3,068)
   Extraordinary gain ......................              61               --              737               --            8,888
                                                 -----------      -----------      -----------      -----------      -----------
   Net income (loss) .......................     $     5,592      $     4,937      $       708      $      (254)     $     5,820
                                                 ===========      ===========      ===========      ===========      ===========

PER SHARE DATA (1)

EARNINGS PER SHARE
   Income (loss) from continuing
     operations ............................     $      1.44      $      1.21      $      (.01)     $      (.06)     $      (.69)
   Extraordinary gain ......................             .02               --              .18               --             1.99
                                                 -----------      -----------      -----------      -----------      -----------
   Net income (loss) .......................     $      1.46      $      1.21      $       .17      $      (.06)     $      1.30
                                                 ===========      ===========      ===========      ===========      ===========

   Weighted average shares (2) .............       3,832,535        4,070,183        4,101,453        4,262,073        4,469,426

EARNINGS PER SHARE - ASSUMING DILUTION
   Income (loss) from continuing
     operations ............................     $      1.43      $      1.21      $      (.01)     $      (.06)     $      (.69)
   Extraordinary gain ......................             .01               --              .18               --             1.99
                                                 -----------      -----------      -----------      -----------      -----------
   Net income (loss) .......................     $      1.44      $      1.21      $       .17      $      (.06)     $      1.30
                                                 ===========      ===========      ===========      ===========      ===========

   Weighted average shares -
     assuming dilution (3) .................       3,871,248        4,088,382        4,101,961        4,262,073        4,469,426

   Distributions (4) .......................     $       .74      $       .69      $       .62      $       .47      $       .14
</TABLE>

-------------------

(1)   Share and per share data have been restated to give effect to 10% share
      distributions paid in September of each of 1994 through 1997.

(2)   Represents the weighted average shares of beneficial interest used in the
      computation of earnings per share.

(3)   Represents the weighted average shares of beneficial interest used in the
      computation of earnings per share-assuming dilution.

(4)   1997 and 1993 distributions were taxable to shareholders as ordinary
      income. Distributions in 1996, 1995, and 1994 represented return of
      capital.



                                       17

<PAGE>   18
ITEM 6. SELECTED FINANCIAL DATA (Continued)

<TABLE>
<CAPTION>
                                                                            December 31,
                                             ----------------------------------------------------------------------
                                                 1997           1996           1995           1994           1993
                                             ----------     ----------     ----------     ----------     ----------
<S>                                          <C>            <C>            <C>            <C>            <C>
BALANCE SHEET DATA

   Real estate .........................     $  233,936     $  193,722     $  195,675     $  184,658     $  168,013
   Notes and interest receivable(1) ....             --             --          6,388          9,997         12,909
   Investments in partnerships .........         13,839          4,739         10,780         11,026         11,804
   Total assets ........................        265,640        211,341        222,038        217,040        199,486
   Notes, debentures, and
      interest payable .................        184,126        134,270        144,497        138,316        114,351
   Shareholders' equity ................         71,091         69,063         69,627         73,360         78,174
   Book value per share ................     $    18.65     $    19.60     $    20.53     $    22.81     $    22.94
</TABLE>

<TABLE>
<CAPTION>
                                                                  For the Years Ended December 31,
                                             ---------------------------------------------------------------------------
                                                1997            1996            1995            1994            1993
                                             ----------      ----------      ----------       ----------      ----------
<S>                                          <C>             <C>             <C>             <C>             <C>
OTHER DATA

Cash flows provided by (used in):
     Operating activities...............     $    3,261      $    3,795      $    2,030      $    1,852      $    3,620
     Investing activities...............        (43,813)           (436)         (5,436)         (1,409)          1,272
     Financing activities...............         40,952          (1,171)          1,596           1,981          (5,582)

Calculation of funds from operations:
     Net income (loss) .................     $    5,592      $    4,937      $      708      $     (254)     $    5,820
     Extraordinary gain ................            (61)             --            (737)             --          (8,888)
     Gain on insurance settlement (2) ..             --            (451)             --              --              --
     Gain on sale of real estate .......         (4,350)         (3,700)           (533)           (385)           (945)
     Gain on sale of investments .......           (215)             --              --              --              --
     Depreciation and amortization
       of real estate assets ...........          7,225           5,374           5,959           4,992           4,639
     Depreciation and amortization
       of real estate assets
       of partnerships .................            356             305             882           1,086             918
     Distributions from partnerships
       in excess of the Trust's
       investments in the partnerships .            (41)           (899)             --              --              --
                                             ----------      ----------      ----------      ----------      ----------

Funds from operations (3) ..............     $    8,506      $    5,566      $    6,279      $    5,439      $    1,544
                                             ==========      ==========      ==========      ==========      ==========
</TABLE>

---------------------------------------------

(1)   Notes and interest receivable at December 31, 1997 and 1996, are
      classified with other assets.

(2)   The gain on insurance settlement represents the Trust's share of the gain
      realized by Indcon, L.P., in which the Trust held a 40% interest until
      November 1997. One of Indcon's warehouses was destroyed by fire in
      September 1995. An insurance settlement totaling $2.2 million was reached
      by the partnership in March 1996. As the partnership did not intend to
      rebuild the property, upon receipt of the insurance proceeds, the property
      was written off. This resulted in a gain of $1.1 million, of which the
      Trust's share was $451,000.


                                       18
<PAGE>   19

ITEM 6.  SELECTED FINANCIAL DATA (Continued)

OTHER DATA (Continued)

-------------------------

(3)   The Trust generally considers funds from operations ("FFO") to be an
      appropriate measure of the performance of an equity real estate investment
      trust ("REIT"). FFO, as defined by the National Association of Real Estate
      Investment Trusts ("NAREIT"), equals net income (loss), computed in
      accordance with generally accepted accounting principles ("GAAP"),
      excluding gains (or losses) from debt restructuring and sales of property,
      plus depreciation and amortization of real estate assets, and after
      adjustments for unconsolidated partnerships and joint ventures.
      Adjustments for unconsolidated partnerships and joint ventures are
      calculated to reflect FFO on the same basis. The amortization of deferred
      financing costs is not added back to net income (loss) in the Trust's
      calculation. This treatment is consistent with the Trust's historical
      calculation of FFO. The Trust believes that FFO is useful to investors as
      a measure of the performance of an equity REIT because, along with cash
      flows from operating activities, investing activities, and financing
      activities, it provides investors an understanding of the ability of the
      Trust to incur and service debt and to make capital expenditures. The
      Trust believes that in order to facilitate a clear understanding of its
      operating results, FFO should be examined in conjunction with net income
      (loss) as presented in the financial statements included elsewhere in this
      report. FFO does not represent cash generated from operating activities in
      accordance with GAAP and therefore should not be considered an alternative
      to net income as an indication of the Trust's operating performance or to
      cash flow as a measure of liquidity and is not necessarily indicative of
      cash available to fund cash needs and cash distributions. The Trust's
      calculation of FFO may differ from the methodology for calculating FFO
      utilized by other REITs and, accordingly, may not be comparable to such
      other REITs.

      Effective January 1, 1997, the Trust modified its calculation of FFO to
      include the add back of amortization of leasing commissions associated
      with its commercial properties. The Trust believes that this treatment is
      consistent with a majority of other REITs. If the Trust had calculated FFO
      in the same manner for each of the years ended December 31, 1996, 1995,
      1994, and 1993, FFO would have been higher by $262,000, $272,000,
      $235,000, and $244,000, respectively.

      Included in FFO for the years ended December 31, 1997, 1995, and 1994, are
      gains totaling $698,000, $412,000, and $141,000, respectively, resulting
      from the Trust's sale of investments in marketable equity securities.

      Included in FFO for the years ended December 31, 1993 and 1996, are
      provisions for losses of $1.4 million and $300,000, respectively. Included
      in FFO for the year ended December 31, 1995, is a provision for losses
      credit of $425,000. See NOTE 2. "ALLOWANCE FOR ESTIMATED LOSSES AND
      PROVISIONS FOR LOSSES" in the Notes to Consolidated Financial Statements
      for descriptions of the 1996 and 1995 provisions for losses. The 1993
      provision for losses was recorded to provide allowances for estimated
      losses against one property held for sale and one mortgage note
      receivable.



                                       19
<PAGE>   20

ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
         AND RESULTS OF OPERATIONS

The following discussion and analysis should be read in conjunction with the
Consolidated Financial Statements and the accompanying Notes thereto.

Introduction

National Income Realty Trust (the "Trust") invests in income-producing real
estate through acquisitions, leases and partnerships. The Trust was organized on
October 31, 1978, and commenced operations on March 27, 1979. At December 31,
1997, the Trust's real estate portfolio included 61 properties (eight held for
sale) located throughout the United States, with concentrations in the Southeast
and Southwest. These properties include 40 apartment complexes, 14 shopping
centers, three office buildings, three parcels of land, and one single-family
residence. All of the Trust's real estate, except for eleven properties, is
encumbered by mortgages. The Trust's current policy is to make mortgage loans
only in connection with, and to facilitate, the sale or acquisition of real
estate. Accordingly, as existing mortgages are paid off, the Trust's portfolio
of mortgage notes receivable has declined and is expected to continue to
decline.

The Trust's objective is to maximize the long term value of its real estate
portfolio with an emphasis on increasing operating income and future cash
distributions to shareholders. Management focuses on both the appreciation of
the existing real estate portfolio, through intensive management and capital
improvements, and enlarging the portfolio with highly selective and
opportunistic acquisitions concentrated on older, under-managed, and
under-performing multifamily projects in geographical regions where the Trust
presently owns properties. The Trust also intends to invest increasing amounts
in new construction of apartment properties either directly or through
partnerships. In the first quarter of 1998, the Trust completed construction of
two apartment properties, one of which is owned through a partnership. The Trust
currently has three apartment properties under construction, all of which are
owned through partnerships. To the extent it invests in construction projects,
the Trust is subject to business risks, such as cost overruns and delays,
associated with such higher risk activities. In addition to raising capital
through operating income, the Trust intends to generate capital through mortgage
refinancings and selective disposition of certain assets.

Liquidity and Capital Resources

Cash and cash equivalents aggregated $4.3 million at December 31, 1997, compared
with $3.9 million at December 31, 1996. The Trust's principal sources of cash
have been property operations and external sources, such as property sales and
refinancings. The Trust expects these sources will continue to be sufficient to
meet projected cash requirements, including debt service obligations, property
maintenance and improvements, and continuation of regular distributions.

     Operating Activities

The Trust's cash flow from property operations (rentals collected less payments
for property operating expenses) continues to increase from $17.6 million in
1995 to $19.3 million in 1996 and $20.7 million in 1997, primarily due to
acquisitions made in 1995, 1996, and 1997. In September 1996, the Trust sold
Century Centre II Office Building ("Century Centre") for $28.2 million. In 1995
and 1996, Century Centre had accounted for $1.4 million and $1.5 million,
respectively, of cash flow from operations. See NOTE 3. "REAL ESTATE AND
DEPRECIATION" in the Notes to Consolidated Financial Statements for a discussion
of the sale.





                                       20
<PAGE>   21

ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
         AND RESULTS OF OPERATIONS (Continued)

Liquidity and Capital Resources (Continued)

     Investing Activities

The Trust purchased six apartment communities in 1995, two in 1996, and five in
1997, increasing the Trust's multifamily portfolio by 1,991 units. The Trust
also purchased a 52,288 square foot shopping center in 1997. The aggregate
purchase prices for the 1995, 1996, and 1997 acquisitions were $11.4 million,
$9.4 million, and $23.4 million respectively. The aggregate cash portions of the
purchase prices for the 1995, 1996, and 1997 acquisitions were $3.8 million,
$3.2 million, and $13.7 million, respectively. The balance of the acquisition
cost was financed through mortgages on certain of the properties.

The Trust also added 300 units to its multifamily portfolio through its
acquisition of an additional 40% interest in English Village Partners, L.P.
("English Village"), increasing its total ownership to 90%, for $1 million in
July 1997. While the Trust previously accounted for its investment in English
Village using the equity method, English Village is now consolidated.

In 1997, the Trust sold multifamily properties in Sacramento, California,
Philadelphia, Pennsylvania, and Kansas City, Missouri, each in which the Trust
owned only a single property, in separate transactions for an aggregate sale
price of $14 million, receiving net cash proceeds of $6.4 million. In
September 1996, the Trust sold Century Centre for $28.2 million, receiving net
cash proceeds of $6.2 million. During 1995, the Trust sold major portions of
Lake Highlands land in Dallas, Texas, and K-Mart Shopping Center in Kansas City,
Missouri. The Trust received aggregate net cash proceeds of $1.6 million in
connection with the 1995 sales.

During 1995, 1996, and 1997, the Trust made real estate improvements totaling $8
million, $13.5 million, and $27.3 million, respectively, to its properties,
including $1.1 million, $5.9 million, and $9.7 million, respectively, on
construction at redevelopment properties. Construction at The Vistas at Lake
Worth was completed in the first quarter of 1998 with 1998 construction costs of
$1.3 million. The Trust anticipates capital improvement expenditures on its
other properties during 1998 to total approximately $13.3 million.

In addition to capital improvements noted above, payments for property operating
expenses in 1995, 1996, and 1997 include property replacements of $2.5 million,
$2.8 million, and $2.1 million, respectively. Property replacements include such
items as plumbing replacements, landscaping, exterior painting, parking lot
improvements, and, in 1995 and 1996, carpet and appliances. In 1997, the Trust
began capitalizing carpet, appliances, and heating, ventilation, and air
conditioning replacements. See discussion below under "Implementation of Change
in Accounting Estimate."

During 1995, 1996, and 1997, the Trust received $3.6 million, $2.1 million, and
$187,000, respectively, representing collections of notes receivable. The Trust
expects mortgage note collections to continue to decline as existing mortgage
loans are paid off and does not anticipate funding mortgage loans in the future,
except in connection with, or to facilitate, the sale of real estate.

In January and February 1995, the Trust sold its remaining 39,500 shares of
beneficial interest of Continental Mortgage and Equity Trust ("CMET") for
$593,000 in cash.





                                       21
<PAGE>   22

ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
         AND RESULTS OF OPERATIONS (Continued)

Liquidity and Capital Resources (Continued)

     Investing Activities (Continued)

In June 1995, the Trust acquired a 50% economic interest in an office building
in Washington, D.C., through the purchase of a first lien mortgage note with a
face value of $8.5 million (the "Note") for $500,000 in cash and a $2.5 million
promissory note which the Trust paid off in September 1995. In accordance with
the terms of the agreement with the property owner, the Trust's $3 million
investment is to be repaid with interest at 11% per annum from cash flow after
operating expenses. The remaining $5.5 million balance of the Note plus accrued
interest may be satisfied by payment of 50% of all funds available after
property operating expenses plus 50% of the proceeds from any sale and any
refinancing. The Trust intends to refinance the property in 1998 for an amount
substantially in excess of its investment.

The Trust and CMET were partners in Income Special Associates ("ISA"), a general
partnership in which the Trust had a 40% interest in earnings, losses, and
distributions. ISA in turn owned a 100% interest in Indcon, L.P. ("Indcon"),
which owned four industrial warehouses at December 31, 1997. During the first
half of 1996, Indcon sold 27 warehouses for $41.2 million, receiving net cash
proceeds of $16.8 million, after the payoff of the existing $23.5 million
mortgage loan and related closing costs. Indcon distributed $6.8 million to the
Trust as its proportionate share of the sale proceeds plus an allowance for
brokerage commissions. In November 1997, the Trust sold its interest in the
partnership to CMET for $1.6 million in cash.

During 1997, the Trust acquired interests in five partnerships in exchange for
capital contributions totaling $1.6 million. Four of the partnerships are each
constructing a luxury apartment complex for a total of 1,062 units. The fifth
partnership purchased two operating properties with a total of 182 units in
December 1997. The Trust also made aggregate advances to these partnerships of
$8.4 million. The advances bear interest at market rates and are to be repaid
out of the first funds available to the respective partnership.

Also, during 1997, the Trust made investments in marketable equity securities of
unaffiliated real estate companies of $2.5 million. During this same period, the
Trust sold $2.6 million in marketable equity securities and realized gains on
these sales totaling $698,000. As of December 31, 1997, there were unrealized
gains on the remaining investments of $133,000.

During the fourth quarter of 1997, the Trust advanced $696,000 to National Omni
Associates, L.P., ("Omni") in exchange for a 46% interest in the partnership. In
January and February 1998, the Trust advanced an additional $4.6 million to the
partnership. In February 1998, Omni purchased 5600 Collins Avenue, a 289-unit
luxury high rise apartment building in Miami Beach, Florida, for $32 million.
$26 million of the purchase price was financed through first and second lien
mortgage debt.



                                       22
<PAGE>   23
ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
         AND RESULTS OF OPERATIONS (Continued)

Liquidity and Capital Resources (Continued)

     Financing Activities

During 1997, the Trust obtained first and interim mortgage financing (including
advances under line of credit facilities) totaling $77.3 million secured by 15
properties and received $38.5 million of net cash proceeds after the payoff of
$32.9 million in existing mortgage debt on such properties, establishing
required escrows, and paying associated closing costs. In addition, the Trust
paid off a $1.3 million mortgage loan secured by Southgate Shopping Center,
scheduled to mature in 2003, for $850,000. In connection with the payoff, the
Trust recognized a $431,000 extraordinary gain on forgiveness of debt. The
Trust also made $2.5 million of other principal payments in 1997.

During 1996, the Trust obtained first mortgage financing totaling $34.3 million
secured by nine Trust properties and received net cash proceeds of $7.3 million
after the payoff of $24.4 million in existing mortgage debt on such properties,
establishing required escrows, and paying associated closing costs. The Trust
also paid off mortgage loans scheduled to mature in 1996 totaling $689,000 and
made $3.4 million of other principal payments.

During 1995, the Trust obtained $18 million in first mortgage financing on five
Trust properties and received net cash proceeds of $4.5 million after the payoff
of $12.2 million in existing mortgage debt. The Trust also obtained short term
financing totaling $5.5 million, $2.5 million of which was paid off in 1996,
which was used to facilitate the payoff of three mortgage loans totaling $6.4
million. Additionally, in September 1995, the Trust paid $2.4 million in
satisfaction of the note payable which financed the acquisition of the 801
Pennsylvania Avenue investment. The Trust also extended or paid off mortgage
loans scheduled to mature in 1995 totaling $5 million and made other principal
payments totaling $2.3 million.

Mortgage principal payments totaling $16.2 million are due in 1998, including
$14.1 million of balloon payments. The Trust intends to either pay off the
maturing mortgages or extend the due dates while seeking to obtain long term
refinancing. However, while management is confident of its ability to acquire
financing as needed, there is no assurance that the Trust will continue to be
successful in its efforts in this regard.

Based on the performance of the Trust's properties, the Trust's Board of
Trustees (the "Board") voted in July 1993 to resume the payment of regular
quarterly cash distributions to shareholders. Cash distributions paid to
shareholders totaled $2.5 million, $2.7 million, and $2.1 million in 1995, 1996,
and 1997, respectively. The Trust also paid 10% share distributions in September
of each of 1995, 1996, and 1997.

During 1995, 1996, and 1997, the Trust repurchased 123,500, 285,189, and 48,472,
of its shares of beneficial interest at a cost of $1.4 million, $3.7 million,
and $748,000, respectively. During 1996, the Board authorized the Trust to
repurchase up to an additional 281,592 shares of beneficial interest, of which
216,363 were purchased during 1996 and 1997.

Two partnerships in which the Trust holds interests obtained first mortgage
financing during 1995. The Trust received distributions totaling $3 million
representing its share of the net refinancing proceeds.



                                       23
<PAGE>   24
ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
         AND RESULTS OF OPERATIONS (Continued)

Results of Operations

1997 COMPARED TO 1996. The Trust reported net income of $5.6 million for the
year ended December 31, 1997, compared to $4.9 million for the year ended
December 31, 1996. The improvement in operating results is primarily related to
increased net rental income as discussed below. Other components of this change
are discussed in the following paragraphs.

Net rental income increased from $19.4 million for the year ended December 31,
1996, to $22.1 million for the corresponding period in 1997.

      Multifamily Properties

      The Trust's multifamily portfolio, which represented 79% of the Trust's
      real estate and included 7,987 operating apartments at December 31, 1997,
      reported an increase in net rental income of $3.5 million, or 24%, for the
      year ended December 31, 1997, compared to the corresponding period in
      1996. Of this increase, $1.3 million is related to properties acquired in
      1996 and 1997. A decrease of $511,000 resulted from the sale of three
      multifamily properties in 1997. The portfolio of 30 apartment properties
      with 5,935 units owned for all of 1996 and 1997 generated an increase of
      $2.7 million, or 21%. Net rental income as a percentage of rental revenue
      for the 5,935 units increased from 38% to 44%. Rental revenue for the same
      store multifamily properties increased $1.6 million, or 5%, chiefly due to
      higher rental rates at certain properties. Average monthly rental revenue
      per unit for the same store properties increased 5% from $474 to $496.
      Property operating expenses on a same store basis decreased $1.1 million,
      or 5%, $957,000 of which is due to a decrease in replacements resulting
      from the change in accounting pursuant to which the Trust began
      capitalizing carpet, appliances, and heating, ventilation, and air
      conditioning replacements in 1997. See discussion below under
      "Implementation of Change in Accounting Estimate." Overall occupancy
      levels for multifamily properties held in both years increased slightly in
      1997 compared to 1996.

      Commercial Properties

      The Trust's commercial portfolio included 1.6 million square feet at
      December 31, 1997. An increase in net rental income of $112,000 resulted
      from the addition of Jackson Square and Mariner Plaza Shopping Centers,
      acquired in January 1996 and August 1997, respectively. A decrease of $1.2
      million resulted from the sale of Century Centre in September 1996.
      Commercial properties held in both years reported an overall increase in
      net rental income of $598,000 principally due to higher rents coupled with
      lower economic vacancies resulting from improved overall physical
      occupancy levels.

Equity in income of partnerships was $643,000 for the year ended December 31,
1997, compared to $1.5 million for the corresponding period in 1996. This
decrease was primarily due to 1996 income related to the distribution of
financing proceeds by Sacramento Nine ("SAC 9") and English Village in excess of
the Trust's investments in those partnerships.



                                       24
<PAGE>   25



ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
         AND RESULTS OF OPERATIONS (Continued)

Results of Operations (Continued)

Interest expense was $12.6 million for the year ended December 31, 1997,
compared to $12 million for the year ended December 31, 1996. An increase of
$1.1 million resulted from interest on mortgage loans obtained or assumed in
connection with 1996 and 1997 property acquisitions. In addition, long term and
interim first mortgage financing, including advances under line of credit
facilities, obtained on existing properties during 1996 and 1997 increased
mortgage loans by $35.8 million and the related interest expense by $1.7 million
for this period. A $1.4 million decrease resulted from the sale of four
properties during 1996 and 1997. The remaining decrease is due to interest
capitalized to the carrying values of unencumbered development properties during
1996 and 1997.

Depreciation expense increased from $5.4 million for the year ended December 31,
1996, to $7 million for the corresponding period in 1997 due to additional
depreciation associated with the 1996 and 1997 property acquisitions and capital
improvements to its existing real estate between 1995 and 1997.

Advisory fees to Tarragon Realty Advisors, Inc. ("Tarragon"), were $1.4 million
in 1997 and $1.1 million in 1996. The advisory fee is an incentive fee equal to
16% per annum of adjusted funds from operations, as defined in the advisory
agreement approved by the Board and shareholders. Funds from operations ("FFO"),
as defined by the National Association of Real Estate Investment Trusts,
increased from $5.6 million for the year ended December 31, 1996, to $8.5
million for the year ended December 31, 1997. However, for purposes of
calculating the advisory fee, the effect of the accounting change is excluded
from FFO. See ITEM 6. "SELECTED FINANCIAL DATA" for the calculation and
definition of FFO.

During 1997, the Trust recognized gains totaling $4.4 million on the sale of
Plaza Hills Apartments, Huntington Green Apartments, and Pheasant Pointe
Apartments and a $54,000 loss related to the sale of a warehouse owned by
Indcon, in which the Trust held an effective 40% interest until November 1997.

During 1997, the Trust recognized gains totaling $698,000 related to the sale of
investments in marketable equity securities and a gain of $215,000 on the sale
of the Trust's investment in Indcon.

1997 extraordinary items include an extraordinary gain on debt forgiveness of
$431,000 in connection with the discounted payoff of the mortgage loan secured
by Southgate Shopping Center and prepayment penalties and the write-off of
deferred financing expenses totaling $370,000 in connection with certain 1997
refinancings.

1996 COMPARED TO 1995. The Trust reported net income of $4.9 million for the
year ended December 31, 1996, compared to $708,000 for the year ended December
31, 1995. The primary reason for the improvement in operating results is the
$3.7 million gain on the sale of Century Centre in September 1996. The other
underlying components of the change in the Trust's results of operations are
discussed in the following paragraphs.

Net rental income increased from $18.1 million for the year ended December 31,
1995, to $19.4 million for the corresponding period in 1996.





                                       25
<PAGE>   26

ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
         AND RESULTS OF OPERATIONS (Continued)

Results of Operations (Continued)

      Multifamily Properties

      The Trust's multifamily portfolio, which represented 75% of the Trust's
      real estate and included 7,078 operating units at December 31, 1996,
      reported an increase in net rental income of $1.2 million, or 9%, for the
      year ended December 31, 1996, as compared to the corresponding period in
      1995, primarily due to properties acquired after 1994. Net rental income
      for multifamily properties held in both years remained relatively stable.
      Increased rental revenue from higher rental rates was offset by increased
      operating expenses related to the Trust's continued efforts to improve its
      properties. Overall, both physical and economic occupancy levels increased
      slightly for multifamily properties held in both years.

      Commercial Properties

      The Trust's commercial portfolio included 1.6 million square feet at
      December 31, 1996. An increase in net rental income of $206,000 resulted
      from the addition of Jackson Square Shopping Center, acquired through a
      deed in lieu of foreclosure in January 1996. A decrease of $549,000
      resulted from the sale of two commercial properties in 1995 and 1996.
      Century Centre, which was sold in September 1996, generated net rental
      income of $1.2 million in 1996 prior to its sale and $1.6 million in 1995.
      Commercial properties held in both years reported an overall increase in
      net rental income of $459,000, principally due to lower vacancies.

Interest revenue decreased from $1.1 million for the year ended December 31,
1995, to $631,000 for the corresponding period in 1996. This decrease resulted
from the payoff of the Greentree mortgage note receivable in September 1995 and
the acquisition of Jackson Square Shopping Center through deed in lieu of
foreclosure in January 1996.

Equity in income of partnerships was $1.5 million for the year ended December
31, 1996, compared to $770,000 for the corresponding period in 1995. This
increase was primarily due to distribution of financing proceeds by SAC 9 and
English Village in excess of the Trust's investments in those partnerships.

Interest expense was $12 million for the year ended December 31, 1996, as
compared to $12.3 million for the year ended December 31, 1995. An increase of
$302,000 resulted from interest on mortgage loans obtained or assumed in
connection with 1995 and 1996 property acquisitions. In addition, long term and
interim first mortgage financing obtained during 1995 and 1996 increased
mortgage loans by $14.2 million and the related interest expense by $459,000 for
this period. Decreases totaling $1.2 million resulted from the sale of two
commercial properties in 1995 and 1996 and interest capitalized to the carrying
values of unencumbered development properties during 1995 and 1996.

Depreciation expense decreased from $6 million for the year ended December 31,
1995, to $5.4 million for the corresponding period in 1996. Effective January 1,
1996, the Trust's adopted Statement of Financial Accounting Standards ("SFAS")
No. 121, which required the Trust to cease depreciation of its real estate held
for sale.






                                       26
<PAGE>   27

ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
         AND RESULTS OF OPERATIONS (Continued)

Results of Operations (Continued)

Advisory fees to Tarragon were $1.1 million in 1996 and $1 million in 1995. The
advisory fee is an incentive fee equal to 16% per annum of adjusted funds from
operations, as defined in the advisory agreement approved by the Board and
shareholders. Prior to April 1995, the advisory agreement also called for a
$100,000 annual base fee. FFO decreased from $6.3 million for the year ended
December 31, 1995, to $5.6 million for the year ended December 31, 1996. See
ITEM 6. "SELECTED FINANCIAL DATA" for the calculation and definition of FFO.

In September 1996, the Trust recorded a $300,000 provision for loss to reduce
the carrying value of Mariposa Manor Apartments to its then estimated fair
value.

During 1995, the Trust recorded a provision for loss credit of $425,000. This
credit was comprised of a provision for loss of $275,000 to reduce the net
carrying value of K-Mart Shopping Center in Kansas City, Missouri, to its net
sale proceeds and a reversal of a previously provided allowance for estimated
loss of $700,000 against Pepperkorn Office Building which was determined to no
longer be necessary after litigation involving the property was decided in favor
of the Trust.

In addition to the $3.7 million gain on the sale of Century Centre discussed
previously, during 1996, the Trust reported a gain of $22,000 on the sale of
real estate related to the sale of 27 Indcon warehouses and a $451,000 gain due
to Indcon's insurance settlement received as a result of the warehouse fire in
September 1995. During 1995, the Trust reported a gain of $412,000 on the sale
of shares of beneficial interest of CMET and gains totaling $533,000 on sales of
portions of Lake Highlands land.

Implementation of Change in Accounting Estimate

Effective January 1, 1997, the Trust implemented prospectively a change in
accounting estimate whereby capital expenditures for carpet, appliances, and
heating, ventilation, and air conditioning (HVAC) replacements are capitalized
rather than expensed. The Trust believes that capitalizing these expenditures
and depreciating them over lives ranging from three to five years more
appropriately reflects the timing of the economic benefits to be received from
these expenditures. Additionally, the Trust believes this treatment is
consistent with policies currently being used by a majority of other REITs.
However, comparability of FFO between REITs is affected by the method of
accounting for these items. For the year ended December 31, 1997, the effect of
this change in accounting estimate was to decrease property operating expenses
and increase net income by $957,000. Had the Trust implemented this change on
January 1, 1995, property operating expenses for the years ended December 31,
1995 and 1996, would have been reduced by $1 million and $1.1 million,
respectively. This change has no effect on the advisory fee as Tarragon waived
any fee resulting from this change in accounting estimate.









                                       27
<PAGE>   28

ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
            AND RESULTS OF OPERATIONS (Continued)

Implementation of Change in Accounting Estimate (Continued)

For the year ended December 31, 1997, capitalized expenditures for these items
resulting from the change in accounting estimate were as follows:

<TABLE>
<S>                                                 <C>
Carpet......................................        $    561
Appliances..................................             143
HVAC replacements...........................             253
                                                    --------
                                                    $    957
                                                    ========
</TABLE>

Allowance for Estimated Losses and Provisions for Losses

The Trust's management periodically evaluates the carrying values of the Trust's
properties held for sale. Generally accepted accounting principles require that
the carrying value of or a property held for sale cannot exceed the lower of its
cost or its estimated fair value less estimated costs to sell. In those
instances in which estimates of fair value less estimated selling costs are less
than the carrying values thereof at the time of evaluation, an allowance for
loss is provided by a charge against operations. The evaluation generally
includes selective site inspections, a review of the property's current rents
compared to market rents, a review of the property's expenses, a review of
maintenance requirements, discussions with the manager of the property, and a
review of the surrounding area. Future evaluations could cause the Trust's
management to adjust current estimates of fair value.

The Trust's management also evaluates the Trust's properties held for investment
for impairment whenever events or changes in circumstances indicate that the
carrying value of an asset may not be recoverable. This evaluation generally
consists of a review of the property's cash flow and current and projected
market conditions, as well as any changes in general and local economic
conditions. If an impairment loss exists based on the results of this
evaluation, a loss is recognized by a charge against current earnings and a
corresponding reduction in the respective asset's carrying value. The amount of
this impairment loss is equal to the amount by which the carrying value of the
property exceeds its estimated fair value.

Environmental Matters

Under various federal, state, and local environmental laws, ordinances, and
regulations, the Trust may be potentially liable for removal or remediation
costs, as well as certain other potential costs (including governmental fines
and injuries to persons and property) relating to hazardous or toxic substances
where property-level managers have arranged for the removal, disposal, or
treatment of hazardous or toxic substances. In addition, certain environmental
laws impose liability for release of asbestos-containing materials into the air,
and third parties may seek recovery from the Trust for personal injury
associated with such materials.

The Trust's management is not aware of any environmental liability relating to
the above matters that would have a material adverse effect on the Trust's
business, financial position, or results of operations.




                                       28
<PAGE>   29
ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
         AND RESULTS OF OPERATIONS (Continued)

Tax Matters

For the years ended December 31, 1997, 1996, and 1995, the Trust elected, and in
the opinion of the Trust's management qualified, to be taxed as a Real Estate
Investment Trust ("REIT"), as defined under Sections 856 through 860 of the
Internal Revenue Code of 1986 (the "Code"). The Code requires a REIT to
distribute at least 95% of its REIT taxable income plus 95% of its net income
from foreclosure property, as defined in Section 857 of the Code, on an annual
basis to shareholders.

Impact of the Year 2000 Issue

The Year 2000 Issue is the result of computer programs being written using two
digits rather than four to define the applicable year. Any of the Trust's
computer programs that have date-sensitive software may recognize a date using
"00" as the year 1900 rather than the year 2000. This could result in a system
failure or miscalculations causing disruptions of operations, including, among
other things, a temporary inability to process transactions, send invoices, or
engage in similar normal business activities.

The Trust has initiated an assessment to determine the extent to which the Trust
is vulnerable to Year 2000 Issues. Management does not anticipate a material
impact on the Trust's business, financial position, or results of operations
from the Year 2000 Issue.

Recent Accounting Pronouncements

In June 1997, the Financial Accounting Standards Board ("FASB") issued SFAS No.
130 - "Reporting Comprehensive Income," which is effective for fiscal years
beginning after December 15, 1997. Comprehensive income is defined as "the
change in equity of a business enterprise during a period from transactions and
other events and circumstances from non-owner sources. It includes all changes
in equity during a period except those resulting from investments by owners and
distributions to owners." The Trust will adopt this statement, as required, on
January 1, 1998, and expects the only effect of adoption to be reporting of
comprehensive income in the Consolidated Statements of Operations.

Also in June 1997, the FASB issued SFAS No. 131 - "Disclosures About Segments of
an Enterprise and Related Information," which supersedes SFAS No. 14 -
"Financial Reporting for Segments of a Business Enterprise," SFAS No. 18 -
"Financial Reporting for Segments of a Business Enterprise - Interim Financial
Statements," SFAS No. 24 - "Reporting Segment Information in Financial
Statements that are Presented in Another Enterprise's Financial Report," and
SFAS No. 30 - "Disclosure of Information About Major Customers." This statement
is effective for financial statements for periods beginning after December 15,
1997. The Trust's management has not fully evaluated the effects of implementing
this statement but expects the Company's current financial statement disclosures
will not be affected.






                                       29
<PAGE>   30
ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
         AND RESULTS OF OPERATIONS (Continued)

Possible Consolidation with Tarragon Realty Investors, Inc.

On February 19, 1998, the Trust and Tarragon Realty Investors, Inc., ("TRI")
jointly announced the agreement of their respective boards to form a single
consolidated entity with TRI, for convenience, as the survivor. The surviving
consolidated entity is intended to operate as a self-administered REIT. The
consolidation transaction will be submitted to shareholders of each of the Trust
and TRI for approval at special meetings to be held during 1998. Under the
proposed agreement, each shareholder of the Trust will receive 1.97 shares of
TRI common stock for each share of beneficial interest of the Trust held. TRI,
also a REIT, has a similar opportunistic approach to real estate investment and
had total consolidated assets of approximately $37 million as of December 31,
1997. Upon the approval and consummation of the consolidation transaction by the
respective shareholders of each entity, TRI will acquire Tarragon, the Trust's
advisor since April 1, 1994, and TRI's advisor since March 1, 1994, for 100,000
shares of common stock of TRI and options to acquire additional shares of common
stock of TRI at prices ranging between $13 and $16 per share. The resulting
consolidated enterprise with TRI as the survivor will emerge from these
transactions as an integrated, self-administered, self-managed REIT controlling
approximately 14,000 apartment units and 2.1 million square feet of retail and
office space, primarily in California, Florida, and Texas. The consolidation
transaction will be accounted for as a reverse acquisition of TRI by the Trust.

William S. Friedman, President, Chief Executive Officer, and Trustee of the
Trust, also serves as Director and Chief Executive Officer of Tarragon and as
Director, President, and Chief Executive Officer of TRI. Tarragon is owned by
Mr. Friedman and his wife, Lucy N. Friedman. The Friedman family also owns
approximately 30% of the outstanding shares of common stock of TRI and
approximately 33% of the outstanding shares of beneficial interest of the Trust.

Risks Associated with Forward-Looking Statements Included in this Form 10-K

This Form 10-K contains certain forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934, which are intended to be covered by the safe harbors
created thereby. These statements include the plans and objectives of management
for future operations, including plans and objectives relating to capital
expenditures on Trust properties. The forward-looking statements included herein
are based on current expectations that involve numerous risks and uncertainties.
Assumptions relating to the foregoing involve judgments with respect to, among
other things, future economic, competitive, and market conditions and future
business decisions, all of which are difficult or impossible to predict
accurately and many of which are beyond the control of the Trust. Although the
Trust believes that the assumptions underlying the forward-looking statements
are reasonable, any of the assumptions could be inaccurate, and, therefore,
there can be no assurance that the forward-looking statements included in this
Form 10-K will prove to be accurate. In light of the significant uncertainties
inherent in the forward-looking statements included herein, the inclusion of
such information should not be regarded as a representation by the Trust or any
other person that the objectives and plans of the Trust will be achieved.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

This item is not applicable to the Trust at this time.




                                       30
<PAGE>   31

ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA


                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS


<TABLE>
<CAPTION>
                                                                         Page
                                                                         ----
<S>                                                                      <C>
Reports of Independent Public Accountants............................    32

Consolidated Balance Sheets -
  December 31, 1997 and 1996.........................................    33

Consolidated Statements of Operations -
  Years Ended December 31, 1997, 1996, and 1995......................    34

Consolidated Statements of Shareholders' Equity -
  Years Ended December 31, 1997, 1996, and 1995......................    35

Consolidated Statements of Cash Flows -
  Years Ended December 31, 1997, 1996, and 1995......................    36

Notes to Consolidated Financial Statements...........................    39

Schedule III - Real Estate and Accumulated  Depreciation.............    62
</TABLE>








All other schedules are omitted because they are not required or are not
applicable or because the information required is included in the Consolidated
Financial Statements or the notes thereto.




                                       31
<PAGE>   32


                    REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS


To the Board of Trustees of National Income Realty Trust


We have audited the accompanying consolidated balance sheets of National Income
Realty Trust and subsidiaries as of December 31, 1997 and 1996, and the related
consolidated statements of operations, shareholders' equity, and cash flows for
each of the three years in the period ended December 31, 1997. These financial
statements are the responsibility of the Trust's management. Our responsibility
is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, 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 to above present fairly, in
all material respects, the financial position of National Income Realty Trust
and subsidiaries as of December 31, 1997 and 1996, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1997, in conformity with generally accepted accounting principles.

Our audits were made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The Supplemental Schedule III is
presented for purposes of complying with the Securities and Exchange
Commission's rules and is not part of the basic financial statements. This
schedule has been subjected to the auditing procedures applied in the audits of
the basic financial statements and, in our opinion, fairly states in all
material respects the financial data required to be set forth therein in
relation to the basic financial statements taken as a whole.



                                                Arthur Andersen LLP

Dallas, Texas
March 27, 1998






                                       32
<PAGE>   33
                          NATIONAL INCOME REALTY TRUST
                           CONSOLIDATED BALANCE SHEETS



<TABLE>
<CAPTION>
                                                                         December 31,
                                                                  ------------------------
                                                                     1997           1996
                                                                  ---------      ---------
         Assets                                                    (dollars in thousands)
<S>                                                               <C>            <C>
Real estate held for sale (net of accumulated depreciation
  of $593 in 1997 and $397 in 1996) .........................     $   5,123      $  12,198
Less - allowance for estimated losses .......................        (1,194)        (1,529)
                                                                  ---------      ---------
                                                                      3,929         10,669
Real estate held for investment (net of accumulated
  depreciation of $45,440 in 1997 and $41,854 in 1996) ......       230,007        183,053
Investments in partnerships .................................        13,839          4,739
Cash and cash equivalents ...................................         4,262          3,862
Restricted cash .............................................         4,300          2,850
Other assets, net (including $42 in 1997 and $30
  in 1996 due from affiliates) ..............................         9,303          6,168
                                                                  ---------      ---------
                                                                  $ 265,640      $ 211,341
                                                                  =========      =========


Liabilities and Shareholders' Equity

Liabilities
Notes and interest payable ..................................     $ 184,126      $ 134,270
Other liabilities (including $67 in 1997 and $10 in 1996
  due to affiliates) ........................................        10,423          8,008
                                                                  ---------      ---------
                                                                    194,549        142,278
Commitments and contingencies................................

Shareholders' equity
Shares of beneficial interest, no par value; authorized
  shares, unlimited; shares outstanding, 3,812,404 in 1997
  and 3,523,729 in 1996 (after deducting 896,962 shares in
  1997 and 767,294 shares in 1996 held in treasury) .........        11,446         10,579
Paid-in capital .............................................       281,638        277,795
Accumulated distributions in excess of
  accumulated earnings ......................................      (222,126)      (219,311)
Unrealized gains on marketable equity securities ............           133             --
                                                                  ---------      ---------
                                                                     71,091         69,063
                                                                  ---------      ---------
                                                                  $ 265,640      $ 211,341
                                                                  =========      =========
</TABLE>



              The accompanying notes are an integral part of these
                       Consolidated Financial Statements.



                                       33
<PAGE>   34

                          NATIONAL INCOME REALTY TRUST
                      CONSOLIDATED STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
                                                                        For the Years Ended December 31,
                                                                  -------------------------------------------
                                                                      1997            1996            1995
                                                                  -----------     -----------     -----------
                                                                 (dollars in thousands, except per share data)
<S>                                                               <C>             <C>             <C>
Revenue
  Rentals ...................................................     $    50,745     $    47,831     $    43,381
  Interest ..................................................             629             631           1,089
  Equity in income of partnerships ..........................             643           1,500             770
                                                                  -----------     -----------     -----------
                                                                       52,017          49,962          45,240
Expenses
  Property operations (including $1,649 in 1997,
   $1,014 in 1996, and $330 in 1995 to affiliates) ..........          28,596          28,411          25,279
  Interest ..................................................          12,602          12,042          12,306
  Depreciation ..............................................           7,022           5,374           5,959
  Advisory fee to affiliate .................................           1,438           1,117           1,037
  General and administrative (including $1,411 in 1997,
   $1,176 in 1996, and $960 in 1995 to affiliates) ..........           2,091           1,932           2,058
  Provision for losses ......................................              --             300            (425)
                                                                  -----------     -----------     -----------
                                                                       51,749          49,176          46,214
                                                                  -----------     -----------     -----------
Income (loss) before net gain on sale of real estate, gain
  on sale of investments, gain on insurance settlement,
  and extraordinary gain ....................................             268             786            (974)
Net gain on sale of real estate .............................           4,350           3,700             533
Gain on sale of investments .................................             913              --             412
Gain on insurance settlement ................................              --             451              --
                                                                  -----------     -----------     -----------
Income (loss) from continuing operations ....................           5,531           4,937             (29)
Extraordinary gain ..........................................              61              --             737
                                                                  -----------     -----------     -----------
Net income ..................................................     $     5,592     $     4,937     $       708
                                                                  ===========     ===========     ===========

Earnings per share
Income (loss) from continuing operations ....................     $      1.44     $      1.21     $      (.01)
Extraordinary gain ..........................................             .02              --             .18
                                                                  -----------     -----------     -----------
Net income ..................................................     $      1.46     $      1.21     $       .17
                                                                  ===========     ===========     ===========
Weighted average shares of beneficial interest
  used in computing earnings per share ......................       3,832,535       4,070,183       4,101,453
                                                                  ===========     ===========     ===========

Earnings per share - assuming dilution
Income from continuing operations ...........................     $      1.43     $      1.21     $      (.01)
Extraordinary gain ..........................................             .01              --             .18
                                                                  -----------     -----------     -----------
Net income ..................................................     $      1.44     $      1.21     $       .17
                                                                  ===========     ===========     ===========
Weighted average shares of beneficial interest used
  in computing earnings per share - assuming dilution .......       3,871,248       4,088,382       4,101,961
                                                                  ===========     ===========     ===========
</TABLE>


              The accompanying notes are an integral part of these
                       Consolidated Financial Statements.


                                       34
<PAGE>   35

                          NATIONAL INCOME REALTY TRUST
                 CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY

<TABLE>
<CAPTION>
                                                                                         Accumulated     Unrealized
                                                                                         Distributions    Gains on
                                                      Shares of                          in Excess of    Marketable
                                                Beneficial Interest         Paid-in       Accumulated      Equity      Shareholders'
                                                Shares        Amount        Capital        Earnings       Securities     Equity
                                              -----------   -----------    -----------    -----------    -----------   ------------
                                                                           (dollars in thousands)
<S>                                             <C>         <C>            <C>            <C>            <C>            <C>
Balance, December 31, 1994 ..................   3,216,267   $     9,657    $   275,178    $  (211,887)   $       412    $    73,360
Repurchase of shares of beneficial interest .    (123,500)         (370)        (1,069)            --             --         (1,439)
Cash distributions ($0.62 per share) ........          --            --             --         (2,590)            --         (2,590)
Share distributions .........................     297,960           894          2,607         (3,501)            --             --
Realized gains on marketable equity
   securities ...............................          --            --             --             --           (412)          (412)
Net income ..................................          --            --             --            708             --            708
                                              -----------   -----------    -----------    -----------    -----------    -----------
Balance, December 31, 1995 ..................   3,390,727        10,181        276,716       (217,270)            --         69,627

Repurchase of shares of beneficial interest .    (285,189)         (856)        (2,812)            --             --         (3,668)
Conversion of convertible subordinated
   debenture ................................      93,076           279            721             --             --          1,000
Cash distributions ($0.69 per share) ........          --            --             --         (2,833)            --         (2,833)
Share distributions .........................     325,115           975          3,170         (4,145)            --             --
Net income ..................................          --            --             --          4,937             --          4,937
                                              -----------   -----------    -----------    -----------    -----------    -----------
Balance, December 31, 1996 ..................   3,523,729        10,579        277,795       (219,311)            --         69,063

Repurchase of shares of beneficial interest .     (48,472)         (145)          (603)            --             --           (748)
Cash distributions ($0.74 per share) ........          --            --             --         (2,949)            --         (2,949)
Share distributions .........................     337,147         1,012          4,446         (5,458)            --             --
Unrealized gains on marketable equity
   securities ...............................          --            --             --             --            831            831
Realized gains on marketable equity
   securities ...............................          --            --             --             --           (698)          (698)
Net income ..................................          --            --             --          5,592             --          5,592
                                              -----------   -----------    -----------    -----------    -----------    -----------
Balance, December 31, 1997 ..................   3,812,404   $    11,446    $   281,638    $  (222,126)   $       133    $    71,091
                                              ===========   ===========    ===========    ===========    ===========    ===========
</TABLE>

The accompanying notes are an integral part of these Consolidated Financial
Statements.



                                       35
<PAGE>   36

                          NATIONAL INCOME REALTY TRUST
                      CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
                                                                       For the Years Ended December 31,
                                                                 -----------------------------------------
                                                                    1997           1996           1995
                                                                 -----------    -----------    -----------
                                                                           (dollars in thousands)
<S>                                                              <C>            <C>            <C>
Cash Flows from Operating Activities
   Rentals collected .........................................   $    50,578    $    48,054    $    42,763
   Interest collected ........................................           634            553          1,062
   Interest paid .............................................       (11,564)       (11,336)       (12,638)
   Payments for property operations (including
     $1,649 in 1997, $1,014 in 1996, and $330
      in 1995 to affiliates) .................................       (29,886)       (28,752)       (25,179)
   General and administrative expenses paid
     (including $1,411 in 1997, $1,176 in 1996, and
     $960 in 1995 to affiliates) .............................        (2,134)        (2,117)        (2,179)
   Advisory fee paid to affiliate ............................        (1,452)        (1,168)        (1,022)
   Deferred borrowing costs paid .............................        (2,915)        (1,439)          (777)
                                                                 -----------    -----------    -----------

     Net cash provided by operating activities ...............         3,261          3,795          2,030
                                                                 -----------    -----------    -----------
Cash Flows from Investing Activities
   Acquisition of real estate ................................       (14,656)        (3,199)        (3,786)
   Proceeds from sale of real estate .........................         6,378          6,156          1,646
   Earnest money deposits paid ...............................          (245)            --             --
   Real estate improvements ..................................       (27,349)       (13,547)        (8,022)
   Collections on notes receivable ...........................           187          2,140          3,609
   Investments in marketable equity securities ...............        (2,462)            --             --
   Proceeds from sale of marketable equity securities ........         2,606             --            593
   Loans and advances to partnerships ........................        (9,133)            --             --
   Acquisition of partnership interest .......................           --              --           (462)
   Distributions from partnership's investing
     activities ..............................................           --           6,817             --
   Distribution of partnership's insurance settlement
     proceeds ................................................           --             760             --
   Proceeds from sale of partnership interest ................         1,600             --             --
   Net (contributions to) distributions from partnerships.....          (739)           437            986
                                                                 -----------    -----------    -----------

     Net cash (used in) investing activities .................       (43,813)          (436)        (5,436)
                                                                 -----------    -----------    -----------
</TABLE>


              The accompanying notes are an integral part of these
                       Consolidated Financial Statements.


                                       36
<PAGE>   37

                          NATIONAL INCOME REALTY TRUST
                CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)

<TABLE>
<CAPTION>
                                                                                        For the Years Ended December 31,
                                                                                   -----------------------------------------
                                                                                       1997           1996           1995
                                                                                   -----------    -----------    -----------
                                                                                             (dollars in thousands)
<S>                                                                                <C>            <C>            <C>
Cash Flows from Financing Activities
   Proceeds from borrowings ....................................................   $    79,477    $    34,323    $    23,500
   Payments on notes payable ...................................................       (36,034)       (28,500)       (23,571)
   Repair escrow (deposits) receipts, net ......................................          (847)          (292)         1,214
   Distributions to shareholders ...............................................        (2,105)        (2,731)        (2,486)
   Repurchase of shares of beneficial interest .................................          (748)        (3,668)        (1,439)
   Borrowings on margin account ................................................         1,209            280            785
   Advances from (repayment of advances from)
     affiliates ................................................................            --           (583)           583
   Distributions from partnerships' financing activities .......................            --             --          3,010
                                                                                   -----------    -----------    -----------
     Net cash provided by (used in) financing activities .......................        40,952         (1,171)         1,596
                                                                                   -----------    -----------    -----------

Net increase (decrease) in cash and cash equivalents ...........................           400          2,188         (1,810)

Cash and cash equivalents, beginning of year ...................................         3,862          1,674          3,484
                                                                                   -----------    -----------    -----------

Cash and cash equivalents, end of year .........................................   $     4,262    $     3,862    $     1,674
                                                                                   ===========    ===========    ===========

Reconciliation of net income to net cash
  provided by operating activities
     Net income ................................................................   $     5,592    $     4,937    $       708
     Net gain on sale of real estate ...........................................        (4,350)        (3,700)          (533)
     Gain on sale of investments ...............................................          (913)            --           (412)
     Gain on insurance settlement ..............................................            --           (451)            --
     Extraordinary gain ........................................................           (61)            --           (737)
     Depreciation and amortization .............................................         7,938          6,333          6,499
     Provision for losses ......................................................            --            300           (425)
     Equity in (income) of partnerships ........................................          (643)        (1,500)          (770)
     Changes in other assets and other liabilities, net of
        effects of noncash investing and financing activities:
        (Increase) decrease in interest receivable .............................             5            (55)            (7)
        (Increase) in other assets .............................................        (6,608)        (2,665)        (1,962)
        Increase in other liabilities ..........................................         1,962            543            333
        Increase (decrease) in interest payable ................................           339             53           (664)
                                                                                   -----------    -----------    -----------

Net cash provided by operating activities ......................................   $     3,261    $     3,795    $     2,030
                                                                                   ===========    ===========    ===========
</TABLE>





              The accompanying notes are an integral part of these
                       Consolidated Financial Statements.



                                       37
<PAGE>   38

                          NATIONAL INCOME REALTY TRUST
                CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)

<TABLE>
<CAPTION>
                                                                                        For the Years Ended December 31,
                                                                                     -----------------------------------------
                                                                                         1997           1996           1995
                                                                                     -----------    -----------    -----------
                                                                                               (dollars in thousands)
<S>                                                                                  <C>            <C>            <C>
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES:

Changes in assets and liabilities in connection with the
   acquisition or foreclosure of real estate:
   Real estate ...................................................................   $    30,762    $    14,954    $    11,024
   Notes and interest receivable .................................................            --         (8,568)            --
   Allowance for estimated losses ................................................            --          3,000             --
   Other assets ..................................................................           416             44            525
   Notes and interest payable ....................................................       (15,756)        (6,157)        (7,556)
   Other liabilities .............................................................          (766)           (74)          (207)
                                                                                     -----------    -----------    -----------
     Cash paid ...................................................................   $    14,656    $     3,199    $     3,786
                                                                                     ===========    ===========    ===========

Assets disposed of and liabilities released in
   connection with the sale of real estate:
   Real estate ...................................................................   $     9,572    $    23,221    $     2,464
   Allowance for estimated losses ................................................            --             --           (275)
   Other assets ..................................................................            29            596             --
   Notes and interest payable ....................................................        (7,493)       (21,127)        (1,076)
   Other liabilities .............................................................          (134)          (212)            --
   Net gain on sale ..............................................................         4,404          3,678            533
                                                                                     -----------    -----------    -----------
     Cash received ...............................................................   $     6,378    $     6,156    $     1,646
                                                                                     ===========    ===========    ===========

   Mortgage debt released in connection with
     litigation settlement .......................................................   $        --    $        --    $     1,020

   Real estate written off pursuant to
     condemnation ................................................................   $     2,210    $        --    $        --

   Note payable written off pursuant to the
     condemnation of the collateral property .....................................   $     1,725    $        --    $        --

   Allowance for estimated losses charged off
     in connection with the write-off of real
     estate ......................................................................   $       485    $        --    $        --
</TABLE>




              The accompanying notes are an integral part of these
                       Consolidated Financial Statements.



                                       38
<PAGE>   39
                          NATIONAL INCOME REALTY TRUST
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The accompanying Consolidated Financial Statements of National Income Realty
Trust, subsidiaries, and the consolidated partnerships have been prepared in
conformity with generally accepted accounting principles ("GAAP"), the most
significant of which are described in NOTE 1. "SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES." The preparation of financial statements in accordance with GAAP
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from those estimates. The Notes to Consolidated Financial Statements are an
integral part of the Consolidated Financial Statements. The data presented in
the Notes to Consolidated Financial Statements are as of December 31 of each
year and for the year then ended, unless otherwise indicated. Dollar amounts in
tables are in thousands, except per share amounts.

Certain balances for 1995 and 1996 have been reclassified to conform to the 1997
presentation.

NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Organization and Trust business. National Income Realty Trust ("NIRT" or the
"Trust") is a California business trust organized on October 31, 1978. The Trust
was formed to invest in real estate, including commercial and multifamily
properties.

Basis of consolidation. The Consolidated Financial Statements include the
accounts of NIRT, its subsidiaries, and partnerships which it controls. All
significant intercompany transactions and balances have been eliminated.

Real estate and depreciation. Real estate held for sale is carried at the lower
of cost or estimated fair value less estimated costs to sell. Real estate held
for investment is carried at cost unless an impairment is determined to exist,
as discussed below. Impaired properties are written down to their estimated fair
values. Foreclosed real estate is initially recorded at new cost, defined as the
lower of the Trust's note receivable carrying amount or the fair value of the
collateral property less estimated costs of sale. The Trust capitalizes property
improvements and major rehabilitation projects which increase the value of the
respective property and have useful lives greater than one year, except for
individual expenditures less than $10,000 which are not part of a planned
renovation project. Under this policy, during 1997, expenditures of $27.9
million were capitalized, including $10 million related to the redevelopment of
The Vistas at Lake Worth, and property replacements of $2.1 million were
expensed. Property replacements include, but are not limited to, such items as
landscaping, exterior painting, and parking lot improvements. Depreciation is
provided against real estate held for investment by the straight-line method
over the estimated useful lives of the assets, which range from three to 40
years.

The Trust capitalizes interest on funds used in constructing property from the
date of initiation of construction activities through the time the property is
ready for leasing. The Trust also capitalizes property taxes and insurance costs
during the construction period. Interest, property taxes, and insurance
expenditures of $945,000 and $693,000 were capitalized during 1997 and 1996,
respectively.




                                       39
<PAGE>   40
                          NATIONAL INCOME REALTY TRUST
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 1.  SIGNIFICANT ACCOUNTING POLICIES (Continued)

Effective January 1, 1997, the Trust implemented prospectively a change in
accounting estimate whereby capital expenditures for carpet, appliances, and
heating, ventilation, and air conditioning (HVAC) replacements are capitalized
rather than expensed. The Trust believes that capitalizing these expenditures
and depreciating them over lives ranging from three to five years more
appropriately reflects the timing of the economic benefits to be received from
these expenditures. Additionally, the Trust believes this treatment is
consistent with policies currently being used by other real estate investment
trusts. This change has no effect on the advisory fee as Tarragon Realty
Advisors, Inc. ("Tarragon"), the Trust's advisor since April 1, 1994, waived any
fee resulting from this change in accounting estimate.

The Trust's management evaluates the Trust's properties held for investment for
impairment whenever events or changes in circumstances indicate that the
carrying value of an asset may not be recoverable. This evaluation generally
consists of a review of the property's cash flow and current and projected
market conditions, as well as any changes in general and local economic
conditions. If an impairment loss exists based on the results of this review, a
loss is recognized by a charge against current earnings and a corresponding
reduction in the respective asset's carrying value. The amount of this
impairment loss is equal to the amount by which the carrying value of the
property exceeds the estimated fair value.

At least annually, all properties held for sale are reviewed by the Trust's
management, and a determination is made if the held for sale classification
remains appropriate. Following are among the factors considered in determining
that a change in classification to held for investment is appropriate: (i) the
property has been held for at least one year; (ii) Trust management has no
intent to dispose of the property within the next twelve months; (iii) the
property is a "qualifying asset" as defined in the Internal Revenue Code of 1986
(the "Code"); (iv) property improvements have been funded; and (v) the Trust's
financial resources are such that the property can be held long-term.

The Trust adopted Statement of Financial Accounting Standards ("SFAS") No. 121 -
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of" on January 1, 1996. There was no cumulative effect nor any
impact on the Trust's financial position as a result of the adoption. Pursuant
to the adoption, the Trust ceased depreciation of its properties held for sale.

Allowance for estimated losses. Valuation allowances are provided for estimated
losses on notes receivable and properties held for sale to the extent that the
investment in the notes or properties exceeds the Trust's estimate of fair value
less estimated selling costs of the collateral securing the notes or the
properties. The provisions for losses are based on estimates, and actual losses
may vary from current estimates. Such estimates are reviewed periodically. Any
additional provision determined to be necessary or the reversal of any existing
allowance no longer required is recorded by a charge or credit to current
earnings.

Cash equivalents. The Trust considers all highly liquid debt instruments
purchased with maturities of three months or less to be cash equivalents.

Restricted cash. Restricted cash represents escrow accounts, generally held by
the lenders of certain of the Trust's mortgage notes payable, for taxes,
insurance, and property repairs.


                                       40
<PAGE>   41
                         NATIONAL INCOME REALTY TRUST
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 1.  SIGNIFICANT ACCOUNTING POLICIES (Continued)

Other assets. Other assets consist primarily of notes and interest receivable,
marketable equity securities, tenant accounts receivable, deferred borrowing
costs, and prepaid leasing commissions. Marketable equity securities are
considered to be available-for-sale and are carried at fair value, defined as
year end closing market value. Net unrealized holding gains and losses are
reported as a separate component of shareholders' equity. Deferred borrowing
costs are amortized on the straight-line method (which approximates the
effective interest method) over the related loans terms, and such amortization
is included in interest expense. Prepaid leasing commissions are amortized to
leasing commission expense, included in property operating expenses, on the
straight-line method over the related lease terms.

Revenue recognition on the sale of real estate. Gains on sales of real estate
are recognized when and to the extent permitted by SFAS No. 66. - "Accounting
for Sales of Real Estate." Until the requirements of SFAS No. 66 for full profit
recognition have been met, transactions are accounted for using the deposit,
installment, cost recovery, or financing methods, whichever is appropriate.

Investment in noncontrolled partnerships. The Trust uses the equity method to
account for investments in partnerships it does not control. Under the equity
method, the Trust's initial investment is increased by the Trust's proportionate
share of the partnership's operating income and additional advances and
decreased by the Trust's proportionate share of the partnership's operating
losses and distributions received.

Earnings per share. Net income per share of beneficial interest (the "Shares"
and each a "Share") is computed based upon the weighted average number of Shares
outstanding during each year. Share and per share data have been restated to
give effect to 10% share distributions paid in September 1996 and September
1997.

On December 31, 1997, the Trust adopted SFAS No. 128 - "Reporting Earnings Per
Share," which superseded the Accounting Principles Board's Opinion No. 15 ("APB
No. 15") "Earnings Per Share." This statement requires business enterprises with
other than simple capital structures to report both basic and diluted earnings
per share for each period for which a statement of operations is presented.
There was no cumulative effect nor any impact on the Trust's financial position
as a result of the adoption.

Fair value of financial instruments. SFAS No. 107 - "Disclosures About Fair
Value of Financial Instruments" requires the Trust to disclose the estimated
fair values of its financial instrument assets and liabilities.

Disclosure about fair value of financial instruments is based on pertinent
information available to management as of December 31, 1997 and 1996.
Considerable judgment is necessary to interpret market data and develop
estimated fair values. Accordingly, the estimated fair values presented do not
purport to present amounts to be ultimately realized or paid by the Trust, which
may vary significantly from the estimated fair values presented. The use of
different market assumptions and/or estimation methodologies may have a material
effect on the estimated fair values.



                                       41
<PAGE>   42

                          NATIONAL INCOME REALTY TRUST
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 1.  SIGNIFICANT ACCOUNTING POLICIES (Continued)

As of December 31, 1997 and 1996, the Trust's management estimates that the
carrying amounts approximate fair value for cash and cash equivalents and
restricted cash because of the short maturities of those instruments. In
addition, the carrying amounts of notes receivable and other liabilities
approximate fair value. The fair values of the Trust's notes payable are
estimated by discounting future expected cash flows using current rates for
loans with similar terms and maturities.

Share option plans. On January 1, 1996, the Trust adopted SFAS No. 123 -
"Accounting and Disclosure of Stock-Based Compensation," which requires
disclosures based on the fair values of share options at the date of grant.
There was no cumulative effect nor any impact on the Trust's financial position
as a result of the adoption. The Trust will continue to measure any compensation
costs associated with the issue of share options using the guidance provided by
APB No. 25. Under APB No. 25, compensation costs related to share options issued
pursuant to compensatory plans are measured based on the difference between the
quoted market price of the shares at the measurement date (ordinarily the date
of grant) and the exercise price and should be charged to expense over the
periods during which the grantee performs the related services. All share
options issued to date by the Trust have exercise prices equal to the market
price of the shares at the dates of grant. See NOTE 9. "SHARE OPTIONS."

NOTE 2.  ALLOWANCE FOR ESTIMATED LOSSES AND PROVISIONS FOR LOSSES

Activity in the allowance for estimated losses was as follows:

<TABLE>
<CAPTION>
                                                        1997             1996
                                                       -------          -------
<S>                                                    <C>              <C>
Balance January 1 ............................         $ 1,529          $ 4,529
Reclassified from other assets ...............             150               --
Amounts charged off ..........................            (485)          (3,000)
                                                       -------          -------

Balance December 31 ..........................         $ 1,194          $ 1,529
                                                       =======          =======
</TABLE>

Amounts charged off in 1997 related to the write-off of K-Mart Shopping Center
in Indianapolis, Indiana, in March 1997.

Amounts charged off in 1996 relate to the acquisition of Jackson Square Shopping
Center through deed in lieu of foreclosure in January 1996.

Additionally, during 1996, the Trust recorded a provision for loss of $300,000
to write down Mariposa Manor Apartments to its then estimated fair value.

In 1995, the Trust recorded a provision for loss credit of $425,000 comprised of
the reversal of a $700,000 allowance provided in 1993 against Pepperkorn Office
Building and a provision of $275,000 to reduce the carrying value of K-Mart
Shopping Center in Kansas City, Missouri, to the net sale proceeds received in
July 1995. For further discussion of these transactions, see NOTE 3. "REAL
ESTATE AND DEPRECIATION."



                                       42
<PAGE>   43

                          NATIONAL INCOME REALTY TRUST
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 3.  REAL ESTATE AND DEPRECIATION

During 1997, 1996, and 1995, the Trust purchased 13 multifamily properties
comprising 1,991 units and one 52,288 square foot shopping center as presented
below. In connection with these acquisitions the Trust paid Tarragon real estate
acquisition fees totaling $538,000. These properties are located in the same
geographical areas where the Trust currently operates and were acquired in
separate transactions from unaffiliated sellers.


<TABLE>
<CAPTION>
                                                                                                         Cost of Acquisition
                                                                 Date                    Square       --------------------------
                 Property               Location               Acquired      Units       Footage        Cash              Debt
             -----------------        ------------            ----------    -------     ---------     ----------       ---------
<S>                                   <C>                      <C>          <C>         <C>           <C>              <C>
           1997 Acquisitions:

           Morningside                Jacksonville, FL           Feb-97          112       89,200     $      521       $   1,641
           Newport                    Plantation, FL             Jun-97          152      139,364          1,526           5,058
           Fountainhead               Kissimmee, FL              Jun-97          184      172,578          7,690              --
           Courtyard at the Park      Miami, FL                  Jul-97          127      117,250            728           2,973
           Mariner Plaza              Tallahassee, FL            Aug-97           --       52,288          1,458              --
           Landmark                   Tallahassee, FL            Oct-97          128      113,720          1,822              --
                                                                            --------   ----------     ----------       ---------
                                                                                 703      684,400         13,745           9,672
                                                                            --------   ----------     ----------       ---------

           1996 Acquisitions:

           Woodbrier                   Oklahoma City, OK         Apr-96          128      114,900          1,277           1,230
           River City Landing          Jacksonville, FL          Jun-96          352      356,800          1,922           4,930
                                                                            --------   ----------     ----------       ---------
                                                                                 480      471,700          3,199           6,160
                                                                            --------   ----------     ----------       ---------

           1995 Acquisitions:

           Park Place                 Los Angeles, CA             Feb-95          39       15,640            380              --
           Marina Park                North Miami, FL             Apr-95          90       86,850            993           2,500
           Mustang Creek              Arlington, TX               May-95         120      167,880            830           2,680
           Park Norton                Los Angeles, CA             Jun-95          55       25,208            154             564
           The Regent                 Jacksonville, FL            Sep-95         304      288,320          1,480              --
           Meadowbrook                Baton Rouge, LA             Oct-95         200      127,524             --           1,813
                                                                            --------   ----------     ----------       ---------
                                                                                 808      711,422          3,837           7,557
                                                                            --------   ----------     ----------       ---------
                                                                               1,991    1,867,522     $   20,781       $  23,389
                                                                            ========   ==========     ==========       =========
</TABLE>

In connection with obtaining the acquisition financing of $2.7 million and
$564,000, respectively, for Mustang Creek and Park Norton in 1995, the Trust
paid Tarragon mortgage brokerage fees totaling $32,440. Also, in connection with
the acquisition of River City Landing in 1996, the seller paid Mr. Bruce A.
Schnitz, Chief Operating Officer of the Trust and Tarragon, a commission of
$82,563 pursuant to a brokerage agreement entered into prior to Mr. Schnitz's
affiliation with Tarragon and the Trust.

The Trust also added 300 units to its multifamily portfolio in July 1997 when it
acquired an additional 40% interest in English Village Partners, L.P., for $1
million. As the Trust now holds a 90% interest in the partnership, the
operations of English Village Apartments, located in Memphis, Tennessee, and
subject to a $6.1 million mortgage, have been consolidated since July 1997.





                                       43
<PAGE>   44
                          NATIONAL INCOME REALTY TRUST
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 3.  REAL ESTATE AND DEPRECIATION (Continued)

The Trust sold Plaza Hills Apartments in Kansas City, Missouri, Huntington Green
Apartments in Philadelphia, Pennsylvania, and Pheasant Pointe Apartments in
Sacramento, California, during 1997 for an aggregate sale price of $14
million, receiving net cash proceeds of $6.4 million and recognizing gains on
the sales totaling $4.4 million.

In November 1995, the City of Indianapolis, Indiana, (the "City") initiated
condemnation proceedings against the Trust's K-Mart Shopping Center acquired
through a deed in lieu of foreclosure in December 1994. The shopping center was
vacant at the time the Trust acquired it, although leased to K-Mart under a net
lease expiring in 1999. The lease was assigned by K-Mart to the City in
September 1995. In March 1996, the Trust ceased payments on the $1.7 million
non-recourse mortgage loan secured by the shopping center. In March 1997, the
Trust wrote off the property and related debt, as the mortgage is now secured by
the condemnation award. No loss was recognized in excess of amounts previously
provided.

In October 1995, the Trust and the borrower on an $8.6 million first mortgage
receivable, which matured in December 1995, negotiated a settlement of the
outstanding balance whereby the borrower agreed to relinquish the collateral
property, Jackson Square Shopping Center, a 342,000 square foot property in
Jackson, Mississippi, through a deed in lieu of foreclosure. The Trust took
possession of the property in January 1996. As the estimated fair value of the
property exceeded the Trust's net carrying value of the mortgage loan, the Trust
recognized no loss in excess of amounts previously provided.

The Trust is in the final stages of reconstructing and expanding The Vistas at
Lake Worth in Fort Worth, Texas, to 265 apartment units at a cost of
approximately $14.3 million, $13 million of which had been expended as of
December 31, 1997. Operations began at the property in December 1997, and
redevelopment was completed in March 1998.

In September 1996, the Trust sold Century Centre II Office Building for $28.2
million in cash. After closing costs, prorations, and the payoff of the $21
million mortgage secured by the property, the Trust received net cash proceeds
of $6.2 million. In connection with this transaction, the Trust recognized a
gain of $3.7 million.

During 1995, the Trust sold portions of Lake Highlands land in Dallas, Texas,
for $885,000 in cash. Net cash proceeds were $790,000 after closing costs. The
Trust recorded gains of $533,000 from the sales.

In July 1995, the Trust purchased a tract of land adjacent to its K-Mart
Shopping Center in Kansas City, Missouri, for $125,000 and simultaneously sold
the K-Mart Shopping Center and the tract of land, keeping a portion of the
undeveloped land, for $1.8 million, including a $414,000 lease termination
payment from K-Mart. After the first lien payoff of $1.1 million and other
related closing costs, net cash proceeds to the Trust were $856,000. In June
1995, the Trust recorded a provision for loss of $275,000 to account for the
excess carrying value of the property over the related sale price.





                                       44
<PAGE>   45
                          NATIONAL INCOME REALTY TRUST
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 3.  REAL ESTATE AND DEPRECIATION (Continued)

The Trust purchased Pepperkorn Office Building located in Manitowoc, Wisconsin,
("Pepperkorn") in July 1991 for $1.1 million, paying $130,000 in cash and
financing the remainder through a $1 million promissory note. Concurrently with
the acquisition, the former owner and primary tenant (the "Seller") signed a
lease at another one of the Trust's properties, Lakeview Mall, also located in
Manitowoc, Wisconsin. In 1993, the State of Wisconsin commenced eminent domain
proceedings to acquire Pepperkorn, and the Trust recorded a provision for loss
of $700,000, equal to the amount by which the carrying value of the property
exceeded the proposed condemnation award. In May 1995, the court ordered the $1
million promissory note executed by the Trust rescinded and found certain
provisions of the Seller's lease at Lakeview Mall were unenforceable.
Accordingly, the note balance was offset against the carrying value of the
property, the net rent receivable, and the condemnation award. As a result, the
Trust reversed the $700,000 allowance during the second quarter of 1995 with a
corresponding credit to earnings. The Trust collected the $232,000 condemnation
award in 1997.

Results of operations for real estate held for sale for the years ended December
31, 1997, 1996, and 1995, were $192,000, $323,000, and $114,000, respectively.
Operations for these properties include rental revenue, property operating
expenses, interest expense, and, prior to January 1, 1996, depreciation expense.
For a listing of properties held for sale, see Schedule III.

NOTE 4.  INVESTMENTS IN AND ADVANCES TO PARTNERSHIPS

Investments in and advances to partnerships consisted of the following at
December 31:

<TABLE>
<CAPTION>
                                                                   1997        1996
                                                                ---------   ---------
<S>                                                             <C>         <C>
Sacramento Nine ("SAC 9")  ..................................   $     557   $     469
Income Special Associates ("ISA")  ..........................          --       1,508
Ansonia Apartments, L.P. ("Ansonia") ........................         970          --
Danforth National Apartments, Ltd. ("Danforth") .............       2,892          --
801 Pennsylvania Avenue .....................................       2,936       2,762
National Omni Associates, L.P. ("Omni") .....................         721          --
RI Windsor, Ltd. ("Windsor") ................................       2,697          --
RI Panama City, Ltd. ("Panama") .............................       1,677          --
Tarragon Savannah, L.P. ("Savannah") ........................       1,389          --
                                                                ---------   ---------
                                                                $  13,839   $   4,739
                                                                =========   =========
</TABLE>

In January 1997, in exchange for a capital contribution of $214,000, which was
matched by the other partners, the Trust received a 1% general partner interest
and a 49% limited partner interest in Windsor, a limited partnership formed to
construct a 324-unit luxury apartment complex to be known as The Mayfaire at
Windsor Parke in Jacksonville, Florida, at an estimated cost of $16 million.
Initial operations began at the property in August 1997, and the property was
completed in the first quarter of 1998. The partnership obtained a $16 million
construction loan to finance the construction. The Trust has also loaned the
partnership $2.5 million which is to be repaid following completion and lease-up
of the property. Until lease-up of the property, the construction loan is
guaranteed by the other general partner. As the Trust holds a non-controlling
interest, it accounts for its investment in the partnership using the equity
method.



                                       45
<PAGE>   46
                          NATIONAL INCOME REALTY TRUST
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 4.  INVESTMENTS IN AND ADVANCES TO PARTNERSHIPS (Continued)

The bulk of the proceeds for the Trust's loan to the partnership were obtained
from a $2.2 million loan secured by 352,000 of the Trust's shares of beneficial
interest. The lender has no voting rights with and does not receive cash
distributions on these shares, which are unregistered. Therefore, these shares
are not included with outstanding shares in the accompanying December 31, 1997,
Consolidated Balance Sheet and the Consolidated Statement of Shareholders'
Equity for the year ended December 31, 1997. The loan matures in January 2000;
however, the Trust intends to repay the loan prior to December 1998 with
proceeds received from the partnership's construction loan.

In June 1997, in exchange for a capital contribution of $200,000, the Trust
received a 1% general partner interest and a 49% limited partner interest in
Panama. This partnership was formed to construct a 200-unit luxury apartment
complex to be known as Harbour Green Apartments in Panama City, Florida, at an
estimated cost of $10.5 million. The first units became available for rent in
January 1998. The property is expected to be completed in the second quarter of
1998. The partnership has obtained an $8.8 million construction loan to finance
construction. The Trust has also loaned the partnership $1.5 million which is to
be repaid from construction loan proceeds following completion and lease-up of
the property. Until lease-up of the property, the construction loan is
guaranteed by the other general partner. The Trust also accounts for its
investment in this partnership using the equity method.

In September 1997, the Trust received a 1% general partner and a 59% limited
partner interest in Danforth in exchange for a $6,000 capital contribution. This
partnership was formed to construct a 288-unit luxury apartment complex to be
known as The Club at Danforth Apartments in Jacksonville, Florida, at an
estimated cost of $17.1 million. The property is expected to be completed in the
third quarter of 1998. The Partnership has obtained a $13.7 million construction
loan to finance construction. The Trust has also loaned the partnership $2.9
million which is to be repaid following completion and lease-up of the property.
In connection with the acquisition of the land on which the property is being
constructed, Danforth paid an acquisition fee of $30,000 to Tarragon. In
February 1998, the Trust acquired an additional 20% limited partner interest in
this partnership. Because both general partners actively participate in the
decision-making of the partnership activities, the Trust accounts for its
investment in this partnership using the equity method.

In December 1997, in exchange for a $200,000 capital contribution, the Trust
received a 1% general partner interest and a 49% limited partner interest in
Savannah. This partnership was formed to construct a 250-unit luxury apartment
complex to be known as The Links at Georgetown located in Savannah, Georgia,
at an estimated cost of $14.5 million. The property is expected to be completed
in the second quarter 1999. The partnership has obtained a $12 million
construction loan to finance construction. The Trust also loaned the partnership
$1.2 million which is to be repaid following completion and lease-up of the
property. Until lease-up of the property, the construction loan is guaranteed by
the other general partner. As the Trust holds a non-controlling interest in the
partnership, it accounts for its investment in the partnership using the equity
method.




                                       46
<PAGE>   47
                          NATIONAL INCOME REALTY TRUST
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 4.  INVESTMENTS IN AND ADVANCES TO PARTNERSHIPS (Continued)

In December 1997, in exchange for a capital contribution of $970,000, the Trust
acquired a 70% general partner interest in Ansonia, which purchased Autumn Ridge
Apartments, a 116-unit property in East Haven, Connecticut, for $2 million and
Meriden East Apartments, a 66-unit property in Meriden, Connecticut, for $1.8
million. Both properties were purchased in December 1997, and $2.9 million of
the aggregate acquisition cost was financed through mortgages on each property.
In connection with the acquisition of these properties, Ansonia paid Tarragon
acquisition fees totaling $38,000. Because both partners participate in the
decision-making of partnership activities, the Trust is a noncontrolling
partner and accounts for its investment in Ansonia using the equity method.

Advances to partnerships included in the accompanying December 31, 1997,
Consolidated Balance Sheet include $721,000 the Trust advanced in December 1997
to Omni in exchange for a 46% interest in this partnership. Subsequent to year
end, the Trust advanced an additional $4.6 million to this partnership, which
purchased 5600 Collins Avenue in Miami Beach, Florida. See NOTE 16. "SUBSEQUENT
EVENTS." As the Trust holds a noncontrolling interest in Omni, its investment
in this partnership is accounted for using the equity method.

The Trust and Continental Mortgage and Equity Trust ("CMET") own SAC 9, a
tenancy-in-common which currently owns two office buildings in the vicinity of
Sacramento, California. The Trust has a 70% undivided interest in SAC 9. Under
the terms of the joint tenancy, unanimous consent is required of both the Trust
and CMET for any material changes in the operations of the properties, including
sales, refinancings, and changes in property management. The Trust, as a
noncontrolling partner, accounts for its investment in SAC 9 using the equity
method.

In August 1995, SAC 9 obtained first mortgage financing in the amount of $3.5
million secured by a previously unencumbered office building. Net financing
proceeds of $3.4 million were distributed, of which the Trust's proportionate
share was $2.4 million. In connection with the financing, SAC 9 paid a mortgage
brokerage fee of $35,000 to Tarragon. Distribution of the financing proceeds to
the Trust resulted in cumulative distributions exceeding the Trust's investment
in SAC 9. Accordingly, during 1996, the Trust recorded income of $129,000
representing the excess of cumulative distributions over the Trust's investment
in SAC 9.

The Trust and CMET were partners in ISA, a general partnership in which the
Trust had a 40% interest in earnings, losses, and distributions. ISA in turn
owned a 100% interest in Indcon, L.P. ("Indcon"), which owned four industrial
warehouses at December 31, 1997. The Trust, as a noncontrolling partner,
accounted for its investment in ISA using the equity method. In August 1997,
Indcon sold a warehouse for $60,000 receiving net cash proceeds of $54,000 of
which the Trust's proportionate share was $22,000. In connection with the sale,
Indcon recorded a loss on the sale totaling $134,000, and the Trust recorded a
$54,000 loss representing its proportionate share of the loss on sale. In
November 1997, the Trust sold its interest in the partnership to CMET for $1.6
million cash. In connection with this transaction, the Trust recognized a gain
on the sale of $215,000.

During the first half of 1996, Indcon sold 27 warehouses for $41.2 million,
receiving net cash proceeds of $16.8 million after the payoff of the existing
$23.5 million mortgage loan and closing costs. The Trust's share of the sales
proceeds was $6.7 million plus $130,000 representing an allowance for brokerage
commissions which the Trust retained and which offset the Trust's share of
Indcon's loss on the sale, resulting in a net gain on the sale of $22,000.

In September 1995, one of Indcon's warehouses was destroyed in a fire. An
insurance settlement totaling $2.2 million was reached by the partnership in
March 1996 resulting in a $1.1 million gain, of which the Trust's proportionate
share was $451,000. The Trust received cash proceeds of $760,000 representing
its proportionate share of the insurance settlement proceeds. Indcon does not
anticipate rebuilding the property.




                                       47
<PAGE>   48
                          NATIONAL INCOME REALTY TRUST
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 4.  INVESTMENTS IN AND ADVANCES TO PARTNERSHIPS (Continued)

In July 1997, the Trust acquired an additional 40% interest in English Village
Partners, L.P., ("English Village") increasing its total interest to 90%, in
exchange for a capital contribution of $1 million. As the Trust now holds a
controlling interest, the operations of English Village Apartments, the
partnership's sole property, have been consolidated since July 1997. See NOTE 3.
"REAL ESTATE AND DEPRECIATION."

Prior to July 1997, the Trust held a 49% limited partner interest and a 1%
general partner interest in English Village and, as a noncontrolling partner,
accounted for its investment using the equity method. In November 1995, English
Village refinanced the mortgage debt secured by English Village Apartments,
increasing the first mortgage loan balance to $6.2 million. Net refinancing
proceeds were $1.3 million, of which the Trust's portion was $619,000.
Distribution of the refinancing proceeds resulted in cumulative distributions
exceeding the Trust's investment in English Village. Also, during 1996,
distributions to the Trust from the operations of English Village Apartments
exceeded the Trust's share of the partnership's net income. Accordingly, during
1996, the Trust recorded income of $771,000 representing the excess of
cumulative distributions over the Trust's investment in English Village.

In June 1995, the Trust acquired a 50% economic interest in an office building
located at 801 Pennsylvania Avenue, Washington, D.C. (the "Property"). This
interest was acquired through the purchase of a first lien mortgage note with a
face value of $8.5 million (the "Note") for $500,000 in cash and a $2.5 million
promissory note, which bore interest at the Prime Rate plus 1% per annum and was
repaid at a $67,000 discount in September 1995. In accordance with the terms of
the Note, the Trust's $3 million investment, as well as any additional advances
made to the Property, is to be repaid from Property cash flow after operating
expenses with interest at the rate of 11% per annum. The $5.5 million remaining
balance of the Note plus accrued interest may be satisfied by payment of 50% of
all funds available after Property operating expenses plus 50% of the proceeds
from any sale and any refinancing. The Note is nonrecourse to all parties and is
secured only by the Property.

Set forth below are summarized financial data for all partnerships the Trust
accounts for using the equity method (unaudited):

<TABLE>
<CAPTION>
                                                         December 31,
                                                     ----------------------
                                                       1997         1996
                                                     ---------    ---------
<S>                                                  <C>          <C>
Real estate (net of accumulated depreciation of
  $2,898 in 1997 and $5,817 in 1996) .............   $  36,969    $  14,316
Other assets .....................................       1,868        1,525
Notes payable ....................................     (24,759)      (8,937)
Other liabilities ................................      (8,615)        (276)
                                                     ---------    ---------
Partners' capital ................................   $   5,463    $   6,628
                                                     =========    =========
</TABLE>





                                       48
<PAGE>   49


                          NATIONAL INCOME REALTY TRUST
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 4.  INVESTMENTS IN AND ADVANCES TO PARTNERSHIPS (Continued)

<TABLE>
<CAPTION>
                                                      For the Years Ended December 31,
                                                     ------------------------------------
                                                        1997         1996         1995
                                                     ----------   ----------   ----------
<S>                                                  <C>          <C>          <C>
Rental revenue ...................................   $    3,823   $    5,090   $    9,889
Property operating expenses ......................      (1,419)      (2,179)      (3,290)
Interest expense .................................        (829)      (1,421)      (3,202)
Depreciation expense .............................        (519)        (535)      (2,013)
                                                     ----------   ----------   ----------
Income before loss on sale of real estate and
  gain on insurance settlement ...................        1,056          955        1,384
Loss on sale of real estate ......................        (134)        (270)           --
Gain on insurance settlement .....................           --        1,126           --
                                                     ----------   ----------   ----------
Net income .......................................   $      922   $    1,811   $    1,384
                                                     ==========   ==========   ==========
</TABLE>

NOTE 5.  INVESTMENTS IN MARKETABLE EQUITY SECURITIES

In accordance with SFAS No. 115, "Accounting for Certain Investments in Debt and
Equity Securities," investments in marketable equity securities are carried at
fair value. These investments are included in "Other assets" in the accompanying
December 31, 1997, Consolidated Balance Sheet. Unrealized gains are included as
a separate component of shareholders' equity. During 1997, unrealized gains
increased $831,000, and investments with a cost basis of $1.9 million
(determined by the average cost method) were sold for $2.6 million, resulting in
realized gains of $698,000.

At December 31, 1994, the Trust owned 39,500 shares of beneficial interest of
CMET, purchased through open market transactions, at a total cost to the Trust
of $181,000. During the first quarter of 1995, the Trust sold the shares for
$593,000 and recognized a $412,000 gain on the sale.

NOTE 6.  NOTES AND INTEREST PAYABLE

Note and interest payable consisted of the following at December 31:

<TABLE>
<CAPTION>
                                                                    1997                              1996
                                                        ----------------------------       ----------------------------
                                                        Estimated                          Estimated
                                                          Fair              Book             Fair               Book
                                                          Value             Value            Value             Value
                                                        ----------         ---------       ----------        ----------
<S>                                                     <C>                <C>             <C>               <C>
  Notes payable ...................................     $  180,461         $ 182,498       $  134,988        $  132,981
                                                        ==========                         ==========
  Accrued interest ................................                            1,628                              1,289
                                                                           ---------                          ---------
                                                                           $ 184,126                          $ 134,270
                                                                           =========                          =========
</TABLE>

Notes payable at December 31, 1997, bear interest at rates ranging from 6.05% to
11.68% per annum and mature from 1998 through 2031. These notes are generally
nonrecourse and are collateralized by deeds of trust on real estate with an
aggregate carrying value of $208 million.


                                       49
<PAGE>   50

                          NATIONAL INCOME REALTY TRUST
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 6.  NOTES  AND INTEREST PAYABLE (Continued)

During 1997, 1996, and 1995, the Trust obtained permanent mortgage financing on
sixteen Trust properties, including Martins Landing and Forest Oaks as discussed
below, totaling $78.7 million, receiving net cash proceeds of $19.7 million
after the payoff of $51.6 million in existing debt. The remainder of the
financing proceeds was used to fund escrows for replacements and repairs and to
pay the associated closing costs. In connection with these financings, the Trust
paid commissions of $611,000 to Tarragon.

At December 31, 1997, scheduled principal payments on notes payable are due as
follows:

<TABLE>
<S>  <C>                                                            <C>
     1998.......................................................... $  16,188
     1999  ........................................................    17,051
     2000  ........................................................    53,324
     2001..........................................................     2,071
     2002  ........................................................     2,767
     Thereafter....................................................    91,097
                                                                    ---------
                                                                    $ 182,498
                                                                    =========
</TABLE>

In September 1995, the Trust negotiated a $2.7 million payoff of the $3.2
million mortgage loan secured by Forest Oaks Apartments in Lexington, Kentucky.
In exchange for the discounted payoff of the Forest Oaks mortgage loan, the
Trust agreed to pay the full balance of the $4.5 million mortgage loan,
originally scheduled to mature February 2023, secured by Martins Landing
Apartments located in Lakeland, Florida. In December 1995, the Trust obtained
interim financing in the amount of $2 million secured by Forest Oaks. For
services provided in connection with obtaining the interim financing, the Trust
paid Tarragon a mortgage brokerage fee of $20,000. The combined $6.7 million
proceeds of the interim financing and the new $5 million first mortgage loan
secured by Martins Landing, which was also obtained in December 1995, along with
general working capital of the Trust, were used to satisfy the mortgage payoffs,
and, in December 1995, the Trust recognized an extraordinary gain of $560,000
due to the forgiveness of debt. In May 1996, the Trust obtained permanent
mortgage financing secured by Forest Oaks in the amount of $3.1 million.

Also in September 1995, the Trust entered into a Loan Sale Agreement (the
"Agreement") with the U. S. Department of Housing and Urban Development ("HUD")
for the discounted purchase of two mortgage loans for $3.9 million, secured
separately by Bryan Hill Apartments located in Bethany, Oklahoma, acquired in
November 1994, and Meadowbrook Apartments, a 200-unit complex in Baton Rouge,
Louisiana. The Trust paid $3.5 million of the purchase price with funds obtained
in November 1995 through interim financing secured by first mortgages against
both properties. The balance was paid through the application of existing escrow
accounts and general working capital of the Trust. In November 1995,
simultaneously with the final payment to HUD, the Trust recognized an
extraordinary gain of $110,000 in connection with the purchase of the $2.2
million Bryan Hill mortgage. Through the discounted purchase of the mortgage
loan secured by Meadowbrook, effective October 1, 1995, the Trust acquired
control of the property and recorded the acquisition as of the same date. The
Trust paid a mortgage brokerage fee of $35,000 to Tarragon for obtaining the
interim financing.



                                       50
<PAGE>   51
                          NATIONAL INCOME REALTY TRUST
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 6.  NOTES  AND INTEREST PAYABLE (Continued)

In August 1996, the Trust obtained a $9 million line of credit secured by
mortgages on four of its multifamily properties, Diamond Loch, Meadowbrook,
Mustang Creek, and The Regent. All of these properties except The Regent
previously collateralized other mortgage loans. The prior loans totaling $3.9
million secured by Diamond Loch and Mustang Creek were paid off at closing.
Additionally, a principal payment of $500,000 was made at closing on the $3.5
million interim mortgage loan obtained in 1995 secured by both Meadowbrook and
Bryan Hill in exchange for the release of Meadowbrook. During 1996, $8.8 million
was advanced under the line of credit, and, after prior loan payoffs and closing
costs, the Trust received net cash proceeds of $4.2 million. The Trust paid
Tarragon financing fees totaling $88,000 for services rendered in connection
with this transaction. In 1997, the remaining $200,000 was advanced under the
line of credit, and the Trust paid Tarragon a $2,000 financing fee. In September
1997, Meadowbrook was released as collateral on the line of credit, and a $2.5
million advance secured by this property was obtained under the revolving credit
facility with GMAC Commercial Mortgage. See discussion below.

Pursuant to a Master Repurchase Agreement (the "Agreement") with an investment
bank entered into in April 1996, the Trust purchased the $3.1 million Fannie Mae
mortgage backed security ("Fannie Mae MBS") issued by the lender in connection
with the financing of Forest Oaks at a 1/2% discount in June 1996 and the $16.8
million Government National Mortgage Association mortgage backed security ("GNMA
MBS") issued by the lender in connection with the financing of Heather Hills at
a 2.7% discount in July 1996. The investment bank purchased the Fannie Mae MBS
and the GNMA MBS from the Trust for 92% of the aggregate value, or $17.9
million, and the Trust agreed to repurchase the MBSs from the investment bank
one month later at the same price plus interest at the London Interbank Offered
Rate ("LIBOR") plus 1/2% per annum. As provided for in the Agreement, the Trust
and the investment bank extended the repurchase date monthly. In January 1997,
the Trust entered into a similar repurchase transaction with a government
sponsored enterprise which purchased the MBSs for 97% of their aggregate value,
or $19.3 million, and the Trust agreed to repurchase them in February 1997 for
the same price plus interest at 5.4% per annum. The Trust and the government
sponsored enterprise have since extended the repurchase date monthly. In
November 1997, the Trust purchased the $2.7 million Fannie Mae MBS issued by the
lender in connection with the financing of Cross Creek Apartments ("Cross
Creek") at a 3% discount. The government sponsored enterprise purchased the
Cross Creek Fannie Mae MBS along with the other MBSs in November 1997 pursuant
to the same reverse repurchase transaction. The repurchase date has been
extended to March 1998, and the current repurchase price is $22.4 million. The
repurchase transaction has resulted in effective interest rates as of December
31, 1997, on the Forest Oaks, Heather Hills, and Cross Creek financings of
6.85%, 6.11%, and 6.87% respectively.

The Trust is exposed to a demand for additional collateral or, in the
alternative, credit loss in the event the interest rate associated with the
repurchase transaction fluctuates in a manner that is unfavorable to the Trust's
interest in the MBSs. However, the Trust intends to either pay off the mortgages
or modify the mortgages to increase the interest rate prior to any significant
credit loss.

In May 1997, the Trust accepted a commitment from GMAC Commercial Mortgage
Corporation for a $50 million revolving credit facility. Advances under the
facility are available to finance properties currently owned by the Trust as
well as new acquisitions. The outstanding balance is limited to the lesser of
75% of the value of the collateral properties or an amount supported by a debt
service coverage ratio of 1.25. The borrowing base



                                       51
<PAGE>   52
                          NATIONAL INCOME REALTY TRUST
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 6.  NOTES  AND INTEREST PAYABLE (Continued)

may be increased by adding new or existing properties to the collateral pool.
Advances are limited to the lesser of 75% of the appraised value of the property
as stabilized or 80% of total acquisition costs which include the purchase price
of a newly acquired property and the cost of improvements incurred between the
date of acquisition and the date that any mortgage secured by that property is
recorded. A newly acquired property is defined as a property owned by the Trust
for less than one year. The outstanding balance under the facility bears
interest at the 30 day LIBOR plus a variable spread of between 2% and 2.5% which
is determined based on the loan-to-value and debt service coverage maintained.
Payment terms include interest only monthly with the outstanding balance due at
maturity, which is 36 months from the date of the first advance. The Trust may
extend the maturity by two six-month terms, but no new fundings may occur under
the facility during any extension period. In 1997, the Trust obtained fundings
under this revolving credit facility totaling $42 million secured by first
mortgages against eight Trust properties. The Trust received net cash proceeds
of $26.3 million from these fundings after the payoff of existing mortgages of
$13.5 million, establishing escrows for taxes, insurance, and repairs, and
paying the associated closing costs. In connection with these fundings, the
Trust paid Tarragon financing fees totaling $420,000.

In December 1993, the Trust issued a $1 million convertible subordinated
debenture to Mr. John A. Doyle, Chief Financial Officer of the Trust until
September 1996, in exchange for his participation interest in the profits of the
Consolidated Capital Properties II ("CCP II") assets, which the Trust acquired
in November 1992. Mr. Doyle was granted this participation as consideration for
his services in connection with the CCP II acquisition. In February 1996, Mr.
Doyle converted the debenture into 93,076 Shares. In September 1996, the Trust
repurchased 50,000 of these Shares from Mr. Doyle for $700,000.

NOTE 7.  DISTRIBUTIONS TO SHAREHOLDERS

The Trust paid cash distributions in 1995, 1996, and 1997 of $2.6 million, $2.8
million, and $2.9 million, respectively. The Trust reported to the Internal
Revenue Service that the 1997 distributions were taxable to shareholders as
ordinary income and the 1996 and 1995 distributions represented return of
capital.

Additionally, in September 1995, 1996, and 1997, the Trust paid 10% share
distributions which resulted in the Trust issuing 297,960 Shares, 325,115
Shares, and 337,147 Shares, respectively.




                                       52
<PAGE>   53

                          NATIONAL INCOME REALTY TRUST
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 8.  EARNINGS PER SHARE

Following is a reconciliation of the weighted average shares of beneficial
interest outstanding used in the computation of earnings per share and earnings
per share - assuming dilution.

<TABLE>
<CAPTION>
                                            For the Years Ended December 31,
                                           ---------------------------------
                                              1997        1996        1995
                                           ---------   ---------   ---------
<S>                                        <C>         <C>         <C>
Weighted average shares of
   beneficial interest .................   3,832,535   4,070,183   4,101,453

Share options ..........................      38,713      18,199         508
                                           ---------   ---------   ---------
Weighted average shares of
   beneficial interest outstanding -
   assuming dilution ...................   3,871,248   4,088,382   4,101,961
                                           =========   =========   =========
</TABLE>

NOTE 9.  SHARE OPTIONS

In November 1995, the Trust's shareholders approved two share option plans: the
Independent Trustee Share Option (the "Trustee Plan") and the Share Option and
Incentive Plan (the "Incentive Plan"). Options granted pursuant to the Trustee
Plan are immediately exercisable and expire on the earlier of the first
anniversary of the date on which a Trustee ceases to be a Trustee of the Trust
or ten years from the date of grant. For each year of service, an Independent
Trustee will be awarded an option to purchase 1,000 shares on January 1 of such
year. The Trustee Plan provides for options for 72,600 shares.

Under the Incentive Plan, options have been granted to certain Trust officers
and key employees of Tarragon and Tarragon Management, Inc.("TMI"), a
wholly-owned subsidiary of Tarragon. The Incentive Plan provides for options
for 363,000 shares. All grants are determined by the Option Committee, which
is presently comprised of two Trustees, Mr. William S. Friedman (President,
Chief Executive Officer, and Trustee of the Trust) and Mr. Carl B. Weisbrod
(Chairman of the Board). Options granted pursuant to the Incentive Plan are
exercisable beginning one year after the date of grant and expire five years
from the date of grant.



                     [This space intentionally left blank.]


                                       53
<PAGE>   54
                          NATIONAL INCOME REALTY TRUST
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 9.  SHARE OPTIONS (Continued)

<TABLE>
<CAPTION>
The following table summarizes share option activity:

                                      Exercise Price     Outstanding    Exercisable
                                      --------------     -----------    -----------
<S>                                  <C>                   <C>           <C>
December 31, 1994, balance ........   $           --           --            --
Options granted ...................             9 1/8         25,410        25,410
                                      ---------------       --------      --------
December 31, 1995, balance ........             9 1/8         25,410        25,410
Options granted ...................    9 1/8 - 11 5/8        104,830        79,860
Options forfeited .................             9 1/8        (24,970)        --
                                      ---------------       --------      --------
December 31, 1996, balance ........    9 1/8 - 11 5/8        105,270       105,270
Options granted ...................   10 7/8 - 15 1/4         55,070         7,700
Options forfeited .................            15 1/4           (400)        --
                                      ---------------       --------      --------
December 31, 1997, balance ........   $9 1/8 - 15 1/4        159,940       112,970
                                      ===============       ========      ========
</TABLE>

The following table summarizes information about the options outstanding at
December 31, 1997:

<TABLE>
<CAPTION>
                                                Outstanding                                                Exercisable
                                 ---------------------------------------------------            ---------------------------
         Range of                            Weighted Average        Weighted Average                      Weighted Average
     Exercise Prices             Options      Contractual Life        Exercise Price            Options     Exercise Price
     -----------------           -------      ----------------        --------------            -------     ---------------
  <S>                           <C>             <C>                       <C>                   <C>              <C>
    $  9 1/8 - $11 5/8           132,440         4.9 years                $10.00                 112,970          $9.83
      14 1/8 -  15 1/4            27,500         4.6 years                 15.02                     -              -
    ------------------           -------         ---------                ------                 -------          -----
    $  9 1/8 - $15 1/4           159,940         4.8 years                $10.86                 112,970          $9.83
    ==================           =======         =========                ======                 =======          =====
</TABLE>

Subsequent to year end, in January 1998, the Trust granted options covering
7,000 shares, all of which were immediately exercisable, pursuant to the Trustee
Plan. Also, an additional 19,470 of the December 31, 1997, outstanding options
became exercisable in January 1998.

The Trust applies APB No. 25 and related Interpretations in accounting for its
plans. All share options issued to date by the Trust have exercise prices equal
to the market price of the shares at the dates of grant. Accordingly, no
compensation cost has been recognized for its share option plans. Had
compensation cost for the Trust's two share option plans been determined based
on the fair value at the grant dates for awards under those plans consistent
with the method of SFAS No. 123, the Trust's net income and earnings per share
would have been reduced to the pro forma amounts indicated below:

<TABLE>
<CAPTION>
                                                         For the Years Ended December 31,
                                              -------------------------------------------------
                                                       1997                     1996
                                              -------------------------------------------------
                                              As Reported  Pro Forma    As Reported   Pro Forma
                                              -----------  ---------    -----------   ---------
<S>                                          <C>           <C>          <C>          <C>
 Net income................................   $ 5,592       $ 5,554      $ 4,937      $ 4,841
 Earnings per share
 Net income................................   $  1.46       $  1.45      $  1.21      $  1.19
 Earnings per share - assuming dilution
 Net income................................   $  1.44       $  1.43      $  1.21      $  1.18
</TABLE>


                                       54
<PAGE>   55
                          NATIONAL INCOME REALTY TRUST
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 9.  SHARE OPTIONS (Continued)

The fair value of each option is estimated on the date of grant using the
Black-Scholes option-pricing model with the following weighted-average
assumptions:

<TABLE>
<CAPTION>
                                               For the Years Ended December 31,
                                               --------------------------------
                                                   1997                1996
                                               ------------        ------------
<S>                                            <C>                 <C>
         Dividend yield ..................                6%                  6%
         Expected volatility .............               20%                 25%
         Risk-free interest rate .........             6.21%                5.5%
         Expected lives (in years) .......                3                   3
         Forfeitures .....................               10%                 10%
</TABLE>

The weighted average fair value per share of options granted in 1997 and
1996 was $1.53 and $1.47, respectively.

NOTE 10.  ADVISORY AGREEMENT

Although the Trust's Board of Trustees (the "Board") is directly responsible for
managing the affairs of the Trust and setting the policies which guide it, the
day-to-day operations of the Trust are performed by an advisory firm which
operates under the supervision of the Board pursuant to a written advisory
agreement approved by shareholders. The duties of the advisor include, among
other things, locating, investigating, evaluating, and recommending real estate
investment and sale opportunities and financing and refinancing sources for the
Trust. The advisor also serves as a consultant in connection with the business
plan and investment policy decisions made by the Board. Since April 1, 1994,
Tarragon has provided advisory services to the Trust under an advisory agreement
approved by the Board and ratified by the shareholders on November 20, 1995. Mr.
Friedman, President, Chief Executive Officer, and Trustee of the Trust, serves
as a Director and Chief Executive Officer of Tarragon. Tarragon is owned by Mr.
Friedman and Lucy N. Friedman, his wife. The Friedman family owns approximately
33% of the outstanding shares of the Trust.

Under the Trust's initial advisory agreement, the Trust paid Tarragon an annual
base advisory fee of $100,000 plus an incentive advisory fee equal to 16% of the
Trust's adjusted funds from operations before deduction of the advisory fee.
Adjusted funds from operations is defined as funds from operations ("FFO"), as
defined by the National Association of Real Estate Investment Trusts, plus any
loss due to the write-down or sale of any real property or mortgage loan
acquired prior to January 1, 1989. FFO represents net income (loss), computed in
accordance with GAAP, excluding gains (or losses) from debt restructuring and
sales of property, plus depreciation and amortization of real estate assets, and
after adjustments for unconsolidated partnerships and joint ventures.
Additionally, Tarragon could receive commissions of 1% based upon (i)
acquisition cost of real estate, (ii) mortgage loans acquired, and (iii)
mortgage loans obtained or refinanced and a 10% incentive sales commission based
on gains from the sale of real estate.


                                       55
<PAGE>   56

                          NATIONAL INCOME REALTY TRUST
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 10.  ADVISORY AGREEMENT (Continued)

At the March 1995 Board meeting, a majority of the Trustees approved a revised
advisory agreement, effective April 1, 1995, which was approved by the
shareholders at the November 20, 1995, shareholder meeting. In addition to
technical changes designed to clarify the responsibilities and rights of
Tarragon, the new agreement eliminated the $100,000 annual base fee, the
incentive sales compensation, and mortgage loan acquisition commissions.
Moreover, it provides that real estate brokerage commissions shall be payable to
Tarragon and its affiliates only following specific Board approval for each
transaction rather than as a general practice. No such commissions have been
paid under the revised agreement. The renewal of the advisory agreement between
the Trust and Tarragon was approved by shareholders on March 20, 1997.

Employees of Tarragon render services to the Trust, as the Trust has no
employees. In accordance with the terms of the advisory agreements, certain
services provided by the advisor, including, but not limited to, accounting,
legal, investor relations, data processing, and the related departmental
overhead, are reimbursed directly by the Trust.

Under the advisory agreement (as required by the Trust's Declaration of Trust),
all or a portion of the advisory fee must be refunded by the advisor to the
Trust if Operating Expenses, as defined, exceed certain specified limitations
based on the book value, net asset value, and net income of the Trust during
such fiscal year. The operating expenses of the Trust did not exceed such
limitation in 1995, 1996, or 1997.

For additional information regarding compensation paid to the advisor, see NOTE
12. "RELATED PARTY TRANSACTIONS" and ITEM 10. "TRUSTEES, EXECUTIVE OFFICERS, AND
ADVISOR OF THE REGISTRANT - The Advisor."

NOTE  11.  PROPERTY MANAGEMENT

Since April 1, 1994, Tarragon has provided property management services to the
Trust for a fee of 4.5% of the monthly gross rents collected on multifamily
properties and 1.5% to 5% of the monthly gross rents collected on commercial
properties. Tarragon subcontracts with other entities for the provision of some
of the property-level management services for the Trust. Beginning April 1,
1996, TMI assumed the property-level management of a majority of the Trust's
properties for a fee of 4.5% of the monthly gross rents collected.






                                       56
<PAGE>   57

                          NATIONAL INCOME REALTY TRUST
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 12.  RELATED PARTY TRANSACTIONS

Fees and expense reimbursements to Tarragon and affiliates for 1997, 1996, and
1995 were as follows:

<TABLE>
<CAPTION>
                                           1997          1996          1995
                                         ---------     ---------     ---------
<S>                                      <C>           <C>           <C>
Fees
  Advisory .........................     $   1,438     $   1,117     $   1,037
  Real estate acquisition ..........           234           106           198
  Equity refinancing ...............           773           187           247
  Property management* .............         1,610         1,014           330
  Commercial lease commissions .....            39            --            --
                                         ---------     ---------     ---------
                                         $   4,094     $   2,424     $   1,812
                                         =========     =========     =========

  Expense reimbursements ...........     $   1,411     $   1,176     $     960
                                         =========     =========     =========
</TABLE>

----------------------------------

* Net of property management fees paid to subcontractors.

Other liabilities at December 31, 1995, included non-interest bearing cash
advances of $283,000 and $300,000 from Tarragon and Lucy N. Friedman (50%
stockholder of Tarragon and a principal shareholder of the Trust), respectively.
Such advances were made to the Trust on a short term basis to facilitate the
negotiated discounted payoffs of the mortgage loans secured by Bryan Hill,
Meadowbrook, and Forest Oaks. In connection with the discounted payoffs, the
Trust realized extraordinary gains on debt forgiveness totaling $670,000. The
Trust repaid the advances during 1996.

NOTE 13.  INCOME TAXES

For 1997, 1996, and 1995, the Trust has elected and qualified to be treated as a
Real Estate Investment Trust ("REIT"), as defined in Sections 856 through 860 of
the Code, and, as such, will not be taxed for federal income tax purposes on
that portion of its taxable income which is distributed to shareholders,
provided that at least 95% of its REIT taxable income, plus 95% of its taxable
income from foreclosure property as defined in Section 857 of the Code, is
distributed. See NOTE 7. "DISTRIBUTIONS TO SHAREHOLDERS." As a result of the
Trust's election to be treated as a REIT for income tax purposes and of its
intention to distribute its taxable income, no deferred tax asset or liability
or related valuation allowance was recorded.

No provision has been made for federal income taxes because the Trust believes
it has qualified as a REIT and expects that it will continue to do so.

The Trust's basis in its net assets for tax purposes differs from that for
financial statement purposes, principally due to the accounting for gains and
losses on property sales, the difference in the allowance for estimated losses,
depreciation on owned properties, and investments in partnerships. At December
31, 1997 and 1996, the Trust's tax basis in its net real estate exceeded
its basis for financial statement purposes by $22.8 million and $19.6 million,
respectively. As a result, aggregate future income for income tax purposes will
be less than such amount for financial statement purposes, and the Trust will be
able to maintain its REIT status without distributing 95% of its financial
statement income. Additionally, at December 31, 1997, the Trust had a tax net
operating loss carryforward of $43 million expiring through 2011.



                                       57
<PAGE>   58

                          NATIONAL INCOME REALTY TRUST
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 14.  RENTALS UNDER OPERATING LEASES

The Trust's rental operations include the leasing of office buildings and
shopping centers subject to leases with terms greater than one year. The leases
thereon expire at various dates through 2010. The following is a schedule of
future minimum rentals on non-cancelable operating leases as of December 31,
1997:

<TABLE>
<S>                                                               <C>
  1998  ........................................................  $    7,325
  1999  ........................................................       6,816
  2000  ........................................................       5,622
  2001  ........................................................       4,350
  2002  ........................................................       2,903
  Thereafter   .................................................       4,766
                                                                  ----------
                                                                  $   31,782
                                                                  ==========
</TABLE>

NOTE 15.  COMMITMENTS AND CONTINGENCIES

Olive Litigation. In February 1990, the Trust, together with CMET, Income
Opportunity Realty Investors, Inc., ("IORI"), and Transcontinental Realty
Investors, Inc. ("TCI"), three real estate entities with, at the time, the same
officers, directors or trustees, and advisor as the Trust, entered into a
settlement of a class and derivative action entitled Olive, et. al. v. National
Income Realty Trust, et. al., relating to the operation and management of each
of the entities. On April 23, 1990, the court granted final approval of the
terms of the original settlement.

On May 4, 1994, the parties entered into a Modification of Stipulation of
Settlement dated April 27, 1994 (the "Modification"), which settled subsequent
claims of breaches of the settlement which were asserted by the plaintiffs and
modified certain provisions of the April 1990 settlement. The Modification was
preliminarily approved by the court on July 1, 1994, and final court approval
was entered on December 12, 1994. The effective date of the Modification was
January 11, 1995.

The Modification provided for, among other things, the addition of at least
three new unaffiliated members to the Trust's Board of Trustees and set forth
new requirements for the approval of any transactions with affiliates over the
next five years. In accordance with the procedures set forth in the
Modification, Irving E. Cohen, Lance Liebman, Sally Hernandez-Pinero, and L. G.
Schafran were appointed to the Board. In addition, Basic Capital Management, the
Trust's previous advisor, Mr. Gene E. Phillips, and Mr. Friedman agreed to pay a
total of $1.2 million to the Trust, CMET, IORI, and TCI, of which the Trust's
share was $150,000. As of December 31, 1996, the Trust had collected the entire
$150,000. Under the Modification, the Trust, CMET, IORI, TCI, and their
shareholders released the defendants from any claims relating to the plaintiffs'
allegations. The Trust, CMET, IORI, and TCI also agreed to waive any demand
requirement for the plaintiffs to pursue claims on behalf of each of them
against certain persons or entities. The Modification also requires that any
shares of the Trust held by Messrs. Phillips and Friedman or their affiliates
shall be (i) voted in favor of the reelection of all current Board members that
stand for reelection during the two calendar years following the effective date
of the Modification and (ii) voted in favor of all new Board members appointed
pursuant to the terms of the Modification that stand for reelection during the
three calendar years following the effective date of the Modification.


                                       58
<PAGE>   59

                          NATIONAL INCOME REALTY TRUST
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 15.  COMMITMENTS AND CONTINGENCIES (Continued)

The Modification also terminated a number of the provisions of the Stipulation
of Settlement, including the requirement that the Trust, CMET, IORI, and TCI
maintain a Related Party Transaction Committee and a Litigation Committee of
their respective Boards. The court will retain jurisdiction to enforce the
Modification.

Other litigation. The Trust is also party to various claims and routine
litigation arising in the ordinary course of business. Management of the Trust
does not believe that the results of such claims and litigation, individually or
in the aggregate, will have a material adverse effect on its business, financial
position, or results of operations.

NOTE 16.  SUBSEQUENT EVENTS

In December 1997, the Trust advanced $721,000 to National Omni Associates, L.P.,
("Omni") in exchange for a 46% interest in the partnership. In January and
February 1998, the Trust advanced the partnership an additional $4.6 million.
Omni purchased 5600 Collins Avenue, a 289-unit, high rise apartment building in
Miami Beach, Florida, for $32 million in February 1998. $26 million of the
purchase price was financed through first and second lien mortgage debt. In
connection with the acquisition, Omni paid Tarragon a $150,000 acquisition fee.

In January 1998, the Trust obtained a $1.2 million advance under the $50 million
revolving credit facility secured by Mariner Plaza Shopping Center, which the
Trust acquired in August 1997. In connection with this funding, the Trust paid
Tarragon a fee of $12,000.

In January and February 1998, the Trust obtained $13.8 million in mortgage
financing secured separately by three properties. After the payoff of the
existing debt, establishing required escrows, and closing costs, the Trust
received net cash proceeds of $4 million. In connection with these
transactions, the Trust paid Tarragon fees totaling $137,620.

On February 19, 1998, the Trust and Tarragon Realty Investors, Inc., ("TRI")
jointly announced the agreement of their respective boards to form a single
consolidated entity with TRI, for convenience, as the survivor. The surviving
consolidated entity is intended to operate as a self-administered REIT. The
consolidation transaction will be submitted to shareholders of each of the Trust
and TRI for approval at special meetings to be held during 1998. Under the
proposed agreement, each shareholder of the Trust will receive 1.97 shares of
TRI common stock for each share of beneficial interest of the Trust held. TRI,
also a REIT, has a similar opportunistic approach to real estate investment and
had total consolidated assets of approximately $37 million as of December 31,
1997. Upon the approval and consummation of the consolidation transaction by the
respective shareholders of each entity, TRI will acquire Tarragon, the Trust's
advisor since April 1, 1994, and TRI's advisor since March 1, 1994, for 100,000
shares of common stock of TRI and options to acquire additional shares of common
stock of TRI at prices ranging between $13 and $16 per share. The resulting
consolidated enterprise with TRI as the survivor will emerge from these
transactions as an integrated, self-administered, self-managed REIT controlling
approximately 14,000 apartment units and 2.1 million square feet of retail and
office space, primarily in California, Florida, and Texas. The consolidation
transaction will be accounted for as a reverse acquisition of TRI by the Trust.



                                       59
<PAGE>   60

                          NATIONAL INCOME REALTY TRUST
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 17.  QUARTERLY RESULTS OF OPERATIONS

The following is a tabulation of the quarterly results of operations for the
years ended December 31, 1997 and 1996:

<TABLE>
<CAPTION>
                                                          First            Second           Third           Fourth
                 1997                                    Quarter          Quarter           Quarter        Quarter
                                                       -----------      -----------      -----------      -----------
<S>                                                    <C>              <C>              <C>              <C>
Revenue ..........................................     $    12,180      $    12,506      $    13,399      $    13,932
Expenses .........................................         (11,839)         (12,141)         (13,593)         (14,176)
                                                       -----------      -----------      -----------      -----------
Income (loss) before net gain on sale
  of real estate, gain on sale of investments,
  and extraordinary gain (loss) ..................             341              365             (194)            (244)
Net gain on sale of real estate ..................              --            1,576            2,774               --
Gain on sale of investments ......................              --               --              686              227
                                                       -----------      -----------      -----------      -----------
Income (loss) from continuing operations .........             341            1,941            3,266              (17)
Extraordinary gain (loss) ........................              --               --              353             (292)
                                                       -----------      -----------      -----------      -----------
Net income (loss) ................................     $       341      $     1,941      $     3,619      $      (309)
                                                       ===========      ===========      ===========      ===========

Earnings per share
Income (loss) from continuing operations .........     $       .09      $       .51      $       .86      $        --
Extraordinary gain (loss) ........................              --               --              .09             (.08)
                                                       -----------      -----------      -----------      -----------
Net income (loss) ................................     $       .09      $       .51      $       .95      $      (.08)
                                                       ===========      ===========      ===========      ===========

Weighted average shares (1) ......................       3,859,018        3,840,352        3,819,027        3,812,404
                                                       ===========      ===========      ===========      ===========

Earnings per share - assuming dilution
Income (loss) from continuing operations .........     $       .09      $       .50      $       .85      $        --
Extraordinary gain (loss) ........................              --               --              .09             (.08)
                                                       -----------      -----------      -----------      -----------
Net income (loss) ................................     $       .09      $       .50      $       .94      $      (.08)
                                                       ===========      ===========      ===========      ===========

Weighted average shares -
  assuming dilution (2) ..........................       3,865,646        3,850,113        3,829,714        3,825,180
                                                       ===========      ===========      ===========      ===========
</TABLE>



--------------------

(1)   Represents weighted average shares of beneficial interest used in
      computing earnings per share. Share and per share amounts have been
      restated to give effect to the September 1997 10% share distribution.

(2)   Represents weighted average shares of beneficial interest used in
      computing earnings per share - assuming dilution.





                                       60
<PAGE>   61
                          NATIONAL INCOME REALTY TRUST
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 17.  QUARTERLY RESULTS OF OPERATIONS (Continued)

<TABLE>
<CAPTION>
                                                 First            Second            Third            Fourth
              1996                              Quarter           Quarter          Quarter          Quarter
                                               -----------      -----------      -----------      -----------
<S>                                            <C>              <C>              <C>              <C>
Revenue ..................................     $    12,020      $    13,233      $    12,566      $    12,143
Expenses .................................         (12,048)         (12,332)         (13,037)         (11,759)
                                               -----------      -----------      -----------      -----------
Income (loss) before gains on sale of
  real estate and insurance settlement ...             (28)             901             (471)             384
Gain on sale of real estate ..............             224             (213)           3,681                8
Gain on insurance settlement .............             451               --               --               --
                                               -----------      -----------      -----------      -----------
Net income ...............................     $       647      $       688      $     3,210      $       392
                                               ===========      ===========      ===========      ===========

Earnings per share - basic and diluted
Net income ...............................     $       .16      $       .17      $       .79      $       .10
                                               ===========      ===========      ===========      ===========

Weighted average shares  (1) .............       4,077,884        4,123,790        4,087,317        3,992,407
                                               ===========      ===========      ===========      ===========

Weighted average shares - assuming
     dilution (2) ........................       4,081,144        4,127,672        4,091,060        3,995,789
                                               ===========      ===========      ===========      ===========
</TABLE>



-----------------------

(1)   Represents weighted average shares of beneficial interest used in
      computing earnings per share. Share and per share amounts have been
      restated to give effect to the September 1996 and 1997 10% share
      distributions.

(2)   Represents weighted average shares of beneficial interest used in
      computing earnings per share - assuming dilution.





                                       61
<PAGE>   62
<TABLE>
<CAPTION>

                                                                                                                 SCHEDULE III

                          NATIONAL INCOME REALTY TRUST
                    REAL ESTATE AND ACCUMULATED DEPRECIATION
                                DECEMBER 31, 1997
                             (DOLLARS IN THOUSANDS)



                                                                             COSTS(A)
                                                                            CAPITALIZED             GROSS CARRYING AMOUNTS
                                                  INITIAL COST TO TRUST     SUBSEQUENT                 AT END OF YEAR
                                                 -----------------------   TO ACQUISITION     --------------------------------
                                                            BUILDINGS AND  --------------               BUILDINGS AND
DESCRIPTION                    ENCUMBRANCES      LAND       IMPROVEMENTS   IMPROVEMENTS       LAND      IMPROVEMENTS     TOTAL
-----------                    ------------      ----       ------------   --------------     ----     --------------    -----
<S>                             <C>            <C>           <C>            <C>            <C>           <C>           <C>
PROPERTIES HELD FOR
INVESTMENT

Apartments

Acadian Place ...............  $    2,775(E)    $    897     $    2,608     $    1,856     $      897    $    4,464     $ 5,361
  Baton Rouge, LA
Bay West ....................       4,841            891          3,566            648            891         4,214       5,105
  Bradenton, FL
Bayfront ....................       2,013            457          2,052          1,471            457         3,523       3,980
  Houston, TX
Bryan Hill ..................       3,500            447          1,803            330            447         2,133       2,580
  Bethany, OK
Carlyle Towers ..............       3,844            559          5,939          1,135            559         7,074       7,633
  Southfield, MI
Cornell .....................       1,490            822          1,183            128            822         1,311       2,133
  Los Angeles, CA
Courtyard at the Park .......       2,953            771          3,086            405            771         3,491       4,262
  Miami, FL
Creekwood North .............       3,009            532          2,127            760            532         2,887       3,419
  Altamonte Springs, FL
Cross Creek .................       2,716            221            883            196            221         1,079       1,300
  Lexington, KY
Diamond Loch ................       9,679(B)         380          2,791            924            380         3,715       4,095
  North Richland Hills, TX
Dunhill/Devonshire/
  Sandstone ..                     13,200(E)       1,048          3,162          2,491            792         5,909       6,701
  Denver, CO
English Village .............       6,019          1,382          5,525             --          1,382         5,525       6,907
  Memphis, TN
Fenway Hall .................       1,303            461          1,460             14            461         1,474       1,935
  Los Angeles, CA
Forest Oaks .................       3,015            691          2,685            425            691         3,110       3,801
  Lexington, KY
Fountainhead ................       5,650(E)       1,573          6,291             32          1,573         6,323       7,896
  Kissimmee, FL
Heather Hills ...............      16,865            643         14,562          6,773            765        21,213      21,978
  Temple Hills, MD
Kirklevington ...............       2,415            490          1,961            636            490         2,597       3,087
  Lexington, KY
Lake Point ..................       9,000(E)       2,075          6,225          2,095          2,075         8,320      10,395
  Memphis, TN
Landmark ....................       1,500            376          1,504             11            376         1,515       1,891
  Tallahassee, FL
<CAPTION>
                                                                                 LIFE ON WHICH
                                                                                 DEPRECIATION
                                                                                  IN LATEST
                                                                                  STATEMENT
                                     ACCUMULATED        DATE OF        DATE      OF OPERATIONS
DESCRIPTION                          DEPRECIATION     CONSTRUCTION    ACQUIRED    IS COMPUTED
-----------                         -------------     -------------   --------   -------------
<S>                               <C>                  <C>           <C>        <C>
PROPERTIES HELD FOR
INVESTMENT

Apartments

Acadian Place .................     $    1,275           1922         Mar-84     5-40 years
  Baton Rouge, LA
Bay West ......................            684           1974         Nov-92     5-40 years
  Bradenton, FL
Bayfront ......................            893           1971         Feb-87     5-40 years
  Houston, TX
Bryan Hill ....................            196           1970         Nov-94     5-40 years
  Bethany, OK
Carlyle Towers ................          1,646           1970         Nov-88     5-40 years
  Southfield, MI
Cornell .......................            265           1929         Apr-90     5-40 years
  Los Angeles, CA
Courtyard at the Park .........             41           1972         Jul-97     5-40 years
  Miami, FL
Creekwood North ...............            310           1973         Nov-92     5-40 years
  Altamonte Springs, FL
Cross Creek ...................            156           1966         Nov-92     5-40 years
  Lexington, KY
Diamond Loch ..................          1,166           1978         Oct-85     5-40 years
  North Richland Hills, TX
Dunhill/Devonshire/Sandstone ..          1,331           1969         Mar-89     5-40 years
  Denver, CO
English Village ...............             73           1973         Jul-97     5-40 years
  Memphis, TN
Fenway Hall ...................            285           1929         Apr-90     5-40 years
  Los Angeles, CA
Forest Oaks ...................            235           1971         Nov-94     5-40 years
  Lexington, KY
Fountainhead ..................             93           1988         Jun-97     5-40 years
  Kissimmee, FL
Heather Hills .................          7,539           1976         May-86     5-40 years
  Temple Hills, MD
Kirklevington .................            363           1975         Nov-92     5-40 years
  Lexington, KY
Lake Point ....................            945           1974         May-93     5-40 years
  Memphis, TN
Landmark ......................             10           1967         Oct-97     5-40 years
  Tallahassee, FL
</TABLE>



                                       62
<PAGE>   63

                                                                    SCHEDULE III
                                                                     (Continued)
                          NATIONAL INCOME REALTY TRUST
                    REAL ESTATE AND ACCUMULATED DEPRECIATION
                                DECEMBER 31, 1997
                             (DOLLARS IN THOUSANDS)

<TABLE>
<CAPTION>

                                                                             COSTS(A)
                                                                            CAPITALIZED            GROSS CARRYING AMOUNTS
                                                 INITIAL COST TO TRUST      SUBSEQUENT                 AT END OF YEAR
                                              -------------------------   TO ACQUISITION    ---------------------------------------
                                                           BUILDINGS AND  --------------                 BUILDINGS AND
DESCRIPTION                ENCUMBRANCES         LAND        IMPROVEMENTS   IMPROVEMENTS       LAND       IMPROVEMENTS      TOTAL
-----------                ------------       ----------     -----------  --------------    ----------     ----------    ----------
<S>                         <C>               <C>            <C>            <C>             <C>            <C>           <C>
PROPERTIES HELD FOR INVESTMENT (Continued)

Apartments  (Continued)

Marina Park ...........     $    2,403        $      657     $    2,625     $    1,132      $      657     $    3,757    $    4,414
  North Miami, FL
Mariposa Manor ........            757               225            901           (293)            225            608           833
  Los Angeles, CA
Martins Landing .......          4,856             1,038          4,201            416           1,038          4,617         5,655
  Lakeland, FL
Meadowbrook ...........          2,513(E)            307          1,230            142             307          1,372         1,679
  Baton Rouge, LA
Morningside ...........          1,623               420          1,678            210             420          1,888         2,308
  Jacksonville, FL
Mustang Creek .........            (C)               718          2,872          1,736             718          4,608         5,326
  Arlington, TX
Newport ...............          5,030             1,334          5,338            297           1,334          5,635         6,969
  Plantation, FL
Palm Court ............          2,901               599          2,393            705             599          3,098         3,697
  North Miami, FL
Park Dale Gardens .....          2,904               354          1,416            654             531          1,893         2,424
  Dallas, TX
Park Norton ...........            545               144            576            457             144          1,033         1,177
  Los Angeles, CA
Park Place ............             --                76            304            152              76            456           532
  Los Angeles, CA
Pinecrest .............         14,420             3,612          8,427          5,830           3,612         14,257        17,869
  Ft. Lauderdale, FL
Prado Bay .............          4,800               614          3,482          1,105             614          4,587         5,201
  North Bay Village, FL
The Regent ............            (B)               303          1,212          4,572             303          5,784         6,087
  Jacksonville, FL
River City Landing ....      6,100 (E)             1,236          5,602          4,756           1,236         10,358        11,594
  Jacksonville, FL
<CAPTION>
                                                                          LIFE ON WHICH
                                                                           DEPRECIATION
                                                                            IN LATEST
                                                                            STATEMENT
                             ACCUMULATED        DATE OF         DATE      OF OPERATIONS
DESCRIPTION                  DEPRECIATION     CONSTRUCTION     ACQUIRED    IS COMPUTED
-----------                  ------------     ------------     --------    -----------
<S>                          <C>                  <C>              <C>    <C>
PROPERTIES HELD FOR INVESTMENT (Continued)

Apartments  (Continued)

Marina Park ...........      $      268           1974         Apr-95     5-40 years
  North Miami, FL
Mariposa Manor ........              70           1924         Sep-94     5-40 years
  Los Angeles, CA
Martins Landing .......             389           1973         Nov-94     5-40 years
  Lakeland, FL
Meadowbrook ...........              73           1968         Oct-95     5-40 years
  Baton Rouge, LA
Morningside ...........              43           1973         Feb-97     5-40 years
  Jacksonville, FL
Mustang Creek .........             287           1974         May-95     5-40 years
  Arlington, TX
Newport ...............              84           1973         Jun-97     5-40 years
  Plantation, FL
Palm Court ............             647           1971         Oct-89     5-40 years
  North Miami, FL
Park Dale Gardens .....             310           1975         Dec-91     5-40 years
  Dallas, TX
Park Norton ...........              26           1924         Jun-95     5-40 years
  Los Angeles, CA
Park Place ............              23           1929         Sep-95     5-40 years
  Los Angeles, CA
Pinecrest .............           2,474           1965         Jul-90     5-40 years
  Ft. Lauderdale, FL
Prado Bay .............             949           1966         Oct-90     5-40 years
  North Bay Village, FL
The Regent ............             186           1972         Sep-95     5-40 years
  Jacksonville, FL
River City Landing ....             242           1965         Jun-96     5-40 years
  Jacksonville, FL
</TABLE>


                                       63
<PAGE>   64
                                                                    SCHEDULE III
                                                                     (Continued)

                          NATIONAL INCOME REALTY TRUST
                    REAL ESTATE AND ACCUMULATED DEPRECIATION
                                DECEMBER 31, 1997
                             (DOLLARS IN THOUSANDS)

<TABLE>
<CAPTION>

                                                                             COSTS(A)
                                                                            CAPITALIZED            GROSS CARRYING AMOUNTS
                                                 INITIAL COST TO TRUST      SUBSEQUENT                 AT END OF YEAR
                                              --------------------------  TO ACQUISITION  ----------------------------------------
                                                            BUILDINGS AND --------------               BUILDINGS AND
DESCRIPTION                     ENCUMBRANCES     LAND       IMPROVEMENTS   IMPROVEMENTS     LAND       IMPROVEMENTS       TOTAL
-----------                     ------------  ----------    ------------   ------------   ----------   ------------     ----------
<S>                              <C>             <C>         <C>          <C>               <C>         <C>            <C>
PROPERTIES HELD FOR INVESTMENT
 (Continued)

Apartments (Continued)

Spring Pines .................   $    1,300(E)   $   371     $    1,486   $      237        $   371     $    1,723     $    2,094
  Houston, TX
Summit on the Lake ...........        4,782          895          3,582          522            895          4,104          4,999
  Ft. Worth, TX
Woodbrier ....................        1,165          508          2,034          135            508          2,169          2,677
  Oklahoma City, OK
Woodcreek (CO) ...............        2,812          913          3,193         (533)           690          2,883          3,573
  Denver, CO
Woodcreek (FL) ...............        3,683          472          4,977        1,186            451          6,184          6,635
  Jacksonville, FL
Vistas at Lake Worth .........           --          752             92       13,045            752         13,137         13,889
  Ft. Worth, TX

Office Buildings

Emerson Center ...............        3,777(C)       131          8,781         (358)         1,048          7,506          8,554
  Atlanta, GA
NW O'Hare ....................          998        1,990          7,965       (2,202)         1,104          6,649          7,753
  Des Plaines, IL
Rancho Sorrento ..............        5,384        1,251         12,901          854            968         14,038         15,006
  San Diego, CA

Shopping Centers

Emerson Center ...............        1,212           --            363           --             --            363            363
  Atlanta, GA
Jackson Square ...............           --        1,115          4,451           21          1,115          4,472          5,587
  Jackson, MS
K-Mart Plaza .................        1,273          689          1,608           --            689          1,608          2,297
  Temple Terrace, FL
Lakeview Mall ................           --          513          2,050          612            341          2,834          3,175
  Manitowoc, WI
Mariner Plaza ................           --          295          1,180           --            295          1,180          1,475
   Tallahassee, FL

<CAPTION>
                                                                            LIFE ON WHICH
                                                                             DEPRECIATION
                                                                              IN LATEST
                                                                              STATEMENT
                                 ACCUMULATED      DATE OF         DATE      OF OPERATIONS
DESCRIPTION                      DEPRECIATION   CONSTRUCTION      ACQUIRED   IS COMPUTED
                                 -----------    ------------     ----------  -----------
<S>                              <C>                  <C>              <C>    <C>
PROPERTIES HELD FOR INVESTMENT
 (Continued)

Apartments (Continued)

Spring Pines .................   $      460           1964         Feb-88     5-40 years
  Houston, TX
Summit on the Lake ...........          368           1986         Mar-94     5-40 years
  Ft. Worth, TX
Woodbrier ....................           96           1970         Apr-96     5-40 years
  Oklahoma City, OK
Woodcreek (CO) ...............        1,159           1980         Aug-86     5-40 years
  Denver, CO
Woodcreek (FL) ...............        2,330           1975         Nov-86     5-40 years
  Jacksonville, FL
Vistas at Lake Worth .........           --           1970         Dec-94     5-40 years
  Ft. Worth, TX

Office Buildings

Emerson Center ...............        4,190           1974         Jul-86     5-40 years
  Atlanta, GA
NW O'Hare ....................        3,361           1972         Apr-86     5-40 years
  Des Plaines, IL
Rancho Sorrento ..............        5,002           1980         May-86     5-40 years
  San Diego, CA

Shopping Centers

Emerson Center ...............           26           1974         Jul-86     5-40 years
  Atlanta, GA
Jackson Square ...............          115           1970         Jan-96     5-40 years
  Jackson, MS
K-Mart Plaza .................          243           1979         Dec-91     5-40 years
  Temple Terrace, FL
Lakeview Mall ................        1,207           1968         Apr-87     5-40 years
  Manitowoc, WI
Mariner Plaza ................           10           1968         Aug-97     5-40 years
   Tallahassee, FL
</TABLE>




                                       64
<PAGE>   65


                                                                   SCHEDULE  III
                                                                     (Continued)

                          NATIONAL INCOME REALTY TRUST
                    REAL ESTATE AND ACCUMULATED DEPRECIATION
                                DECEMBER 31, 1997
                             (DOLLARS IN THOUSANDS)


<TABLE>
<CAPTION>

                                                                  COSTS(A)
                                                                 CAPITALIZED            GROSS CARRYING AMOUNTS
                                      INITIAL COST TO TRUST      SUBSEQUENT                 AT END OF YEAR
                                    -------------------------  TO ACQUISITION   --------------------------------------
                                                BUILDINGS AND  --------------                BUILDINGS AND
DESCRIPTION          ENCUMBRANCES    LAND        IMPROVEMENTS   IMPROVEMENTS      LAND       IMPROVEMENTS     TOTAL
-----------           ----------    ---------   -------------  --------------   ----------   -------------  ----------
<S>                   <C>           <C>            <C>            <C>            <C>            <C>         <C>
PROPERTIES HELD FOR INVESTMENT (Continued)

Shopping Centers (Continued)

Midland Plaza .....    $      283    $      321    $      748    $       59    $      321    $      807    $    1,128
  Midland, MI
Midway Mills ......         4,101           588         2,365         1,468         1,227         3,194         4,421
  Carrollton, TX
Northside Mall ....         1,710         1,591         3,712           238         1,591         3,950         5,541
  Gainesville, FL
Southgate .........            --           578         2,430           674           602         3,080         3,682
  Waco, TX
Stewart Square ....         2,070           294         1,460           620           294         2,080         2,374
  Las Vegas, NV
                       ----------    ----------    ----------    ----------    ----------    ----------    ----------
                          179,189        39,620       177,048        58,779        39,658       235,789       275,447
                       ----------    ----------    ----------    ----------    ----------    ----------    ----------

<CAPTION>
                                                                            LIFE ON WHICH
                                                                             DEPRECIATION
                                                                              IN LATEST
                                                                              STATEMENT
                                 ACCUMULATED      DATE OF         DATE      OF OPERATIONS
DESCRIPTION                      DEPRECIATION   CONSTRUCTION      ACQUIRED   IS COMPUTED
                                 -----------    ------------     ----------  -----------
<S>                              <C>                  <C>              <C>    <C>
PROPERTIES HELD FOR INVESTMENT (Continued)

Shopping Centers (Continued)

Midland Plaza .....              $      113        1976            Dec-91      5-40 years
  Midland, MI
Midway Mills ......                   1,269        1986            Oct-91      5-40 years
  Carrollton, TX
Northside Mall ....                     651        1977            Dec-91      5-40 years
  Gainesville, FL
Southgate .........                     485        1959            Jul-91      5-40 years
  Waco, TX
Stewart Square ....                     778        1971            Oct-87      5-40 years
  Las Vegas, NV
                                 ----------
                                     45,440
                                 ----------
</TABLE>




                                       65
<PAGE>   66

                                                                    SCHEDULE III
                                                                     (Continued)

                          NATIONAL INCOME REALTY TRUST
                    REAL ESTATE AND ACCUMULATED DEPRECIATION
                                DECEMBER 31, 1997
                             (DOLLARS IN THOUSANDS)

<TABLE>
<CAPTION>

                                                                             COSTS(A)
                                                                            CAPITALIZED             GROSS CARRYING AMOUNTS
                                                  INITIAL COST TO TRUST     SUBSEQUENT                 AT END OF YEAR
                                                 -----------------------   TO ACQUISITION     --------------------------------
                                                            BUILDINGS AND  --------------               BUILDINGS AND
DESCRIPTION                    ENCUMBRANCES      LAND       IMPROVEMENTS   IMPROVEMENTS       LAND      IMPROVEMENTS     TOTAL
-----------                    ------------      ----       ------------   --------------     ----     --------------    -----
<S>                             <C>            <C>           <C>            <C>            <C>           <C>           <C>
PROPERTIES HELD FOR SALE

Shopping Centers

K-Mart Plaza .................  $    1,256     $      571    $    1,333     $       12     $      571    $    1,345    $    1,916
  Charlotte, NC
K-Mart Plaza .................       1,015            497         1,159             --            497         1,159         1,656
  Thomasville, GA
Mountain View ................       1,038            118           578            226            140           782           922
  Las Vegas, NV
Times Square .................          --            125           499             47            125           546           671
  Lubbock, TX

Other

Snyder Residence .............          --             --            39             --             --            39            39
  Gilbert, AZ

Land

Orangeburg, SC ...............          --            122            --             --            122            --           122
Dallas, TX ...................          --            737         3,782         (4,438)(D)         81            --            81
Kansas City, MO ..............          --            802         1,871         (2,364)           309            --           309
                                ----------     ----------    ----------     ----------     ----------    ----------    ----------
                                     3,309          2,972         9,261         (6,517)         1,845         3,871         5,716
                                ----------     ----------    ----------     ----------     ----------    ----------    ----------

                                $  182,498     $   42,592    $  186,309     $   52,262     $   41,503    $  239,660    $  281,163
                                ==========     ==========    ==========     ==========     ==========    ==========    ==========
Allowance for estimated losses                                                                                             (1,194)
                                                                                                                       ----------
                                                                                                                       $  279,969
                                                                                                                       ==========

<CAPTION>
                                                                               LIFE ON WHICH
                                                                               DEPRECIATION
                                                                                IN LATEST
                                                                                STATEMENT
                                    ACCUMULATED        DATE OF        DATE     OF OPERATIONS
DESCRIPTION                         DEPRECIATION    CONSTRUCTION    ACQUIRED   IS COMPUTED
-----------                         ------------    ------------    --------   -----------
<S>                                  <C>                 <C>             <C>   <C>
PROPERTIES HELD FOR SALE

Shopping Centers

K-Mart Plaza .................       $      136          1977        Dec-91    5-40 years
  Charlotte, NC
K-Mart Plaza .................              118          1974        Dec-91    5-40 years
  Thomasville, GA
Mountain View ................              246          1971        Oct-87    5-40 years
  Las Vegas, NV
Times Square .................               93          1985        Jul-89    5-40 years
  Lubbock, TX

Other

Snyder Residence .............               --            --            --            --
  Gilbert, AZ

Land

Orangeburg, SC ...............               --            --        Jun-89            --
Dallas, TX ...................               --            --        Jun-86            --
Kansas City, MO ..............               --            --        Dec-91            --
                                    ----------
                                           593
                                    ----------

                                    $   46,033
                                    ==========
Allowance for estimated losses
</TABLE>

----------------------------------------

(A)   Represents property improvements and write-down of properties due to
      permanent impairment.

(B)   Represent the Trust's line of credit with a current balance of $7.5
      million and the $2.2 million equity loan, both collateralized by mortgages
      on Diamond Loch Apartments, Mustang Creek Apartments, and The Regent
      Apartments. The $2.2 million equity loan is also secured by 352,000 of the
      Trust's shares of beneficial interest.

(C)   Includes $923,000 of unsecured debt associated with the property.

(D)   Basis charged against allowance previously provided.

(E)   Represents advances under the $50 million revolving credit facility with
      GMAC Commercial Mortgage.



                                       66
<PAGE>   67
                                                                    SCHEDULE III
                                                                     (Continued)

                          NATIONAL INCOME REALTY TRUST
                    REAL ESTATE AND ACCUMULATED DEPRECIATION

<TABLE>
<CAPTION>
                                                   1997          1996          1995
                                                ---------     ---------     ---------
<S>                                             <C>           <C>           <C>
                                                          (dollars in thousands)
Reconciliation of real estate

Balance at January 1, ......................    $ 237,502     $ 240,822     $ 224,785

  Additions
     Acquisitions and improvements .........       58,683        22,896        20,025
     Foreclosures ..........................           --         5,575            --
  Deductions
     Sales .................................      (12,762)      (31,491)       (2,598)
     Write-offs ............................       (2,260)           --        (1,390)
     Write-downs due to permanent impairment           --          (300)           --
                                                ---------     ---------     ---------

Balance at December 31, ....................    $ 281,163     $ 237,502     $ 240,822
                                                =========     =========     =========

Reconciliation of accumulated depreciation

Balance at January 1, ......................    $  42,251     $  45,147     $  39,427

  Additions
     Depreciation ..........................        7,022         5,374         5,959
  Deductions
     Sale of real estate ...................       (3,190)       (8,270)         (166)
     Write-offs ............................          (50)           --           (73)
                                                ---------     ---------     ---------

Balance at December 31, ....................    $  46,033     $  42,251     $  45,147
                                                =========     =========     =========
</TABLE>





                                       67
<PAGE>   68
ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
         AND FINANCIAL DISCLOSURE

Not applicable.

                        -------------------------------

                                    PART III

ITEM 10.  TRUSTEES, EXECUTIVE OFFICERS, AND ADVISOR OF THE REGISTRANT

Trustees

The affairs of National Income Realty Trust (the "Trust") are managed and
controlled by a Board of Trustees (the "Board"), presently consisting of eight
members. The Trustees are elected at the annual meeting of shareholders or
appointed by the incumbent Board and serve until the next annual meeting of
shareholders or until a successor has been elected or approved.

In May 1994, the Trust, together with Continental Mortgage and Equity Trust
("CMET"), Income Opportunity Realty Investors, Inc. ("IORI"), and
Transcontinental Realty Investors, Inc. ("TCI"), entered into a Modification of
Stipulation of Settlement dated April 27, 1994 (the "Modification"), which
settled subsequent claims of breaches of the settlement which were asserted by
plaintiffs and modified certain provisions of a 1990 settlement of the action
styled Olive, et. al. v. National Income Realty Trust, et. al. (the "Olive
Case"). The original settlement, approved April 23, 1990, by the Court, related
to the operation and management of each of the entities. The Modification was
approved by the Court on December 12, 1994, and became effective January 11,
1995.

The Modification provided for, among other things, the resignation of certain
trustees, the addition of at least three new, unaffiliated members to be
appointed to the Board, and set forth new requirements for approval of any
transactions with affiliates over the next five years. Under the Modification,
the Trust, the other entities, and their shareholders released the defendants
from any claims relating to the plaintiffs' allegations. The Trust and other
entities also agreed to waive any demand requirement for plaintiffs to pursue
claims on behalf of each of them against certain persons or entities. The
Modification also requires that any shares of the Trust held by William S.
Friedman or his affiliates shall be voted (i) in favor of the re-election of all
current Board members that stand for re-election during the two calendar years
following January 11, 1995, and (ii) in favor of all new Board members appointed
pursuant to the terms of the Modification that stand for re-election during the
three calendar years following January 11, 1995. The Modification also
terminated a number of provisions of the original Stipulation of Settlement,
including the requirement that the Trust or the other entities maintain a
Related Party Transaction Committee and a Litigation Committee of the Board.

Pursuant to the requirements (and in anticipation of the effectiveness) of the
Modification, the Trust did not hold an Annual Meeting of Shareholders in 1994,
John A. Doyle (a Trustee since February 1994) resigned as a Trustee on April 22,
1994, Ted P. Stokely (a Trustee since April 1990) resigned as a Trustee in
August 1994, A. Bob Jordan (a Trustee since October 1992) resigned as a Trustee
in June 1994, Bennett B. Sims (a Trustee since April 1990) resigned as a Trustee
in August 1994, Geoffrey C. Etnire ( a Trustee since January 1993) ceased to be
a Trustee on March 9, 1995, and Willie K. Davis (a Trustee since October 1988)
retired as a Trustee effective March 31, 1995. Carl B. Weisbrod (a Trustee since
February 1994) was elected Chairman of the Board on March 9, 1995, to replace
Mr. Friedman, who remains as President, Chief Executive Officer, and Trustee of
the



                                       68
<PAGE>   69

ITEM 10.  TRUSTEES, EXECUTIVE OFFICERS, AND ADVISOR OF THE REGISTRANT
          (Continued)

Trustees (Continued)

Trust. Between May 1994 and March 1995, the Board appointed four new,
independent Trustees to replace a number of those who resigned, and the number
of members of the Board was reduced from ten at December 31, 1993, to eight at
March 31, 1995. Independent Trustees appointed are Irving E. Cohen (June 2,
1994), Sally Hernandez-Pinero (May 19, 1994), Lance Liebman (March 9, 1995), and
L. G. Schafran (March 9, 1995). Dan L. Johnston, Raymond V. J. Schrag, and
Messrs. Friedman and Weisbrod have continued as Trustees. All of the Trustees
listed below were re-elected as members of the Board at the annual meeting of
shareholders held on March 20, 1997.

The current Trustees are listed below, together with their ages, terms of
service, all positions and offices with the Trust and Tarragon Realty Advisors,
Inc. ("Tarragon" or the "Advisor"), the Trust's advisor since April 1, 1994,
their principal occupations, business experience, and directorships with other
companies during the last five years or more. The designation "Affiliated," when
used below with respect to a Trustee, means that the Trustee is an officer,
director, or employee of Tarragon or an officer of the Trust. The designation
"Independent," when used below with respect to a Trustee, means that the Trustee
is not an officer of the Trust nor a director, officer, or employee of Tarragon,
although the Trust may have certain business or professional relationships with
such Trustee as discussed in ITEM 13. "CERTAIN RELATIONSHIPS AND RELATED
TRANSACTIONS - Certain Business Relationships." Also, see ITEM 11. "EXECUTIVE
COMPENSATION" for compensation paid to Independent Trustees.

IRVING E. COHEN:  Age 51, Trustee (since June 1994) (Independent).

      Vice President and Regional Director (since 1997), Cherokee Environmental
      Realty Advisors, LLC, a real estate investor; Managing Director and Chief
      Acquisition Officer (since 1996), Dames & Moore/Brookhill, LLC, a real
      estate development company; Managing Director (since 1994), CPR Group, a
      real estate consulting company; and Managing Partner (1990 to 1994),
      Fuller Corporate Realty Partners, a New York City real estate asset
      management entity.

WILLIAM S. FRIEDMAN:  Age 54, Trustee (Affiliated).

      Trustee or Director (since March 1988), Chief Executive Officer (since
      December 1993), President (since December 1988), Acting Chief Financial
      Officer (May 1990 to February 1991), Treasurer (August to September 1989),
      and Acting Principal Financial and Accounting Officer (December 1988 to
      August 1989) of the Trust and Tarragon Realty Investors, Inc. ("TRI");
      Trustee or Director (March 1988 to February 1994), Chief Executive Officer
      (December 1993 to February 1994), President (December 1988 to February
      1994), Acting Chief Financial Officer (May 1990 to February 1991),
      Treasurer (August to September 1989), and Acting Principal Accounting
      Officer (December 1988 to August 1989) of CMET, IORI, and TCI; Director
      and Chief Executive Officer (since December 1990) of Tarragon; President
      (February 1989 to May 1993) and Director (February to December 1989) of
      Basic Capital Management, Inc. ("BCM"), the advisor to the Trust (March
      1989 to March 1994); General Partner (1987 to March 1994) of Syntek Asset
      Management, L.P., ("SAMLP") which is the General Partner of National
      Realty, L.P., ("NRLP") and National Operating, L.P. ("NOLP"); Director
      and President (March 1989 to February 1994) and Secretary (March 1989 to
      December 1990) of




                                       69
<PAGE>   70
ITEM 10.  TRUSTEES, EXECUTIVE OFFICERS, AND ADVISOR OF THE REGISTRANT
          (Continued)

Trustees (Continued)

      Syntek Asset Management, Inc., the Managing General Partner of SAMLP and
      a corporation owned by BCM; and practicing Attorney (since 1971) with the
      Law Offices of William S. Friedman.

SALLY HERNANDEZ-PINERO:  Age 45, Trustee (since May 1994) (Independent).

      Of Counsel (since October 1994), Kalkines, Arky, Zall and Bernstein, New
      York City; Chairwoman (February 1992 to April 1994), New York City Housing
      Authority; Director (since July 1994) of Consolidated Edison; Director
      (since April 1994) of Dime Savings Bank; and Attorney at Law (since 1978).

DAN L. JOHNSTON: Age 59, Trustee (April 1990 to June 1990 and since February
1991) (Independent).

      Attorney in solo practice, New York, New York (1991 to 1994 and since
      August 1995); Partner in the law firm of Johnston, Kaplan and Lombardi
      (January to July 1995), New York City; Director (since 1992) of the
      Complex Drug Investigation and Prosecution Project for the Jefferson
      Institute for Justice Studies; Director or Trustee (April 1990 to June
      1990 and February 1991 to January 1995) of CMET, IORI, and TCI; and
      Director (December 1992 to May 1995) of TRI.

LANCE LIEBMAN:  Age 56, Trustee (since March 1995) (Independent).

      William S. Beinecke Professor of Law and Dean (1991-1996), Columbia School
      of Law, New York City; Director (since 1991) of Greater New York Insurance
      Co. (both mutual and stock companies); Director (since 1995) of M & F
      Worldwide; Director (since 1996) of World Financial Properties, Inc.; and
      Attorney at Law (since 1967).

L. G. SCHAFRAN:  Age 59, Trustee (since March 1995) (Independent).

      Managing General Partner (since 1984), L. G. Schafran & Associates, a real
      estate investment and development firm in New York City; Director,
      Publicker Industries, Inc. (since 1986), an Old Greenwich, Connecticut,
      NYSE listed holding company that operates through subsidiaries in
      manufacturing services; Director, Capsure Holdings Corp. (since 1986), a
      Chicago, Illinois, NYSE listed property and casualty insurer; Director,
      Oxigene, Inc. (since March 1993), a U.S. and Swedish pharmaceutical
      developer; Director, Glasstech, Inc. (1) (since January 1995), Perrysberg,
      Ohio, manufacturer of glass bending and tempering equipment; and Director
      (since December 1993), Member (since September 1994), and Chairman (since
      December 1994) of the Executive Committee of The Dart Group Corporation, a
      Landover, Maryland, NYSE listed holding company engaged with other
      publicly traded subsidiaries in discount automotive parts and accessories
      (Trak Auto Corporation), discount bookstores (Crown Bookstores), discount
      supermarkets, beverages, and real estate; and Chairman (since January
      1996), Delta-Omega Technologies, Inc., a Broussard, Louisiana,
      manufacturer and distributor of environmentally safe line foams and
      industrial cleaners and degreasers.

----------------------------------------------

(1)   On May 24, 1993, Glasstech, Inc., filed a voluntary petition under Chapter
      11 of The United States Bankruptcy Code for the District of Delaware. An
      Order confirming a plan of reorganization became effective January 3,
      1995, which is the same day Mr. Schafran became a director of Glasstech,
      Inc.



                                       70
<PAGE>   71

ITEM 10.  TRUSTEES, EXECUTIVE OFFICERS, AND ADVISOR OF THE REGISTRANT
          (Continued)

Trustees (Continued)

RAYMOND V. J. SCHRAG:  Age 52, Trustee (since October 1988) (Independent).

      Attorney, Law Offices of Raymond V. J. Schrag in New York, New York (since
      January 1995); attorney, Law Offices of Paul J. Schrag in New York, New
      York (since 1975); Director (October 1988 to May 1995) of TRI; and
      Director or Trustee (October 1988 to August 1994) of CMET, IORI, and TCI.

CARL B. WEISBROD: Age 53, Chairman of the Board (since March 1995) and Trustee
(since February 1994) (Independent).

      Trustee (since 1996), Ford Foundation; President (since 1994), Alliance
      for Downtown New York, Inc.; Director (February 1994 to May 1995) of TRI;
      and President and Chief Executive Officer (April 1990 to 1994) of New York
      City Economic Development Corporation.

LITIGATION AND CLAIMS INVOLVING MR. FRIEDMAN RELATED TO SOUTHMARK CORPORATION

Separation of Messrs. Phillips and Friedman from Southmark. Until January 1989,
Mr. Friedman was an executive officer and director of Southmark Corporation
("Southmark"), serving as Vice Chairman of the Board (since 1982), Director
(since 1980), and Secretary (since 1984) of Southmark. As a result of a deadlock
on Southmark's Board of Directors, Mr. Friedman and Gene E. Phillips (who served
as Trustee of the Trust until December 7, 1992) reached a series of related
agreements (later modified) with Southmark on January 17, 1989 (collectively,
the "Separation Agreement"), whereby Messrs. Friedman and Phillips resigned
their positions with Southmark and certain of Southmark's subsidiaries and
affiliates. Southmark filed a voluntary petition in bankruptcy under Chapter 11
of the United States Bankruptcy Code on July 14, 1989. Subsequent to the filing
of the Southmark bankruptcy, several lawsuits were filed against Southmark, its
former officers and directors (including Mr. Friedman), and others, alleging,
among other things, that such persons and entities misrepresented the financial
condition of Southmark. Mr. Friedman denies all of such allegations. Those
lawsuits in which Mr. Friedman was also a defendant during the last five years
are summarized below. The Trust was not a defendant in any of these lawsuits,
all of which have been dismissed or settled.

Mr. Friedman also served as a director of Pacific Standard Life Insurance
Company ("PSL"), a wholly-owned subsidiary of Southmark, from October 1984 to
January 1989. In a proceeding brought by the California Insurance commissioner
(the "Commissioner"), a California Superior Court appointed a conservator for
PSL on December 11, 1989. On October 12, 1990, the Commissioner filed suit
against the former directors of PSL (including Mr. Friedman) seeking damages of
$12 million and additional punitive damages. Such lawsuit alleged, among other
things, that the defendants knowingly and willfully conspired among themselves
to breach their duties as directors of PSL to benefit Southmark. Such suit
further alleged that PSL's board of directors failed to convene meetings and
delegated to Mr. Phillips authority to make decisions regarding loans,
investments, and other transfers and exchanges of PSL assets. In August 1993,
five former directors of PSL, including Mr. Friedman, settled this lawsuit
without admitting any liability. Mr. Friedman complied with his obligation under
the settlement and was discharged from any further liability in January 1998.




                                       71
<PAGE>   72

ITEM 10.  TRUSTEES, EXECUTIVE OFFICERS, AND ADVISOR OF THE REGISTRANT
          (Continued)

Trustees (Continued)

One of Southmark's principal businesses was real estate syndication, and, from
1981 through 1987, Southmark raised over $500 million in investments from
limited partners in several hundred limited partnerships. Seven lawsuits were
filed by investors alleging breach of fiduciary duties on the part of Mr.
Friedman and others. Two cases were settled in July and October 1993 for nominal
payments. In one case, all claims were dismissed by the Court, and the
defendants (including Mr. Friedman) were awarded sanctions against plaintiff's
counsel. The other four cases were voluntarily dismissed by the plaintiffs
without payment of any kind by the defendants.

San Jacinto Savings Association. On November 30, 1990, San Jacinto Savings
Association ("SJSA"), a savings institution that had been owned by Southmark
since 1983, was placed under conservatorship of the Resolution Trust Corporation
("RTC") by federal banking authorities. The Office of Thrift Supervision ("OTS")
also conducted a formal investigation of SJSA and its affiliates. During late
November 1994, Mr. Friedman entered into certain agreements with the RTC and OTS
settling all claims relating to (i) his involvement with SJSA and (ii) any
guarantor arrangement of Mr. Friedman as to other financial institutions taken
over by the RTC. Mr. Friedman's liability terminated on September 30, 1996, when
the respondents as a group had paid a total of $4 million out of the total
requirement. Mr. Friedman also consented to an order prohibiting him from
participating in an insured depository institution without the prior written
approval of the Director of OTS.

Board Committees

The Board held three meetings and acted by written consent seven times during
1997. For such year, no incumbent Trustee attended fewer than 75% of the
aggregate of (i) the total number of meetings held by the Board during the
period for which he (she) had been a Trustee and (ii) the total number of
meetings held by all committees of the Board on which he (she) served during the
periods that he (she) served.

The Board has an Audit Committee, an Advisory Review Committee, and an Option
Committee. The Audit Committee, consisting of three Independent trustees,
Messrs. Schrag (Chairman), Johnston, and Weisbrod, reviews the Trust's operating
and accounting procedures. This committee met once during 1997. The Advisory
Review Committee, established in March 1995, monitors actions taken by the
Advisor which have the potential for a conflict of interest, in particular
decisions relating to the allocation of investment opportunities among the Trust
and the other entities affiliated with the Advisor. The committee consists of
Mr. Weisbrod (Chairman), Ms. Hernandez-Pinero, and Mr. Cohen and did not meet
during 1997. The Option Committee was formed in 1995 for purposes of authorizing
option grants under the Share Option and Incentive Plan, approved at the
November 1995 shareholder meeting. This committee is presently comprised of two
members including Messrs. Friedman and Weisbrod and acted by written consent
twice during 1997.

The Board does not have Nominating or Compensation Committees.

Executive Officers

William S. Friedman, President and Chief Executive Officer, currently serves as
the only executive officer of the Trust. His position with the Trust is not
subject to a vote of shareholders. Mr. Friedman's age, term of service, all
positions and offices with the Trust and Tarragon, other principal occupations,
business experience, and directorships with other companies during the last five
years or more are set forth above.




                                       72
<PAGE>   73

ITEM 10.  TRUSTEES, EXECUTIVE OFFICERS, AND ADVISOR OF THE REGISTRANT
          (Continued)

Officers

Although not executive officers of the Trust, the following persons currently
serve as officers of the Trust. Their positions with the Trust are not subject
to a vote of shareholders. Their ages, terms of service, all positions and
offices with the Trust and Tarragon, other principal occupations, business
experience, and directorships with other companies during the last five years
are set forth below:

BRUCE SCHNITZ:  Age 48, Chief Operating Officer.

    Chief Operating Officer (since January 1996) of the Trust, TRI, and
    Tarragon; President of Tarragon Management, Inc. ("TMI") (since February
    1996); President and Chief Executive Officer (1993 to 1994) of McNeil
    Acquisition Corporation; and President, Chief Operating Officer, and
    Director (1991 to 1993), McNeil Real Estate Management, Inc.

ROBERT C. IRVINE:  Age 48, Executive Vice President and Chief Financial Officer.

    Chief Financial Officer (since September 1996) of the Trust, TRI, Tarragon,
    and TMI; Executive Vice President and Chief Financial Officer of FYI, Inc.
    (February 1996 to July 1996); Executive Vice President, Secretary,
    Treasurer, Chief Financial Officer, and Director (1991 to 1995) of McNeil
    Real Estate Management, Inc.; Vice President of McNeil Investors (1991 to
    1995); and Certified Public Accountant (since 1977).

CHRIS W. CLINTON:  Age 51, Senior Vice President - Asset Management.

     Senior Vice President - Asset Management (since May 1995), and Senior Vice
     President - Commercial Asset Management (March 1994 to April 1995) of the
     Trust and TRI; Senior Vice President (since March 1994) of Tarragon; and
     Vice President (October 1988 to March 1994) of the Trust, American Realty
     Trust, Inc. ("ART"), CMET, IORI, NIRT, TCI, and BCM.

WILLIAM L. GRIGSBY:   Age 49, Senior Vice President-Construction.

      Senior Vice President - Construction (since September 1996) of the Trust
      and TRI; Senior Vice President (since September 1996) of Tarragon;
      Director of Construction (December 1994 to August 1996) of the Trust and
      TRI; Area Vice President of Property Management, Grapat Group Real Estate
      Management (1993 - 1994); and Registered Landscape Architect since 1979.

PETER LARSEN:  Age 56, Senior Vice President - Acquisitions.

      Senior Vice President - Acquisitions (since July 1997) of the Trust and
      TRI, Senior Vice President (since July 1997) of Tarragon; Vice President -
      Acquisitions (April 1996 to June 1997) of the Trust and TRI; Vice
      President (April 1996 to June 1997) of Tarragon; Independent Consultant
      (January 1995 to June 1996); and Vice President (May 1992 to December
      1994) of BCM and Carmel Realty Services, Inc. ("CRSI").


                                       73
<PAGE>   74

ITEM 10.  TRUSTEES, EXECUTIVE OFFICERS, AND ADVISOR OF THE REGISTRANT
          (Continued)

Officers (Continued)

TODD C. MINOR:  Age 39, Treasurer.

     Treasurer (since December 1996), Senior Vice President - Mortgage Servicing
     and Financing (May 1995 to November 1996), and Senior Vice President -
     Finance (March 1994 to April 1995 and July 1993 to January 1994) of the
     Trust and TRI; Senior Vice President (since March 1994) of Tarragon; Senior
     Vice President - Finance (July 1993 to March 1994) of BCM, ART, CMET, IORI,
     and TCI; Vice President (January 1989 to July 1993) of BCM; and Vice
     President (April 1991 to July 1993) of the Trust, ART, CMET, IORI, TRI, and
     TCI.

NEIL SWINGRUBER:  Age 38,  Senior Vice President - Director of Property
Management.

     Senior Vice President - Director of Property Management (since June 1997)
     of the Trust and TRI; Executive Vice President (since February 1996) of
     TMI; Vice President of Property Management (1994 to 1995) of Binings; and
     Vice President of Property Management (1986 to 1993) of McNeil Real Estate
     Management, Inc.

JANICE CLINE:  Age 48, Vice President - Asset Management.

     Vice President - Asset Management of the Trust and TRI (since March 1997);
     Vice President of Tarragon (since March 1997); Asset Manager for MBL Life
     Insurance Company (August 1995 to March 1997); Senior Asset Analyst,
     Structured Finance, for J.E. Robert Companies (January to July 1995); and
     Senior Investment Administrator, Asset Manager, and Real Estate Paralegal
     for The Travelers Corporation and Travelers Realty Investment Company
     (October 1987 to May 1994).

ERIN D. DAVIS:  Age 36, Vice President and Chief Accounting Officer.

     Vice President and Chief Accounting Officer (since September 1996) of the
     Trust, TRI, and Tarragon; Accounting Manager of the Trust, TRI, and
     Tarragon (June 1995 to August 1996); Senior Associate, BDO Seidman (January
     1993 to June 1995); and Certified Public Accountant (since 1990).

In addition to the foregoing officers, the Trust has other officers who are not
listed herein.

Compliance with Section 16(a) of the Securities Exchange Act of 1934

Under the securities laws of the United States, the Trust's Trustees, certain
officers, and any persons holding more than ten percent of the Trust's shares of
beneficial interest are required to report their ownership of the Trust's shares
and any changes in that ownership to the Securities and Exchange Commission (the
"Commission"). Specific due dates for these reports have been established, and
the Trust is required to report any failure to file by these dates during fiscal
1997. All of these filing requirements were satisfied during 1997. In making
these statements, the Trust has relied on the written representations of its
incumbent Trustees and officers, its ten percent holders, and copies of the
reports that they have filed with the Commission.




                                       74
<PAGE>   75
ITEM 10.  TRUSTEES, EXECUTIVE OFFICERS, AND ADVISOR OF THE REGISTRANT
          (Continued)

The Advisor

Although the Board is directly responsible for managing the affairs of the Trust
and for setting the policies which guide it, the day-to-day operations of the
Trust are performed by an advisory firm which operates under the supervision of
the Board pursuant to a written advisory agreement approved by shareholders. The
duties of the advisor include, among other things, locating, investigating,
evaluating, and recommending real estate investment and sale opportunities and
financing and refinancing sources for the Trust. The advisor also serves as a
consultant in connection with the business plan and investment policy decisions
made by the Board.

Tarragon has provided advisory services to the Trust since April 1, 1994. On
March 20, 1997, the shareholders approved the renewal of the advisory agreement
dated April 1, 1995, between Tarragon and the Trust. Mr. Friedman serves as a
Director and Chief Executive Officer of Tarragon. Tarragon is owned by Mr.
Friedman and Lucy N. Friedman, his wife. The Friedman family owns approximately
33% of the outstanding shares of beneficial interest of the Trust.

The advisory agreement provides for an incentive advisory fee equal to 16% of
the Trust's adjusted funds from operations before deduction of the advisory fee.
Adjusted funds from operations is defined as funds from operations ("FFO"), as
defined by the National Association of Real Estate Investment Trusts, plus any
loss due to the write-down or sale of any real property or mortgage loan
acquired prior to January 1, 1989. FFO represents net income <loss>, computed in
accordance with generally accepted accounting principles, before gains (or
losses) from the sales of properties and debt restructurings plus depreciation
and amortization of real estate assets, and after adjustments for unconsolidated
partnerships and joint ventures. The incentive fee is cumulative within any
fiscal year to maintain the 16% per annum rate. Between April 1994 and April
1995, the advisory agreement also provided for a $100,000 annual base advisory
fee.

In addition to the advisory fee, the advisory agreement provides for the
following compensation to Tarragon:

     (a)    Tarragon is to receive an acquisition commission of 1% of the
            acquisition cost of real estate for supervising the acquisition,
            purchase, or long-term lease of real estate for the Trust, except
            that no fee will be paid for any acquisition through or from an
            affiliate of the Trust or Tarragon. The aggregate of each purchase
            price of each property including the acquisition commission and all
            real estate brokerage fees may not exceed such property's appraised
            value at acquisition.

     (b)    For obtaining loans to the Trust or refinancing on its properties,
            Tarragon is to receive a mortgage brokerage and refinancing fee
            equal to the lesser of (i) 1% of the amount of the loan or the
            amount refinanced or (ii) a brokerage or refinancing fee which is
            reasonable and fair under the circumstances; provided, however, that
            no such fee shall be paid on loans from Tarragon or an affiliate
            without the approval of the Board. No fee shall be paid on loan
            extensions.

In addition, the advisory agreement provides that real estate brokerage
commissions shall be payable to Tarragon and its affiliates only following
specific approval by the Board for each transaction rather than as a general
practice.





                                       75
<PAGE>   76
ITEM 10.  TRUSTEES, EXECUTIVE OFFICERS, AND ADVISOR OF THE REGISTRANT
          (Continued)

The Advisor  (Continued)

If and to the extent that the Trust were to request the advisor or an affiliate
of the advisor to render services for the Trust other than those specifically
required by the advisory agreement, such services would be separately
compensated on terms to be agreed upon between such party and the Trust from
time to time. The advisor is required to formulate and submit annually for
approval by the Board a budget and business plan for the Trust containing a
twelve-month forecast of operations and cash flow, a general plan for asset
sales or acquisitions, borrowing activity, and other investments, and the
advisor is required to report quarterly to the Board on the Trust's performance
against the business plan. In addition, all transactions or investments by the
Trust shall require prior approval by the Board unless they are explicitly
provided for in the approved business plan or are made pursuant to authority
expressly delegated to the advisor by the Board.

The advisory agreement also requires prior approval of the Board for retention
of all consultants and third party professionals, other than legal counsel. The
agreement provides that the advisor shall be deemed to be in a fiduciary
relationship to the Trust's shareholders; contains guidelines for the advisor's
allocation of investment opportunities as among itself, the Trust, and other
entities it advises; and contains a broad standard governing the advisor's
liability for losses incurred by the Trust. Under the advisory agreement,
neither the advisor nor any of its stockholders, directors, officers, or
employees shall be liable to the Trust, the Trustees, or the holders of
securities of the Trust for any losses from the operations of the Trust if the
advisor had determined, in good faith, that the course of conduct which caused
the loss or liability was in the best interests of the Trust, and the loss or
liability was not the result of negligence or misconduct by the advisor.

In no event will the directors, officers, or employees of the advisor be
personally liable for any action unless it was the result of willful
misfeasance, bad faith, gross negligence, or reckless disregard of duty.

Employees of the advisor render services to the Trust, as the Trust has no
employees. In accordance with the terms of the advisory agreement, certain
services provided by the advisor including, but not limited to, accounting,
legal, investor relations, data processing, and the related departmental
overhead are reimbursed directly by the Trust.

Under the advisory agreement, all or a portion of the advisory fee must be
refunded by the advisor to the Trust if the Operating Expenses, as defined,
exceed certain limits based on book value, net asset value, and net income of
the Trust during such fiscal year. The operating expenses of the Trust did not
exceed such limitation in 1995, 1996, or 1997.

The advisory agreement may be assigned only with the prior consent of the Trust.



                                       76
<PAGE>   77







ITEM 10.  DIRECTORS, EXECUTIVE OFFICERS, AND ADVISOR OF THE REGISTRANT
          (Continued)

The directors and principal officers of Tarragon are set forth below:

WILLIAM S. FRIEDMAN:      Director and Chief Executive Officer

BRUCE A. SCHNITZ:         Chief Operating Officer

ROBERT C. IRVINE:         Executive Vice President and Chief Financial Officer

CHRIS W. CLINTON:         Senior Vice President

WILLIAM L. GRIGSBY:       Senior Vice President

PETER LARSEN:             Senior Vice President

TODD C. MINOR:            Treasurer

JANICE CLINE:             Vice President

ERIN D. DAVIS:            Vice President and Chief Accounting Officer

EILEEN GOLDBERG:          Secretary

Property Management

Since April 1, 1994, Tarragon has provided property management services to the
Trust for a fee of 4.5% of the monthly gross rents collected. Until April 1996,
Tarragon subcontracted with other entities for the provision of the
property-level management services to the Trust. TMI currently provides
property-level management services to most of the Trust 's properties for a fee
of 4.5% of the monthly gross rents collected.

Since April 1, 1994, Tarragon 's real estate brokerage affiliate has been
available to and may act as a broker in both purchases and sales of Trust
property with commissions payable in amounts customarily charged in arm's-length
transactions by others rendering similar property acquisition services in the
same geographical location and for comparable property. Such commissions require
Board approval.







                                       77
<PAGE>   78
ITEM 11.  EXECUTIVE COMPENSATION

The Trust has no employees and pays no compensation to its executive officer.
The Trustees and executive officers of the Trust who are also officers or
employees of Tarragon are compensated by Tarragon. Such affiliated Trustees and
executive officers perform a variety of services for the advisor, and the amount
of their compensation is determined solely by Tarragon.

The Independent Trustees are paid an annual stipend directly by the Trust and
granted certain share options, as discussed below. The Independent Trustees (i)
review the business plan of the Trust to determine that it is in the best
interest of the shareholders, (ii) review the Trust's agreement with the
advisor, (iii) supervise the performance of the advisor and review the
reasonableness of the compensation which the Trust pays to its advisor in terms
of the nature and quality of services performed, (iv) review the reasonableness
of the total fees and expenses of the Trust, and (v) select, when necessary, a
qualified independent real estate appraiser to appraise properties acquired by
the Trust. The Independent Trustees receive compensation in the amount of
$15,000 per year plus $25,000 per year to the Chairman of the Board and
reimbursement of expenses. In addition, each Independent Trustee receives (i)
$2,000 per year for each committee of the Board of Trustees on which he (she)
serves, (ii) $1,000 per year for each committee chairmanship, and (iii) $1,000
per day for any special services rendered to the Trust outside of the ordinary
duties as Trustee, plus reimbursement for expenses, provided such services are
specifically requested by the Board.

Fees paid to Independent Trustees during 1996 and 1997 are as follows:

<TABLE>
<CAPTION>
                                                            1996           1997
                                                          ---------     ----------
<S>                                                      <C>           <C>
      Irving E. Cohen............................        $   17,000    $    17,000
      Sally Hernandez-Pinero.....................            17,000         17,000
      Dan L. Johnston............................            17,000         17,000
      Lance Liebman..............................            15,000         15,000
      L.G. Schafran..............................            15,000         15,000
      Raymond V. J. Schrag.......................            18,000         18,000
      Carl B. Weisbrod...........................            40,000         40,000
                                                          ---------     ----------
                                                          $ 139,000     $  139,000
                                                          =========     ==========
</TABLE>

Pursuant to the approval of the Independent Trustee Share Option Plan (the
"Trustee Plan") in November 1995, the Trust issued to each of the seven
Independent Trustees on November 20, 1995, options to acquire 3,000 shares (a
total of 21,000 shares). The exercise price of the options is equal to the
market price on the grant date. The options expire on the earlier of the first
anniversary of the date on which a Trustee ceases to be a Trustee of the Trust
or ten years from the date of grant (the "Termination Date") and are exercisable
at any time between the date of grant and the Termination Date. In addition, for
each year such Trustee continues to serve as a Trustee, he (she) will be awarded
an option covering 1,000 shares on January 1 of each year. Accordingly, on each
of January 1, 1996, 1997, and 1998, the Trust issued to each Independent Trustee
additional options covering 1,000 shares (a total of 21,000 shares) with
exercise prices equal to the market price on the dates of grant and the same
Termination Date as the options granted in November 1995. The options issued in
November 1995 and January 1996 and 1997 have been adjusted to give effect to the
10% share distributions paid in September 1996 and 1997 so that all Trustee
options now cover a total of 48,580 shares. The Trustee Plan provides for a
total of 72,600 shares.



                                       78
<PAGE>   79
ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

Security Ownership of Certain Beneficial Owners. The following table sets forth
the ownership of the Trust's shares of beneficial interest, both beneficially
and of record, both individually and in the aggregate for those persons or
entities known by the Trust to be beneficial owners of more than 5% of its
shares of beneficial interest as of the close of business on March 13, 1998.

<TABLE>
<CAPTION>
                                  Amount and Nature
    Name and Address of            of Beneficial               Percent of
     Beneficial Owner                Ownership                 Class (1)
     ----------------         -------------------------        ---------
<S>                           <C>          <C>                    <C>
Lucy N. Friedman              1,255,914    (2)(3)(4)(5)           33%
280 Park Avenue                            (6)(7)(8)
East Building, 20th Floor
New York, New York  10017
</TABLE>


(1)   Percentages are based upon 3,809,829 shares of beneficial interest
      outstanding at March 13, 1998.

(2)   Includes 18,465 shares owned by Lucy N. Friedman's husband, William S.
      Friedman.

(3)   Includes 804,393 shares owned by Mrs. Friedman.

(4)   Does not include 19,965 shares owned by Mrs. Friedman's adult son, Ezra
      Friedman, and 25,413 shares owned by Mrs. Friedman's adult daughter, Tanya
      Friedman. Mrs. Friedman disclaims beneficial ownership of such shares.

(5)   Includes 35,052 shares owned by a trust for the benefit of the children
      and grandchildren of Samuel Friedman, deceased, William S. Friedman's
      father, for which Robert A. Friedman and Gerald C. Friedman, siblings of
      William S. Friedman, are the trustees. Such shares are distributable, per
      stirpes, to two of Mr. Friedman's siblings and his four children. Mrs.
      Friedman disclaims beneficial ownership of such shares.

(6)   Includes 47,456 shares owned by Tarragon Capital Corporation ("TCC"), of
      which Mrs. Friedman and Mr. Friedman are executive officers and directors,
      and 38,984 shares owned by Tarragon Partners, Ltd., of which Mrs. Friedman
      and Mr. Friedman are limited partners.

(7)   Includes 13,943 shares and 14,099 shares owned by Mrs. Friedman's minor
      sons, Gideon and Samuel Friedman. Mrs. Friedman disclaims beneficial
      ownership of such shares. It also includes 266,200 shares owned by
      Beachwold Partners, L.P., in which Mrs. Friedman and Mr. Friedman are the
      general partners and their four children are the limited partners.

(8)   Includes 17,322 shares held by William S. Friedman Grantor Trust for
      benefit of the children of Mr. Friedman, of which Mrs. Friedman is the
      trustee.





                                       79
<PAGE>   80
ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
          (Continued)

Security Ownership of Management. The following table sets forth the ownership
of the Trust's shares of beneficial interest, both beneficial and of record,
both individually and in the aggregate for the Trustees and executive officers
of the Trust as of the close of business on March 13, 1998.

<TABLE>
<CAPTION>
                                            Amount and Nature
                                             of Beneficial             Percent of
 Name of Beneficial Owner                       Ownership               Class (1)
 ------------------------             ---------------------------       ---------

<S>                                   <C>           <C>                   <C>
William S. Friedman                   1,255,914     (2)(3)(4)(5)          33%
                                                    (6)(7)(8)(9)

Irving E. Cohen                           7,571     (10)                  *

Sally Hernandez-Pinero                    6,940     (11)                  *

Dan L. Johnston                           7,055     (12)                  *

Lance Liebman                             7,545     (13)                  *

L. G. Schafran                            6,940     (11)                  *

Raymond V.J. Schrag                      14,726     (14)                  *

Carl B. Weisbrod                          7,501     (15)                  *

All Trustees and Executive            1,314,192     (2)(3)(4)(5)(6)       34.5%
Officers as a group                                 (7)(8)(9)(10)(11)
(8 individuals)                                     (12)(13)(14)(15)
</TABLE>

----------------

*     Less than 1%.

(1)   Percentages are based upon 3,809,829 shares of beneficial interest
      outstanding at March 13, 1998.

(2)   Mr. Friedman owns 18,465 shares of beneficial interest personally.

(3)   Includes 804,393 shares owned by Mrs. Friedman. Mr. Friedman disclaims
      beneficial ownership of such shares.

(4)   Does not include 19,965 shares owned by Mr. Friedman's adult son, Ezra
      Friedman, and 25,413 shares owned by Mr. Friedman's adult daughter, Tanya
      Friedman. Mr. Friedman disclaims beneficial ownership of such shares.




                                       80
<PAGE>   81
ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
          (Continued)

(5)   Includes 35,052 shares owned by a trust for the benefit of the children
      and grandchildren of Samuel Friedman, deceased, William S. Friedman's
      father, for which Robert A. Friedman and Gerald C. Friedman, siblings of
      William S. Friedman, are the trustees. Such shares are distributable, per
      stirpes, to two of Mr. Friedman's siblings and his four children. Mr.
      Friedman disclaims beneficial ownership of such shares.

(6)   Includes 47,456 shares owned by TCC.

(7)   Includes 38,984 shares owned by Tarragon Partners, Ltd.

(8)   Includes 13,943 shares and 14,099 shares owned by Mr. Friedman's minor
      sons, Gideon and Samuel Friedman. Mr. Friedman disclaims beneficial
      ownership of such shares. It also includes 266,200 shares owned by
      Beachwold Partners, L.P.

(9)   Includes 17,322 shares held by William S. Friedman Grantor Trust.

(10)  Includes 631 shares owned by Irving E. Cohen directly and 6,940 shares
      covered by four separate presently exercisable options.

(11)  Includes 6,940 shares covered by four separate presently exercisable
      options.

(12)  Includes 115 shares owned by Dan L. Johnston directly and 6,940 shares
      covered by four separate presently exercisable options.

(13)  Includes 605 shares owned by Lance Liebman directly and 6,940 shares
      covered by four separate presently exercisable options.

(14)  Includes 7,786 shares owned by Raymond V. J. Schrag directly and 6,940
      shares covered by four separate presently exercisable options. Does not
      include 665 shares owned by Mr. Schrag's wife as custodian for his minor
      son, Ben, or 665 shares owned by Mr. Schrag's adult daughter, Rebecca, as
      to which Mr. Schrag disclaims any beneficial ownership.

(15)  Includes 561 shares owned by Carl B. Weisbrod directly and 6,940 shares
      covered by four separate presently exercisable options.





                     [This space intentionally left blank.]




                                       81
<PAGE>   82
ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Certain Business Relationships

Since April 1, 1994, Tarragon has served as the Trust's advisor pursuant to an
advisory agreement. Mr. Friedman serves as Director and Chief Executive Officer
of Tarragon. Tarragon is owned by Mr. Friedman and Lucy N. Friedman, his wife.
The Friedman family owns approximately 33% of the outstanding shares of the
Trust.

Since March 1, 1994, Tarragon has also served as TRI's advisor. William S.
Friedman also serves as a Director, President, and Chief Executive Officer of
TRI. TRI has the same relationship with Tarragon as the Trust. Mr. Friedman owes
fiduciary duties to TRI as well as the Trust under applicable law.

In February 1998, National Omni Associates, L.P., in which the Trust holds a 46%
interest, paid a brokerage commission of $100,000 to Highland Funding Corp., for
which Chester Beck, who serves as a Director for TRI, serves as President, for
consulting services provided in connection with the acquisition of 5600 Collins
Avenue.

From January 1993 to December 1997, FMS, Inc., a company of which Mr. Willie K.
Davis, former Trustee of the Trust and current Director of TRI, is Chairman,
President, and sole shareholder, provided property-level management services for
several properties owned by the Trust. In 1997 and 1996, FMS, Inc., earned fees
of $82,292 and $80,920, respectively, for performing such services. The Trust
believes that such fees were at least as favorable to the Trust as those that
would have been paid to unaffiliated third parties for the performance of
similar services.

Related Party Transactions

Historically, the Trust has engaged in and may continue to engage in business
transactions, including real estate partnerships, with related parties. Prior to
January 11, 1995, all related party transactions entered into by the Trust were
to be approved by a majority of the Trust's Board of Trustees, including a
majority of the Independent Trustees. In addition, the Related Party Transaction
Committee of the Board was to review all such transactions prior to their
submission to the Board for consideration. The Trust's management believes that
all of the related party transactions were at least as advantageous to the Trust
as could have been obtained from unrelated third parties.

The Trust is a partner with CMET in Sacramento Nine ("SAC 9"). SAC 9, which
currently owns two office buildings in the vicinity of Sacramento, California,
is owned 70% by the Trust which is a non-controlling partner. The SAC 9 joint
tenancy agreement requires unanimous consent of both the Trust and CMET for any
material changes in the operations of SAC 9's properties, including sales,
refinancings, and property management changes. Until March 9, 1995, Geoffrey C.
Etnire, a Trustee of CMET, was also a Trustee of the Trust. Since that time, the
Trust and CMET share no Trustees.

On December 10, 1990, the Board, based on the recommendation of its Related
Party Transaction Committee, authorized the purchase of up to $1 million of the
shares of beneficial interest of CMET through negotiated or open market
transactions. At December 31, 1994, the Trust owned 39,500 shares of beneficial
interest of CMET which it purchased in 1990 and 1991 through open market
transactions at a total cost to the Trust of $180,500. During the first quarter
of 1995, the Trust sold the shares for $592,500 and, as a result, recorded a
$412,000 gain on sale of investments.



                                       82
<PAGE>   83
ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS (Continued)

Related Party Transactions (Continued)

In December 1993, the Board approved the issuance of a $1 million convertible
subordinated debenture to Mr. Doyle, Chief Financial Officer of the Trust until
September 1996, in exchange for his 10% participation in the profits of the
Consolidated Capital Properties II ("CCP II") assets, which the Trust had
acquired in November 1992. This participation was granted as consideration for
Mr. Doyle's services to the Trust in connection with the CCP II portfolio. The
debenture bore interest at 6% per annum and was scheduled to mature in December
1999. In February 1996, Mr. Doyle converted the debenture into 93,076 Shares.
The Trust repurchased 50,000 of these shares from Mr. Doyle in September 1996
for $700,000.

Other liabilities at December 31, 1995, included non-interest bearing cash
advances of $300,000 and $283,000 from Lucy N. Friedman (50% stockholder of
Tarragon and a principal shareholder of the Trust) and Tarragon, respectively.
Such advances were made to the Trust on a short term basis to facilitate the
1995 negotiated discounted payoffs of the mortgage loans secured by Bryan Hill
Apartments, Meadowbrook Apartments, and Forest Oaks Apartments. In connection
with the discounted payoffs, the Trust realized extraordinary gains on debt
forgiveness totaling $670,000. The Trust repaid the advances in 1996. The
remaining $255,000 due to affiliates at December 31, 1995, represented accrued
mortgage brokerage commissions, advisory fees, and expense reimbursements to
Tarragon which were paid in January 1996.

The Trust has incurred fees and expense reimbursements paid to Tarragon and TMI
as follows (dollars in thousands):

<TABLE>
<CAPTION>
                                                  1996                 1997
                                                 -------             --------
<S>                                              <C>                 <C>
        Advisory fees.......................     $ 1,117             $  1,438
        Property management fees ...........       1,014                1,610
        Commercial lease commissions........         -                     39
        Real estate acquisition fees........         106                  234
        Equity refinancing fees.............         187                  773
        Expense reimbursements..............       1,176                1,411
</TABLE>

The Trust's Declaration of Trust provides that:

    "[t]he Trustees shall not . . . purchase, sell, or lease any Real Properties
    or Mortgages to or from . . . the Advisor or any of [its] Affiliates," and
    that "[t]he Trustees shall not . . . make any loan to . . . the Advisor or
    any of [its] Affiliates."

Moreover, the Declaration of Trust further provides that:

    "[t]he Trust shall not purchase or lease, directly or indirectly, any Real
    Property or purchase any Mortgage from the Advisor or any affiliated Person,
    or any partnership in which any of the foregoing may also be a general
    partner, and the Trust will not sell or lease, directly or indirectly, any
    of its Real Property or sell any Mortgage to any of the foregoing Persons."
    The Declaration of Trust further provides that "the Trust shall not directly
    or indirectly, engage in any transaction with any Trustee, officer, or
    employee of the Trust or any director, officer, or employee of the Advisor .
    . . or of any company or other organization of which any of the foregoing is
    an Affiliate, except for . . . [among other things] transactions with . . .
    the Advisor or Affiliates thereof involving loans, real estate brokerage
    services, real property management services, the




                                       83
<PAGE>   84

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS (Continued)

Related Party Transactions (Continued)

   servicing of Mortgages, the leasing of real or personal property, or other
   services, provided such transactions are on terms not less favorable to the
   Trust than the terms on which nonaffiliated parties are then making similar
   loans or performing similar services for comparable entities in the same area
   and are not entered into on an exclusive basis."

The Declaration of Trust defines "Affiliate" as follows:

   "[A]s to any Person, any other Person who owns beneficially, directly, or
   indirectly, 1% or more of the outstanding capital stock, shares, or equity
   interests of such Person or of any other Person which controls, is controlled
   by, or is under common control with, such Person or is an officer, retired
   officer, director, employee, partner, or trustee (excluding independent
   trustees not otherwise affiliated with the entity) of such Person or of any
   other Person which controls, is controlled by, or is under common control
   with, such Person."

As discussed in "Related Party Transactions" above, beginning September 1990,
the Trust had invested in shares of CMET. As of December 31, 1994, the Trust
owned 39,500 shares of CMET. CMET had the same advisor as the Trust and certain
of its Trustees were also Trustees of CMET at the time such shares were
acquired. Under the terms of its Declaration of Trust, as amended, the Trust was
prohibited from holding the shares of CMET beyond July 30, 1996. Prior to March
31, 1995, all remaining 39,500 CMET shares were sold in open market
transactions.

Prior to January 11, 1995, all related party transactions that the Trust
contemplated were to be reviewed by the Related Party Transaction Committee of
the Trust's Board of Trustees to determine whether such transactions were (i)
fair to the Trust and (ii) permitted by the Trust's governing documents. Each of
the members of the Related Party Transaction Committee was a Trustee who was not
an officer, director, or employee of the Trust's advisor, Tarragon, and was not
an officer or employee of the Trust. Such committee was disbanded in February
1995 and its responsibilities assumed by the Independent Trustees.

Pursuant to the terms of the Modification in the Olive case, which became
effective January 11, 1995, any related party transaction which the Trust may
enter into prior to April 27, 1999, with two categories of exceptions, will
require the unanimous approval of the Trust's Board of Trustees. In addition,
except for the categories noted below, certain defined related party
transactions may only be entered into in exceptional circumstances and after
determination by the Trust's Board of Trustees that the transaction is in the
best interests of the Trust and that no other opportunity exists that is as good
as the opportunity presented by such transaction. Two categories of exception
are:

      (i)   direct contractual agreements for services between the Trust and the
            Advisor or one of its affiliates (i.e., the Advisory Agreement,
            property management contracts, etc.) which require prior approval by
            two-thirds of the Trustees of the Trust and, if required, approval
            by a majority of the Shareholders;

      (ii)  joint ventures among the Trust and another party to the Modification
            in the Olive case or any of their affiliates or subsidiaries and a
            third party having no prior or intended future business or financial
            relationship with specified persons, or any affiliate of such
            persons, may be entered into on the affirmative vote of a majority
            of the Trustees of the Trust.



                                       84
<PAGE>   85

                                     PART IV


ITEM 14.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

(a)  The following documents are filed as part of this Report:

1. Consolidated Financial Statements

Report of Independent Public Accountants  -  Arthur Andersen LLP

Consolidated Balance Sheets - December 31, 1997 and 1996

Consolidated Statements of Operations -
   Years Ended December 31, 1997, 1996, and 1995

Consolidated Statements of Shareholders' Equity
   Years Ended December 31, 1997, 1996, and 1995

Consolidated Statements of Cash Flows
   Years Ended December 31, 1997, 1996, and 1995

Notes to Consolidated Financial Statements

2. Financial Statement Schedules

Schedule  III  -    Real Estate and Accumulated Depreciation

All other schedules are omitted because they are not applicable or because the
required information is shown in the Consolidated Financial Statements or the
notes thereto.

3. Exhibits

The following documents are filed as Exhibits to this report:

Exhibit
Number                Description
--------   ------------------------------------------------------------

3.1        Second Amended and Restated Declaration of Trust (incorporated by
           reference to the Registrant's Current Report on Form 8-K dated August
           14, 1987).

3.2        Amendment No. 1 to the Second Amended and Restated Declaration of
           Trust, (incorporated by reference to the Registrant's Current Report
           on Form 8-K dated July 5, 1989) reporting change in name of Trust.


                                       85
<PAGE>   86


ITEM 14.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON
          FORM 8-K (Continued)

Exhibit
Number                Description
--------   ------------------------------------------------------------

3.3        Amendment No. 2 to the Second Amended and Restated Declaration of
           Trust, (incorporated by reference to the Registrant's Current Report
           on Form 8-K dated March 22, 1990) reporting deletion of liquidation
           provisions.

3.4        Amendment No. 3 to the Second Amended and Restated Declaration of
           Trust, (incorporated by reference to the Registrant's Current Report
           on Form 8-K dated June 3, 1992) reporting the extension of the
           holding period of the Trust's marketable equity securities.

3.5        Amendment No. 4 to the Second Amended and Restated Declaration of
           Trust, dated March 20, 1997, (incorporated by reference to the
           Registrant's Quarterly Report on Form 10-Q for the quarterly period
           ended March 31, 1997) reporting amendments to various authority
           provisions of the Declaration of Trust.

3.6        Restated Trustees' Regulations dated as of April 21, 1989
           (incorporated by reference to the Registrant's Current Report on Form
           8-K dated March 24, 1989).

10.1       Advisory Agreement dated April 1, 1995, between National Income
           Realty Trust and Tarragon Realty Advisors, Inc. (incorporated by
           reference to Exhibit No. 10.1 to the Registrant's Current Report on
           Form 8-K dated April 1, 1995).

21.0       Subsidiaries of the Registrant.

27.0       Financial Data Schedule.

(b)   No reports on Form 8-K were filed during the fourth quarter covered by
      this report or with respect to events occurring after the period
      covered by this report but prior to the filing of this report.







                     [This space intentionally left blank.]



                                       86
<PAGE>   87
                                   SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.

                          NATIONAL INCOME REALTY TRUST

Dated: March  30, 1998                        By: /s/ William S. Friedman
      -----------------------                    ------------------------------
                                                 William S. Friedman
                                                 President, Chief Executive
                                                 Officer, and Trustee

Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the date indicated.


<TABLE>
<CAPTION>
Signature                             Capacities In Which Signed             Date
<S>                                   <C>                                    <C>
/s/ Carl B. Weisbrod                  Trustee and Chairman of the Board      March  13, 1998
--------------------------------
Carl B. Weisbrod

/s/ William S. Friedman               President, Chief Executive Officer,    March  30, 1998
--------------------------------      and Trustee
 William S. Friedman                  (Principal Executive Officer)

/s/ Robert C. Irvine                  Executive Vice President and           March  30, 1998
--------------------------------      Chief Financial Officer
Robert C. Irvine                      (Principal Financial Officer)

/s/ Erin D. Davis                     Vice President and                     March  30, 1998
--------------------------------      Chief Accounting Officer
Erin D. Davis                         (Principal Accounting Officer)

/s/ Irving E. Cohen                   Trustee                                March  30, 1998
--------------------------------
Irving E. Cohen

/s/ Sally Hernandez-Pinero            Trustee                                March  30, 1998
--------------------------------
Sally Hernandez-Pinero

/s/ Dan L. Johnston                   Trustee                                March  30, 1998
--------------------------------
Dan L. Johnston

/s/ Lance Liebman                     Trustee                                March  30, 1998
--------------------------------
Lance Liebman


--------------------------------      Trustee
Lawrence G. Schafran


/s/ Raymond V.J. Schrag               Trustee                                March  30, 1998
--------------------------------
Raymond V. J. Schrag
</TABLE>


                                       87


<PAGE>   88
                                 EXHIBIT INDEX

<TABLE>
<CAPTION>
Exhibit
Number                Description
--------   ------------------------------------------------------------
<S>        <C>
3.1        Second Amended and Restated Declaration of Trust (incorporated by
           reference to the Registrant's Current Report on Form 8-K dated August
           14, 1987).

3.2        Amendment No. 1 to the Second Amended and Restated Declaration of
           Trust, (incorporated by reference to the Registrant's Current Report
           on Form 8-K dated July 5, 1989) reporting change in name of Trust.

3.3        Amendment No. 2 to the Second Amended and Restated Declaration of
           Trust, (incorporated by reference to the Registrant's Current Report
           on Form 8-K dated March 22, 1990) reporting deletion of liquidation
           provisions.

3.4        Amendment No. 3 to the Second Amended and Restated Declaration of
           Trust, (incorporated by reference to the Registrant's Current Report
           on Form 8-K dated June 3, 1992) reporting the extension of the
           holding period of the Trust's marketable equity securities.

3.5        Amendment No. 4 to the Second Amended and Restated Declaration of
           Trust, dated March 20, 1997, (incorporated by reference to the
           Registrant's Quarterly Report on Form 10-Q for the quarterly period
           ended March 31, 1997) reporting amendments to various authority
           provisions of the Declaration of Trust.

3.6        Restated Trustees' Regulations dated as of April 21, 1989
           (incorporated by reference to the Registrant's Current Report on Form
           8-K dated March 24, 1989).

10.1       Advisory Agreement dated April 1, 1995, between National Income
           Realty Trust and Tarragon Realty Advisors, Inc. (incorporated by
           reference to Exhibit No. 10.1 to the Registrant's Current Report on
           Form 8-K dated April 1, 1995).

21.0       Subsidiaries of the Registrant.

27.0       Financial Data Schedule.
</TABLE>