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



                                    FORM 10-Q



    [X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
                 ACT OF 1934 FOR THE QUARTER ENDED JUNE 30, 1998
                                                  ---------------


                         Commission File Number 0-10503
                                               ---------


                      CONTINENTAL MORTGAGE AND EQUITY TRUST
             ------------------------------------------------------
             (Exact Name of Registrant as Specified in Its Charter)



                California                                    94-2738844
   ---------------------------------                     ---------------------
    (State or Other Jurisdiction of                        (I.R.S. Employer
     Incorporation or Organization)                        Identification No.)



10670 North Central Expressway, Suite 300, Dallas, TX             75231
-------------------------------------------------------------------------------
(Address of Principal Executive Offices)                        (Zip Code)


                                 (214) 692-4700
                         -------------------------------
                         (Registrant's Telephone Number,
                              Including Area Code)


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



Shares of Beneficial Interest,
        no par value                                  4,012,404
------------------------------             ------------------------------
          (Class)                          (Outstanding at July 31, 1998)



                                        1
<PAGE>   2

                          PART I. FINANCIAL INFORMATION


ITEM 1.  FINANCIAL STATEMENTS

The accompanying Consolidated Financial Statements have not been audited by
independent certified public accountants, but in the opinion of the management
of Continental Mortgage and Equity Trust (the "Trust"), all adjustments
(consisting of normal recurring accruals) necessary for a fair presentation of
consolidated results of operations, consolidated financial position and
consolidated cash flows at the dates and for the periods indicated, have been
included.


                      CONTINENTAL MORTGAGE AND EQUITY TRUST
                           CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
                                                                    June 30,       December 31,
                                                                     1998              1997
                                                                 ------------      ------------
                                                                     (dollars in thousands)
<S>                                                              <C>               <C>         
                               Assets

 Notes and interest receivable
    Performing .............................................     $      2,658      $      2,853
    Nonperforming, nonaccruing .............................            2,257             2,257
                                                                 ------------      ------------
                                                                        4,915             5,110

 Less - allowance for estimated losses .....................           (1,456)           (1,481)
                                                                 ------------      ------------
                                                                        3,459             3,629

 Foreclosed real estate held for sale, net of
    accumulated depreciation ($698 in 1998 and $725
    in 1997) ...............................................            4,991             5,670

 Real estate under contract for sale, net of
    accumulated depreciation ($3,024 in 1997) ..............               --             5,940

 Real estate held for investment, net of accumulated
    depreciation ($22,644 in 1998 and $19,393 in 1997) .....          289,628           250,084
 Investment in marketable equity securities of
    affiliates, at market ..................................           13,597            13,042
 Cash and cash equivalents .................................            5,203             3,088
 Other assets (including $214 in 1998 and $791 in
    1997 from affiliates) ..................................           16,091            17,917
                                                                 ------------      ------------

                                                                 $    332,969      $    299,370
                                                                 ============      ============
 </TABLE>


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



                                        2
<PAGE>   3

                      CONTINENTAL MORTGAGE AND EQUITY TRUST
                     CONSOLIDATED BALANCE SHEETS - Continued

<TABLE>
<CAPTION>
                                                                                        June 30,           December 31,
                                                                                          1998                 1997
                                                                                      --------------      --------------
                                                                                            (dollars in thousands)
<S>                                                                                   <C>                 <C>           
       Liabilities and Shareholders' Equity

 Liabilities
 Notes and interest payable .....................................................     $      235,189      $      199,712
 Other liabilities (including $2,381 in 1997 to
    affiliates) .................................................................              8,129              11,615
                                                                                      --------------      --------------

                                                                                             243,318             211,327

 Commitments and contingencies

 Shareholders' equity
 Shares of Beneficial Interest, no par value; authorized shares, unlimited;
    issued and outstanding, 4,012,404 shares in 1998 and 4,021,470
    shares in 1997 ..............................................................              8,036               8,054
 Paid-in capital ................................................................            256,980             257,101
 Accumulated distributions in excess of accumulated
    earnings ....................................................................           (187,604)           (188,849)
 Net unrealized gains on marketable equity
    securities of affiliates ....................................................             12,239              11,737
                                                                                      --------------      --------------

                                                                                              89,651              88,043
                                                                                      --------------      --------------

                                                                                      $      332,969      $      299,370
                                                                                      ==============      ==============
 </TABLE>




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




                                        3
<PAGE>   4

                      CONTINENTAL MORTGAGE AND EQUITY TRUST
                      CONSOLIDATED STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
                                                      For the Three Months                       For the Six Months
                                                         Ended June 30,                            Ended June 30,
                                              ------------------------------------      ------------------------------------
                                                   1998                  1997                1998                  1997
                                              ---------------      ---------------      ---------------      ---------------
                                                                 (dollars in thousands, except per share)
<S>                                           <C>                  <C>                  <C>                  <C>            
 Revenues
    Rents ...............................     $        15,938      $        13,136      $        30,748      $        26,205
    Interest ............................                 140                  194                  371                  466
                                              ---------------      ---------------      ---------------      ---------------
                                                       16,078               13,330               31,119               26,671

 Expenses
    Property operations .................               8,957                7,426               17,434               15,131
    Interest ............................               5,073                4,363               10,157                7,895
    Depreciation ........................               1,984                1,457                4,069                2,977
    Advisory fee to affiliate ...........                 642                  560                1,206                1,004
    Net income fee to affiliate .........                 (93)                 386                  198                  386
    General and administrative ..........                 535                  817                1,139                1,402
                                              ---------------      ---------------      ---------------      ---------------
                                                       17,098               15,009               34,203               28,795
                                              ---------------      ---------------      ---------------      ---------------

 (Loss) from operations .................              (1,020)              (1,679)              (3,084)              (2,124)

 Equity in income of
    partnerships ........................                  35                   26                   70                   73
 Gains (loss) on sale of real
    estate ..............................                (154)               6,810                5,462                6,810
                                              ---------------      ---------------      ---------------      ---------------


 Net income (loss) ......................     $        (1,139)     $         5,157      $         2,448      $         4,759
                                              ===============      ===============      ===============      ===============



 Earnings per share
    Net income (loss) ...................     $          (.28)     $          1.28      $           .61      $          1.18
                                              ===============      ===============      ===============      ===============



 Weighted average shares of
    beneficial interest used in
    computing earnings per share ........           4,007,538            4,026,002            4,010,342            4,026,099
                                              ===============      ===============      ===============      ===============
 </TABLE>



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




                                        4
<PAGE>   5

                      CONTINENTAL MORTGAGE AND EQUITY TRUST
                 CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY

<TABLE>
<CAPTION>
                                                                               Accumulated
                                         Shares of                            Distributions    Accumulated
                                    Beneficial Interest                        in Excess of       Other
                                --------------------------        Paid-in      Accumulated    Comprehensive   Shareholders'
                                   Shares         Amount          Capital        Earnings         Income         Equity
                                ----------      ----------      ----------      ----------      ----------     ----------
                                                        (dollars in thousands, except per share)
<S>                              <C>            <C>             <C>             <C>             <C>            <C>       
 Balance, January 1,
    1998 ..................      4,021,470      $    8,054      $  257,101      $ (188,849)     $   11,737     $   88,043


 Comprehensive Income

    Net income ............             --              --              --           2,448              --          2,448

    Unrealized gains on
       marketable equity
       securities .........             --              --              --              --             502            502
                                                                                                               ----------
                                                                                                                    2,950

 Repurchase of shares of
    beneficial interest ...        (15,000)            (30)           (210)             --              --           (240)


 Shares of beneficial
    interest sold under
    dividend reinvestment
    plan ..................          6,208              12              89              --              --            101

 Fractional shares ........           (274)             --              --              --              --             --


 Distributions ($.30
    per share) ............             --              --              --          (1,203)             --         (1,203)
                                ----------      ----------      ----------      ----------      ----------     ----------


 Balance, June 30,
    1998 ..................      4,012,404      $    8,036      $  256,980      $ (187,604)     $   12,239     $   89,651
                                ==========      ==========      ==========      ==========      ==========     ==========
 </TABLE>

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




                                        5
<PAGE>   6

                      CONTINENTAL MORTGAGE AND EQUITY TRUST
                      CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
                                                                 For the Six Months
                                                                   Ended June 30,
                                                             --------------------------
                                                                1998            1997
                                                             ----------      ----------
                                                               (dollars in thousands)
<S>                                                          <C>             <C>       
 Cash Flows from Operating Activities
    Rents collected ....................................     $   30,685      $   26,207
    Interest collected .................................            266             585
    Interest paid ......................................         (9,346)         (7,238)
    Payments for property operations ...................        (19,513)        (15,365)
    General and administrative expenses paid ...........         (1,529)         (1,901)
    Advisory and net income fee paid to affiliate ......         (1,608)         (2,076)
    Distributions from partnerships' operating cash
       flow ............................................             80             210
    Other ..............................................         (1,280)            524
                                                             ----------      ----------

       Net cash provided by (used in) operating
           activities ..................................         (2,245)            946


 Cash Flows from Investing Activities
    Acquisition of real estate .........................        (39,975)        (10,841)
    Real estate improvements ...........................         (2,486)         (2,039)
    Proceeds from sale of real estate ..................         14,119          12,654
    Sale of notes receivable ...........................            304              --
    Funding of note receivable .........................             --             (73)
    Collections on notes receivable ....................            350             851
    Deposits on pending acquisitions ...................           (175)         (4,867)
    Deferred financing costs ...........................         (1,873)           (445)
                                                             ----------      ----------

       Net cash (used in) investing activities .........        (29,736)         (4,760)


 Cash Flows from Financing Activities
    Distributions to shareholders ......................         (1,203)         (1,047)
    Proceeds from notes payable and margin borrowings ..         63,273          20,765
    Payments on notes payable ..........................        (27,835)        (16,026)
    Repurchase of shares of beneficial interest ........           (240)             --
    Shares of beneficial interest sold under
       dividend reinvestment program ...................            101              --
                                                             ----------      ----------

       Net cash provided by financing activities .......         34,096           3,692
                                                             ----------      ----------


 Net increase (decrease) in cash and cash
    equivalents ........................................          2,115            (122)

 Cash and cash equivalents, beginning of period ........          3,088           2,961
                                                             ----------      ----------

 Cash and cash equivalents, end of period ..............     $    5,203      $    2,839
                                                             ==========      ==========
 </TABLE>


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




                                        6
<PAGE>   7

                      CONTINENTAL MORTGAGE AND EQUITY TRUST
                CONSOLIDATED STATEMENTS OF CASH FLOWS - Continued

<TABLE>
<CAPTION>
                                                                      For the Six Months
                                                                        Ended June 30,
                                                                  --------------------------
                                                                     1998            1997
                                                                  ----------      ----------
                                                                    (dollars in thousands)
<S>                                                               <C>             <C>       
 Reconciliation of net income to net cash provided
    by operating activities
 Net income .................................................     $    2,448      $    4,759
    Adjustments to reconcile net income to net cash
       provided by operating activities
    Depreciation ............................................          4,069           2,977
    Gain on sale of real estate .............................         (5,462)         (6,810)
    Distributions from partnerships' operating cash
       flow .................................................             80             210
    Equity in (income) of partnerships ......................            (70)            (73)
    (Increase) decrease in interest receivable ..............            (70)            213
    Decrease in other assets ................................            979           1,296
    (Decrease) in other liabilities .........................         (4,257)         (1,677)
    Increase in interest payable ............................             38              51
                                                                  ----------      ----------

       Net cash provided by (used in) operating
           activities .......................................     $   (2,245)     $      946
                                                                  ==========      ==========



 Noncash investing and financing activities


    Notes payable from acquisition of real estate ...........     $       --      $    8,056

    Unrealized gain on marketable equity securities .........            502           5,236

    Note receivable from sale of real estate ................            467              --
 </TABLE>


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




                                        7
<PAGE>   8

                      CONTINENTAL MORTGAGE AND EQUITY TRUST
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



NOTE 1.       BASIS OF PRESENTATION

The accompanying Consolidated Financial Statements have been prepared in
accordance with generally accepted accounting principles for interim financial
information and with the instructions to Form 10-Q and Article 10 of Regulation
S-X. Accordingly, they do not include all of the information and footnotes
required by generally accepted accounting principles for complete financial
statements. Operating results for the six month period ended June 30, 1998 are
not necessarily indicative of the results that may be expected for the year
ending December 31, 1998. Dollar amounts in tables are in thousands. For further
information, refer to the Consolidated Financial Statements and Notes thereto
included in the Trust's Annual Report on Form 10-K for the year ended December
31, 1997 ("1997 Form 10-K").

Certain balances for 1997 have been reclassified to conform to the 1998
presentation.

NOTE 2.       MORTGAGE NOTES RECEIVABLE

As more fully discussed in NOTE 4. "NOTES PAYABLE," seven of the Trust's
mortgage notes receivable, with a combined principal balance of $1.4 million at
December 31, 1997, were pledged as additional collateral on a $2.3 million loan,
primarily secured by the AMOCO Office Building in New Orleans, Louisiana. In
March 1998, the note payable secured by the AMOCO Office Building was refinanced
and the collateral notes were released.

In April 1998, the Trust sold five mortgage loans secured by single-family
residences located in Arizona and Hawaii for $319,000 in cash. The Trust
received net cash of $304,000 after the payment of various closing costs
associated with the sale. The Trust recognized no gain or loss on the sale.

NOTE 3.       REAL ESTATE

In January 1998, the Trust completed the sale of the Edgewood Apartments, a 353
unit apartment complex in Lansing, Illinois, that was under contract for sale at
December 31, 1997. The apartment complex was sold for $12.1 million in cash,
with the Trust receiving net cash of $2.3 million after the payoff of $9.3
million in existing mortgage debt and the payment of various closing costs
associated with the sale. The Trust paid a real estate brokerage commission of
$302,000 to Carmel Realty, Inc. ("Carmel Realty"), an affiliate of Basic Capital
Management, Inc. ("BCM"), the Trust's advisor, based on the $12.1 million sales
price of the property. The Trust recognized a gain of $5.6 million on the sale.

Also in January 1998, the Trust purchased the McKinney 36 land, 36.4 acres of
undeveloped land in Collin County, Texas, for $2.1 million in




                                        8
<PAGE>   9

                      CONTINENTAL MORTGAGE AND EQUITY TRUST
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)


NOTE 3.       REAL ESTATE (Continued)

cash. The Trust paid a real estate brokerage commission of $82,000 to Carmel
Realty and a property acquisition fee of $21,000 to BCM based on the $2.1
million purchase price of the property.

In March 1998, the Trust purchased 1010 Common Street, a 494,579 square foot
office building in New Orleans, Louisiana, for $14.5 million. The building was
acquired subject to ground leases that expire from November 2029 to April 2069.
The Trust paid $6.3 million in cash and obtained new mortgage financing of $8.2
million. The lender has committed to fund an additional $3.8 million for tenant
improvements. The mortgage bears interest at 9.7% per annum, requires monthly
payments of interest only and matures in March 2001. The Trust paid a real
estate brokerage commission of $337,500 to Carmel Realty and a property
acquisition fee of $145,000 to BCM based on the $14.5 million purchase price of
the property. In April 1998, the Trust purchased four of the ground leases for
$200,000 in cash.

Also in March 1998, the Trust purchased 225 Baronne Street, a 416,834 square
foot office building in New Orleans, Louisiana, for $11.2 million. The Trust
paid $3.8 million in cash and obtained new mortgage financing of $7.4 million.
The lender has committed to fund an additional $1.6 million for tenant
improvements. The mortgage bears interest at 9.7% per annum, requires monthly
payments of interest only and matures in March 2001. The Trust paid a real
estate brokerage commission of $288,000 to Carmel Realty and a property
acquisition fee of $112,000 to BCM based on the $11.2 million purchase price of
the property.

Further in March 1998, the Trust sold 4050 Getwell, a 112,382 square foot
industrial warehouse in Memphis, Tennessee, for $2.1 million in cash. The Trust
received net cash of $1.2 million after the payoff of $793,000 in existing
mortgage debt and the payment of various closing costs associated with the sale.
The Trust paid a real estate brokerage commission of $81,500 to Carmel Realty
based on the $2.1 million sales price of the property. The Trust recognized no
gain or loss on the sale.

In April 1998, the Trust purchased Fontenelle Hills, a 338 unit apartment
complex in Bellevue, Nebraska, for $12.8 million. The Trust paid $2.0 million in
cash and obtained new mortgage financing of $10.8 million. The mortgage bears
interest at 7.16% per annum, requires monthly payments of principal and interest
of $73,017 and matures in April 2008. The Trust paid a real estate brokerage
commission of $311,000 to Carmel Realty and a property acquisition fee of
$128,000 to BCM based on the $12.8 million purchase price of the property.

Also in April 1998, the Trust purchased the Whisenant land, 16.802 acres of
undeveloped land in Collin County, Texas, for $600,000 in cash. The Trust paid a
real estate brokerage commission of $24,000 to Carmel Realty and an acquisition
fee of $6,000 to BCM based on the $600,000 purchase price of the property.




                                        9
<PAGE>   10

                      CONTINENTAL MORTGAGE AND EQUITY TRUST
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)


NOTE 3.         REAL ESTATE (Continued)

In May 1998, the Trust sold the Pinemont Professional Building, a 19,685 square
foot office building in Houston, Texas, for $570,000. the Trust received $57,000
in cash and provided $467,000 of seller financing in the form of a wraparound
mortgage note. The note bears interest at 10.4% per annum, requires monthly
payments of principal and interest of $6,281 and matures in July 2008. The Trust
recognized a loss of $154,000 on the sale.

The Trust has begun rebuilding an industrial warehouse in Atlanta, Georgia that
was destroyed by fire in 1996. The Trust has expended to date $309,000 and
expects to expend an additional $196,000 prior to the building's completion
during the third quarter of 1998.

NOTE 4.         NOTES PAYABLE

In January 1998, the Trust refinanced the mortgage debt secured by the Promenade
Shopping Center in Highlands Ranch, Colorado in the amount of $7.7 million. The
Trust received net cash of $2.1 million after the payoff of $5.4 million in
existing mortgage debt, the funding of required escrows and the payment of
various closing costs associated with the financing. The new mortgage bears
interest at 7.42% per annum, requires monthly payments of principal and interest
of $56,502 and matures in January 2008. The Trust paid a mortgage brokerage and
equity refinancing fee of $77,000 to BCM based on the new $7.7 million mortgage.

In March 1998, the Trust refinanced the mortgage debt in the amount of $15.0
million secured by the AMOCO Office Building in New Orleans, Louisiana, and by
seven mortgage notes receivable. The Trust received net cash of $11.9 million
after the payoff of $3.8 million in existing mortgage debt and the payment of
various closing costs associated with the financing. The lender has committed to
fund an additional $1.0 million in tenant improvements. The new mortgage bears
interest at 8.7% per annum, requires monthly payments of interest only and
matures in March 2001. The Trust paid BCM a mortgage brokerage and equity
refinancing fee of $160,000 based on the new $16.0 million mortgage.

The mortgage debt secured by the AMOCO, 1010 Common Street and 225 Baronne
Street Office Buildings in New Orleans, Louisiana are cross-collateralized and
cross defaulted. Both the Trust and BCM have guaranteed repayment of the debt.
Also, the Trust has committed to borrow an additional $163.0 million during the
period ending March 2000 from the lender. In exchange for this commitment, the
lender may record a second lien mortgage on the New Orleans properties of up to
$2.0 million. $1.0 million of this lien will be released upon the lender funding
an additional $63.0 million in new loans to the Trust or BCM affiliated
entities, with the remaining $1.0 million released pro rata as the remaining
$100.0 million in new loans is funded. At June 30, 1998, $156.2 million of the
borrowing commitment remained to be satisfied.




                                       10
<PAGE>   11

                      CONTINENTAL MORTGAGE AND EQUITY TRUST
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)


NOTE 4.         NOTES PAYABLE (Continued)

Also in March 1998, the Trust refinanced the mortgage debt secured by the
McCallum Crossing Apartments in Dallas, Texas in the amount of $8.4 million. The
Trust received net cash of $1.8 million after the payoff of $6.3 million in
existing mortgage debt and the payment of various closing costs associated with
the financing. The new mortgage bears interest at 7.19% per annum, requires
monthly payments of principal and interest of $56,961 and matures in April 2008.
The Trust paid a mortgage brokerage and equity refinancing fee of $84,000 to BCM
based on the new $8.4 million mortgage.

In April 1998, the Trust obtained mortgage financing secured by the previously
unencumbered McKinney 36 land in Collin County, Texas in the amount of $2.1
million. The Trust received net cash of $2.0 million after the payment of
various closing costs associated with the financing. The new mortgage bears
interest at 9.25% per annum, requires monthly payments of interest only and
matures in April 2000. The Trust paid a mortgage brokerage and equity
refinancing fee of $21,000 to BCM based on the $2.1 million mortgage.

In May 1998, the Trust refinanced the mortgage debt secured by the Willow Wick
Apartments in North Augusta, South Carolina in the amount of $2.1 million. The
Trust received net cash of $1.1 million after the payoff of $854,000 in existing
mortgage debt and the payment of various closing costs associated with the
financing. The new mortgage bears interest at 7.205% per annum, requires monthly
payments of principal and interest of $13,990 and matures in June 2008. The
Trust paid BCM a mortgage brokerage and equity refinancing fee of $21,000 based
on the new $2.1 million mortgage.

NOTE 5.         COMMITMENTS AND CONTINGENCIES

The Trust is involved in various lawsuits arising in the ordinary course of
business. Management of the Trust is of the opinion that the outcome of these
lawsuits would have no material impact on the Trust's financial condition,
results of operations or liquidity.

NOTE 6.         SUBSEQUENT EVENTS

In July 1998, the Trust purchased the Solco Allen land, 55.725 acres of
undeveloped land in Collin County, Texas, for $1.3 million in cash. The Trust
paid a real estate brokerage commission of $53,000 to Carmel Realty and an
acquisition fee of $13,000 to BCM based on the $1.3 million purchase price of
the property.

Also in July 1998, the Trust purchased the Sandison land, 100.171 acres of
undeveloped land in Collin County, Texas, for $4.7 million in cash. The Trust
paid a real estate brokerage commission of $95,000 to Carmel Realty and an
acquisition fee of $47,000 to BCM based on the $4.7 million purchase price of
the property.




                                       11
<PAGE>   12

                      CONTINENTAL MORTGAGE AND EQUITY TRUST
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)


NOTE 6.         SUBSEQUENT EVENTS (Continued)

In conjunction with these purchases, the Trust obtained mortgage financing in
the amount of $5.2 million secured by the Solco Allen, Sandison and the
unencumbered Whisenant land, all in Collin County, Texas. The new mortgage bears
interest at 9.25% per annum, requires monthly payments of interest only and
matures in April 2000.


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


ITEM 2.         MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
                RESULTS OF OPERATIONS


Introduction

Continental Mortgage and Equity Trust (the "Trust") was formed to invest in real
estate through acquisitions, leases and partnerships and in mortgage loans on
real estate, including first, wraparound and junior mortgage loans. The Trust
was organized on August 27, 1980 and commenced operations on December 3, 1980.

Liquidity and Capital Resources

Cash and cash equivalents aggregated $5.2 million at June 30, 1998, compared
with $3.1 million at December 31, 1997. The principal reasons for the decrease
in cash are discussed in the paragraphs below.

The Trust's principal sources of cash have been and will continue to be property
operations, proceeds from property sales, principal payments on mortgage notes
receivable and borrowings. The Trust expects that net cash provided by operating
activities and from anticipated external sources, such as property sales,
financings and refinancings, will be sufficient to meet the Trust's various cash
needs, including, but not limited to, debt service obligations, shareholder
distributions and property maintenance and improvements.

The Trust's cash flow from property operations (rents collected less payments
for expenses applicable to rental income) increased from $10.8 million in the
first six months of 1997 to $11.2 million in the first six months of 1998. Of
this net increase, $2.4 million is the result of the Trust acquiring eight
additional income producing properties during 1997 and 1998. This increase is
partially offset by the sale of four commercial properties in 1997 and one
apartment complex in 1998. The Trust's management believes that the Trust's cash
flow from property operations will continue to increase as the Trust continues
to benefit from the properties acquired in the last six months of 1997 and first
six months of 1998.




                                       12
<PAGE>   13

ITEM 2.         MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
                RESULTS OF OPERATIONS (Continued)

Liquidity and Capital Resources (Continued)

In January 1998, the Trust refinanced the mortgage debt secured by the Promenade
Shopping Center in Highlands Ranch, Colorado in the amount of $7.7 million. The
Trust received net cash of $2.1 million after the payoff of the then existing
mortgage debt.

Also in January 1998, the Trust purchased the McKinney 36 land, 36.4 acres of
undeveloped land in Collin County, Texas, for $2.1 million in cash. In April
1998, the Trust obtained mortgage financing secured by such land in the amount
of $2.1 million. The Trust received net cash of $2.0 million.

In March 1998, the Trust purchased 1010 Common Street, a 494,579 square foot
office building in New Orleans, Louisiana, for $14.5 million consisting of $6.3
million in cash and mortgage financing of $8.2 million.

Also in March 1998, the Trust purchased 225 Baronne Street, a 416,834 square
foot office building in New Orleans, Louisiana, for $11.2 million consisting of
$3.8 million in cash and mortgage financing of $7.4 million.

In March 1998, the Trust refinanced the mortgage debt in the amount of $15.0
million secured by the AMOCO Office Building in New Orleans, Louisiana, and by
seven mortgage notes receivable. The Trust received net cash of $11.9 million
after the payoff of the then existing mortgage debt.

The mortgage debt secured by the above three New Orleans properties is
cross-collateralized and cross defaulted. Both the Trust and Basic Capital
Management, Inc. ("BCM"), the Trust's advisor, have guaranteed repayment of the
debt. The Trust committed to borrow an additional $163.0 million from the lender
during the period ending March 2000, of which $156.2 million of the borrowing
commitment at June 30, 1998, remained to be satisfied. In exchange for this
commitment, the lender may record a second lien mortgage on the New Orleans
properties of up to $2.0 million. $1.0 million of this lien will be released
upon the lender funding an additional $63.0 million in new loans to the Trust or
BCM affiliated entities, with the remaining $1.0 million released pro rata as
the remaining $100.0 million in new loans is funded.

Also in March 1998, the Trust sold 4050 Getwell, a 112,382 square foot
industrial warehouse in Memphis, Tennessee, for $2.1 million in cash. The Trust
received net cash of $1.2 million after the payoff of the then existing mortgage
debt.

Further in March 1998, the Trust refinanced the mortgage debt secured by the
McCallum Crossing Apartments in Dallas, Texas, in the amount of $8.4 million.
The Trust received net cash of $1.8 million after the payoff of the then
existing mortgage debt.




                                       13
<PAGE>   14

ITEM 2.         MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
                RESULTS OF OPERATIONS (Continued)

Liquidity and Capital Resources (Continued)

In April 1998, the Trust purchased Fontenelle Hills, a 338 unit apartment
complex in Bellevue, Nebraska, for $12.8 million, consisting of $2.0 million in
cash and mortgage financing of $10.8 million.

Also in April 1998, the Trust purchased the Whisenant land, 16.802 acres of
undeveloped land in Collin County, Texas, for $600,000 in cash.

In May 1998, the Trust refinanced the mortgage debt secured by the Willow Wick
Apartments in North Augusta, South Carolina in the amount of $2.1 million. The
Trust received net cash of $1.1 million after the payoff of the then existing
mortgage debt.

In July 1998, the Trust purchased Solco Allen land, 55.725 acres of undeveloped
land in Collin County, Texas, for $1.3 million in cash.

Also in July 1998, the Trust purchased the Sandison land, 100.171 acres of
undeveloped land in Collin County, Texas, for $4.7 million in cash.

In conjunction with these purchases, the Trust obtained mortgage financing in
the amount of $5.2 million secured by the Solco Allen, Sandison and the
unencumbered Whisenant land, all in Collin County, Texas.

In December 1989, the Trust's Board of Trustees authorized the Trust to
repurchase a total of 1,465,000 of its shares of beneficial interest. The Trust
completed the authorized repurchases during the first quarter of 1998. The Trust
repurchased such shares at a total cost to the Trust of $7.8 million. In April
1998, the Trust's Board of Trustees authorized the Trust to repurchase an
additional 200,000 of its shares of beneficial interest. No shares have been
repurchased under this authorization.

In the first six months of 1998, the Trust paid quarterly distributions of $.30
per share or a total of $1.2 million and sold 6,208 shares of beneficial
interest through its dividend reinvestment plan for a total of $101,000.

The Trust's management reviews the carrying value of the Trust's mortgage notes
receivable and properties at least annually and whenever events or a change in
circumstances indicate that impairment may exist. Impairment is considered to
exist if, in the case of a property, the future cash flow from the property
(undiscounted and without interest) is less than the carrying amount of the
property. For notes receivable impairment is considered to exist if it is
probable that all amounts due under the terms of the note will not be collected.
In those instances where impairment is found to exist, a provision for loss is
recorded by a charge against earnings. The Trust's mortgage note receivable
review includes an evaluation of the collateral property securing such note. The
property review generally includes selective property inspections, a review of
the property's current rents compared to market rents, a





                                       14
<PAGE>   15

ITEM 2.         MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
                RESULTS OF OPERATIONS (Continued)

Liquidity and Capital Resources (Continued)

review of the property's expenses, a review of maintenance requirements, a
review of the property's cash flow, discussions with the manager of the property
and a review of properties in the surrounding area.

Results of Operations

The Trust had a net loss of $1.1 million for the three months ended June 30,
1998 and net income of $2.4 million, which includes gains on sale of real estate
of $5.5 million, for the six months ended June 30, 1998. The Trust had net
income of $5.2 million and $4.8 million for the three and six months ended June
30, 1997, which included gains on sale of real estate totaling $6.8 million.
Fluctuations in these and other components of the Trust's revenues and expenses
between the 1997 and 1998 periods are discussed below.

Rents increased from $13.1 million and $26.2 million for the three and six
months ended June 30, 1997 to $15.9 million and $30.7 million for the three and
six months ended June 30, 1998. Of these increases, $3.0 million and $4.9
million is attributable to the acquisition of three apartment complexes and
eight commercial properties subsequent to June 30, 1997. Increases of $1.0
million and $1.9 million are due to increased rental and occupancy rates at the
Trust's apartment complexes and commercial properties. These increases are
partially offset by decreases of $1.2 million and $2.3 million due to the sale
of one apartment complex and three commercial properties subsequent to June 30,
1997. Rents are expected to continue to increase due to revenues from properties
acquired subsequent to June 30, 1997.

Interest income was $194,000 and $466,000 for the three and six months ended
June 30, 1997 compared to $140,000 and $371,000 for the three and six months
ended June 30, 1998. The decreases are due to the sale of five mortgage notes
receivable in 1998 and the payoff of five mortgage notes receivable in 1997,
partially offset by an increase in short-term investment income. Interest income
in the remaining quarters of 1998 is expected to approximate that of the second
quarter of 1998.

Property operating expenses increased from $7.4 million and $15.1 million for
the three and six months ended June 30, 1997 to $9.0 million and $17.4 million
for the three and six months ended June 30, 1998. Of these increases, $1.7
million and $2.8 million is due to the acquisition of three apartment complexes
and eight commercial properties subsequent to June 30, 1997. These increases are
partially offset by decreases of $694,000 and $1.2 million due to the sale of
one apartment complex in 1998 and three commercial properties subsequent to June
30, 1997. Property operating expenses are expected to continue to increase due
to a full year of operations from properties acquired in 1997 and 1998.

Interest expense increased from $4.4 million and $7.9 million for the three and
six months ended June 30, 1997 to $5.1 million and $10.2 million for the three
and six months ended June 30, 1998. Of these




                                       15
<PAGE>   16

ITEM 2.         MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
                RESULTS OF OPERATIONS (Continued)

Results of Operations (Continued)

increases, $1.3 million and $2.7 million is due to interest expense recorded on
mortgages secured by eleven properties, encumbered by debt, acquired in 1997 and
three properties, encumbered by debt, acquired in 1998. An additional $149,000
and $668,000 is due to interest expense recorded on borrowings in 1997 and 1998,
secured by mortgages on five previously unencumbered apartment complexes and
four previously unencumbered commercial properties and a parcel of undeveloped
land in 1997 and a parcel of undeveloped land in 1998 and the refinancing of six
existing mortgages in 1997 and two existing mortgages in 1998 where the loan
balance was increased. These increases are partially offset by decreases of
$777,000 and $1.2 million due to the sale of four commercial properties in 1997
and an apartment complex in 1998. Interest expense is expected to increase in
the remaining six months of 1998, as a result of a full year of interest expense
on properties acquired or refinanced in 1997 and the properties acquired or
refinanced in the first six months of 1998.

Depreciation expense increased from $1.4 million and $3.0 million for the three
and six months ended June 30, 1997 to $2.0 million and $4.1 million for the
three and six months ended June 30, 1998. These increases are due to the
acquisition of three apartment complexes and eight commercial properties
subsequent to June 1997, partially offset by the sales of four commercial
properties in 1997 and one apartment complex in 1998. Depreciation is expected
to increase during the remaining six months of 1998, as a result of a full year
of depreciation on the properties acquired in 1997 and the properties acquired
in the first six months of 1998.

Advisory fee to affiliate increased from $560,000 and $1.0 million for the three
and six months ended June 30, 1997 to $642,000 and $1.2 million for the three
and six months ended June 30, 1998. This increase is due to an increase in the
Trust's gross assets, the basis for the advisory fee, as a result of property
acquisitions in 1997 and in 1998 partially offset by the sale of four commercial
properties in 1997 and one apartment complex in 1998. The advisory fee is
expected to continue to increase as the Trust makes additional property
acquisitions.

For the three months ended June 30, 1998, the Trust recorded net income fee
refund of $93,000 and for the six months ended June 30, 1998, the Trust recorded
a net income fee of $198,000 as a result of the $5.6 million gain on the sale of
the Edgewood Apartments, as discussed below. A net income fee of $386,000 was
recorded by the Trust for the three and six months ended June 30, 1997 as a
result of gains totaling $6.8 million from the sale of two commercial
properties, also as discussed below.

General and administrative expenses decreased from $817,000 and $1.4 million for
the three and six months ended June 30, 1997 to $535,000 and $1.1 million for
the three and six months ended June 30, 1998. These decreases are primarily
attributable to a decrease in legal fees, partially offset by an increase in
Advisor cost reimbursements.




                                       16
<PAGE>   17

ITEM 2.         MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
                RESULTS OF OPERATIONS (Continued)

Results of Operations (Continued)

The Trust's equity in earnings of partnerships was $26,000 and $73,000 for the
three and six months ended June 30, 1997 as compared to $35,000 and $70,000 for
the three and six months ended June 30, 1998. The decrease is due primarily to
the acquisition by the Trust in October 1997 of the remaining 40% interest in
the Indcon Partnership.

For the three months ended June 30, 1998, the Trust recognized a loss of
$154,000 on the sale of Pinemont Professional Building in May 1998. For the six
months ended June 30, 1998, the Trust recognized a net gain on the sale of real
estate of $5.5 million, $5.6 million of such gain being from the sale of the
Edgewood Apartments in January 1998. For the three and six months ended June 30,
1997, the Trust recognized gains on the sale of real estate totaling $6.8
million, $5.4 million on the sale of Tollhill West Office Building in April 1997
and $1.4 million on the sale of 2626 Cole Office Building in May 1997.

Tax Matters

As more fully discussed in the Trust's 1997 Form 10-K, the Trust has 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, as amended, (the "Code"). To continue to qualify
for federal taxation as a REIT under the Code, the Trust is required to hold at
least 75% of the value of its total assets in real estate assets, government
securities and cash and cash equivalents at the close of each quarter of each
taxable year. The Code also 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.

Inflation

The effects of inflation on the Trust's operations are not quantifiable.
Revenues from property operations fluctuate proportionately with increases and
decreases in housing costs. Fluctuations in the rate of inflation also affect
the sales values of properties and, correspondingly, the ultimate gains to be
realized by the Trust from property sales. To the extent that inflation affects
interest rates, the Trust's earnings from short-term investments and the cost of
new borrowings as well as its existing variable rate borrowings will be
affected.

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 relating to hazardous or toxic
substances (including governmental fines and injuries to persons and property)
where property-level managers have arranged for




                                       17
<PAGE>   18

ITEM 2.         MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
                RESULTS OF OPERATIONS (Continued)

Environmental Matters (Continued)

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, assets or results of operations.

Year 2000

BCM, the Trust's advisor, has advised the Trust that its current computer
software has been certified by the Information Technology Association of America
("ITAA") as year 2000 compliant. The Trust's Advisor has also advised the Trust
that it has recently received and plans to install in the third quarter of 1998
the ITAA certified year 2000 compliant operating system for its computer
hardware.


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


                           PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

Olive Litigation. In February 1990, the Trust, together with Income Opportunity
Realty Investors, Inc., National Income Realty Trust and Transcontinental Realty
Investors, Inc., 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. pending before the United States District Court for
the Northern District of California and relating to the operation and management
of each of the entities (the "Olive Litigation"). On April 23, 1990, the court
granted final approval of the terms of a Settlement.

On May 4, 1994, the parties entered into a Modification of Stipulation of
Settlement dated April 27, 1994 (the "Olive Modification") that settled
subsequent claims of breaches of the settlement that were asserted by the
plaintiffs and that modified certain provisions of the April 1990 settlement.
The Olive 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 Olive Modification was January 11, 1995.

The Court retained jurisdiction to enforce the Olive Modification, and during
August and September 1996, the Court held evidentiary hearings to





                                       18
<PAGE>   19

ITEM 1. LEGAL PROCEEDINGS (Continued)

assess compliance with the terms of the Olive Modification by various parties.
The Court issued no ruling or order with respect to the matters addressed at the
hearings.

Separately, in 1996, legal counsel for the plaintiffs notified the Trust's Board
of Trustees that he intended to assert that certain actions taken by the Board
of Trustees breached the terms of the Olive Modification. On January 27, 1997,
the parties entered into an Amendment to the Olive Modification, effective
January 9, 1997 (the "Olive Amendment"), which was submitted to the Court for
approval on January 29, 1997. The Olive Amendment provides for the settlement of
all matters raised at the evidentiary hearings and by plaintiffs' counsel in his
notices to the Trust's Board of Trustees. On May 2, 1997, a hearing was held for
the Court to consider approval of the Olive Amendment. As a result of the
hearing, the parties entered into a revised Olive Amendment. The Court issued an
order approving the Olive Amendment on July 3, 1997.

The Olive Amendment provides for the addition of four new unaffiliated members
to the Trust's Board of Trustees and sets forth new requirements for the
approval of any transactions with certain affiliates until April 28, 1999. In
addition, the Trust, IORI, TCI and their shareholders released the defendants
from any claims relating to the plaintiffs' allegations and matters which were
the subject of the evidentiary hearings. The plaintiffs' allegations of any
breaches of the Modification shall be settled by mutual agreement of the parties
or, lacking such agreement, by an arbitration proceeding.

Under the Olive Amendment, all shares of the Trust owned by Gene E. Phillips or
any of his affiliates shall be voted at all shareholders' meetings held until
April 28, 1999 in favor of all new Board members added under the Olive
Amendment. The Olive Amendment also requires that, until April 28, 1999, all
shares of the Trust owned by Gene E. Phillips or his affiliates in excess of
forty percent (40%) of the Trust's outstanding shares shall be voted pro rata to
the votes cast by all non-affiliated shareholders of the Trust.

In accordance with the Olive Amendment, Richard W. Douglas, Larry E. Harley and
R. Douglas Leonhard were added to the Trust's Board of Trustees in January 1998
and Murray Shaw was added to the Trust's Board of Trustees in February 1998.

ITEM 5.         OTHER INFORMATION

On October 25, 1996, the Trust's Board of Trustees approved a proposal to
convert the Trust from a California business trust into a Nevada corporation. On
February 10, 1998, the incorporation proposal was considered by the Trust's
current Board of Trustees and was unanimously approved by such Board members.
The Trust's Board of Trustees believes that the change from a California
business trust to a Nevada corporation will afford the Trust greater legal
certainty in matters of corporate governance and indemnification and therefore
greater predictability in





                                       19
<PAGE>   20

ITEM 5.         OTHER INFORMATION (Continued)

the conduct of its business as a corporation under Nevada law. The Trust's
management is evaluating the various alternative methods to accomplish this
conversion.


ITEM 6.         EXHIBITS AND REPORTS ON FORM 8-K


(a)             Exhibits:

<TABLE>
<CAPTION>
Exhibit
Number                      Description
-------         ----------------------------------------------
<S>             <C>                       
 27.0           Financial Data Schedule
</TABLE>

(b)             Reports on Form 8-K as follows:

                A Current Report on Form 8-K, dated April 3, 1998, was filed
                June 25, 1998, with respect to Item 2. "Acquisition or
                Disposition of Assets," and Item 7. "Financial Statements and
                Exhibits," which reports the acquisition of the 225 Baronne
                Street, 1010 Common Street Office Building, Fontenelle Hills
                Apartments and McKinney 36 land.





                                       20
<PAGE>   21

                                 SIGNATURE PAGE



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



                                    CONTINENTAL MORTGAGE AND EQUITY TRUST




Date:  August 11, 1998              By:    /s/ Randall M. Paulson
     -------------------               --------------------------------------
                                       Randall M. Paulson
                                       President






Date:  August 11, 1998              By:    /s/ Thomas A. Holland
     -------------------               --------------------------------------
                                       Thomas A. Holland
                                       Executive Vice President and
                                       Chief Financial Officer
                                       (Principal Financial and
                                       Accounting Officer)







                                       21
<PAGE>   22

                      CONTINENTAL MORTGAGE AND EQUITY TRUST

                                   EXHIBITS TO
                          QUARTERLY REPORT ON FORM 10-Q

                     For the Six Months Ended June 30, 1998


<TABLE>
<CAPTION>
Exhibit                                                        Page
Number                 Description                            Number
-------           -----------------------------------         ------
<S>               <C>                                          <C>
 27.0             Financial Data Schedule.                      23
</TABLE>






                                       22