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UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 Form 10-KSB þ
    
    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934
 o
    
    TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934
 For the fiscal year ended December 31, 2004
 Commission File Number: 0-25074 PARAGON REAL ESTATE EQUITY AND INVESTMENT TRUST  Maryland
    
    39-6594066(State or other jurisdiction of incorporation)
    
    (I.R.S. Employer Identification Number)1240 Huron Road, Suite 301, Cleveland, OH
    
    44115(Address of principal executive offices)
    
    (Zip code)
 Issuers telephone number: 216-430-2700 Fax number: 216-430-2702   Securities registered under Section 12(b) of the Act: None Securities registered under to Section 12(g) of the Act: Common Shares, $0.01 par value Check whether the registrant (1) filed all reports required to be filed by Section 13 or 15(d) of
the Exchange Act during the past 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to the filing requirements for the past 90
days. Yes þ No o Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-B
contained in this form, and no disclosure will 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-KSB or any amendment to this Form 10-KSB[ ]. Registrants revenues for its most recent fiscal year: $660,028. At February 17, 2005, the Registrant had 33,240,615 common shares of beneficial interest (including
2,859,765 shares held in treasury), $0.01 par value, and 278,455 Class A Cumulative Convertible
Preferred Shares. The aggregate market value of the voting common and preferred shares held by
non-affiliates of the Registrant was approximately $1,603,829 based on the closing price of $0.13
per common share on the American Stock Exchange on February 17, 2005. The aggregate market value
of the voting preferred shares was valued as if each of the remaining 117,045 preferred shares held
by non-affiliates were converted into 3.448 common shares on February 17, 2005. DOCUMENTS INCORPORATED BY REFERENCE None Transitional Small Business Disclosure Format (Check one): Yes o No þ




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PARAGON REAL ESTATE EQUITY AND INVESTMENT TRUST
2004 ANNUAL REPORT ON FORM 10-KSB
TABLE OF CONTENTS PagePART IItem 1
    
    Description of Business
    
    
    2Item 2
    
    Description of Property
    
    
    12Item 3
    
    Legal Proceedings
    
    
    13Item 4
    
    Submission of Matters to a Vote of Security Holders
    
    
    13PART IIItem 5
    
    Market for Common Equity and Related Shareholder Matters
    
    
    13Item 6
    
    Managements Discussion and Analysis or Plan of Operation
    
    
    15Item 7
    
    Financial Statements
    
    
    22Item 8
    
    Changes In and Disagreements with Accountants on Accounting
and Financial Disclosure
    
    
    22Item 8a
    
    Disclosure Controls and Procedures
    
    
    22Item 8b
    
    Other Information
    
    
    22PART IIIItem 9
    
    Trustees and Executive Officers
    
    
    23Item 10
    
    Executive Compensation
    
    
    25Item 11
    
    Security Ownership of Certain Beneficial Owners and Management
    
    
    27Item 12
    
    Certain Relationships and Related Transactions
    
    
    30Item 13
    
    Exhibits and Reports on Form 8-K
    
    
    31Item 14
    
    Principal Accountant Fees and Services
    
    
    33SIGNATURES
    
    
    
    
    34EX-31.1 CERTIFICATION 302-CEOEX-31.2 CERTIFICATION 302-CFOEX-32.1 CERTIFICATION 906-CEO AND CFO
  EXHIBITS
     Exhibit 31.1Section 302 CEO Certificate
     Exhibit 31.2Section 302 CFO Certificate
     Exhibit 32.1Section 906 CEO & CFO Certificate 1




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PART I 
 Item 1. Description of Business Company Overview Paragon Real Estate Equity and Investment Trust (the Company, Paragon, we, our, or us) is
a real estate company with its primary focus on acquiring, owning and operating multi-family
residential real estate. As of December 31, 2004, we owned a 1.0% interest in Paragon Real Estate,
LP, the operating partnership that owns Richton Trail Apartments (Richton Trail), an apartment
complex containing 72 units. Hampton Court Associates owns the remaining 99.0% interest in Paragon
Real Estate, LP. Because we are the sole general partner of Paragon Real Estate, LP, we
consolidate Richton Trail in our financial statements and show separately amounts for minority
interest for Hampton Court Associates, which is the only limited partner. Hampton Court Associates
ownership interest in Paragon Real Estate, LP is 813,938 restricted limited partnership units, each
redeemable after July 1, 2007 for cash, or at our option, 22.881 of our common shares. Paragon is also the sole member of Paragon Housing LLC, which is the general partner of River West
Apartments Limited Partnership (River West). River West is a single asset entity owning an
apartment complex of 30 units. We do not consolidate Paragon Housing LLC with Paragons financial
statements because we have neither financial nor voting control over the entity. Our exposure is
limited to Paragon Housing LLCs $100 capital contribution in River West, and we and Paragon
Housing LLC are not obligated on any of the liabilities of River West. The Company was formed on March 15, 1994 as a Maryland real estate investment trust (REIT). We
operated as a traditional real estate investment trust by buying, selling, owning and operating
commercial and residential properties through December 31, 1999. In February 2000, former management of the Company purchased a software technology company. As a
result of the operations of the technology company commencing in 2000, the Company did not meet the
Internal Revenue Code qualifications to be a REIT for federal tax purposes. In July 2001, former
management sold the software technology company, but continued marketing the software product. In
2002, the Company discontinued the operations of the technology segment. Although Paragon is no
longer a REIT for federal tax purposes, we can elect REIT status effective for 2005. We are
continuing to evaluate our tax status to take advantage of our tax loss carryforwards before
electing to be a REIT again. During the first half of 2003, we put into place a new management team and shareholders elected
five new Trustees. Paragon has developed a value-added business plan that is primarily focused on
acquiring well located, under-performing multi-family residential properties, including affordable
housing complexes, and repositioning them through renovation, leasing, improved management, and
branding. This strategy, while unique to public companies, is common among private companies on
both a local and limited regional basis. Paragons investments will be in properties, portfolios
and companies with value-added programs. Paragon intends to raise equity through public and private
offerings. We will also use joint venture structures for property and portfolio acquisitions, and
tax-deferred operating partnership units for acquisitions of companies. Failure to obtain external
sources of capital or to find sellers willing to exchange their properties for tax-deferred
partnership units will materially and adversely affect our strategy and our operations, liquidity
and financial results. Because the cash flow from our properties is not expected to fully fund our future liquidity
requirements, we have reduced our material future obligations, which include a mortgage on the
apartment complex and the employment contracts for our three executive officers. The debt service
payment is being funded from the cash flow of the property secured by the mortgage, and the current
salary requirements of the employment contracts is only $5,000 per month for each executive
officer. We historically have financed our long-term capital needs, including acquisitions, as
follows: 2




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
    Borrowings from new loans;
    Additional equity issuances of our common and preferred shares; and
    Proceeds from the sales of our real estate and technology segment. There can be no assurance any of the alternatives will be adopted, or if adopted, will be
successful. Real Estate Paragon Real Estate, LP, an operating partnership of which we are sole general partner and own a
1.0% interest, owns one residential apartment complex containing 72 units. Effective July 1, 2003, we closed the acquisition of our residential apartment complex, Richton
Trail, located near Chicago, Illinois. Our operating partnership, Paragon Real Estate, LP, acquired
the residential complex along with the associated mortgage from Hampton Court Associates, a
partnership controlled by James C. Mastandrea, its general partner and our Chairman, Chief
Executive Officer and President. In consideration for transferring Richton Trail, Hampton Court
Associates received 813,938 restricted limited partnership units of Paragon Real Estate, LP. Each
unit is redeemable after four years for cash, or at our option, 22.881 of our common shares. Paragon Housing LLC is a limited liability company in which we are the sole member and have a $100
investment. It is the general partner of another unrelated limited partnership owning a
residential apartment complex of 30 units, which is not consolidated with our financial statements. Real Estate Tenants Our tenants have leases that are generally for terms of one year or less. Competition The real estate market is highly competitive. Competing properties may be newer or have more
desirable locations than the Companys current property holdings. If the market does not absorb
newly constructed units, market vacancies will increase and market rents may decline. As a result,
we may have difficulty leasing units within our properties and may be forced to lower rents on
leases to compete effectively. We compete for the acquisition of properties with many entities, including, among others, publicly
traded REITs, life insurance companies, pension funds, partnerships and individual investors. Many
competitors may have substantially greater financial resources than us. In addition, certain
competitors may be willing to accept lower returns on their investments. If competitors prevent us
from buying properties that may be targeted for acquisition, our capital appreciation and valuation
may be impacted. Discontinued Operations We sold our 92.9% general partnership interest in four commercial properties on October 1, 2003.
The results of operations for these properties are presented in the accompanying Consolidated
Statement of Operations as Income/Loss from discontinued operations. 3




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The following is a summary of the income from discontinued operations of our commercial properties
for the years ended December 31, 2004 and 2003. Year ended December 31,2004
    
    
    2003Revenues
    
    $
    
    
    
    $
    1,007,813Operating expenses
    
    
    
    
    
    
    (444,995
    )Depreciation and amortization
    
    
    
    
    
    
    (157,735
    )Interest expense
    
    
    
    
    
    
    (251,900
    )General and administrative
    
    
    
    
    
    
    (305,087
    )Non-recurring real estate expenses
    
    
    
    
    
    
    (305,970
    )Income (loss) from discontinued operations
    
    $
    
    
    
    $
    (457,874
    )
 Employees The Company has four full-time employees as of February 17, 2005. Risk Factors The Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking
statements. Certain information included in this Annual Report on Form 10-KSB and other materials
filed by the Company with the Securities and Exchange Commission (as well as information included
in oral statements or other written statements made or to be made by the Company) contain
statements that are forward-looking, such as statements relating to business development and real
estate development activities, acquisitions, dispositions, future capital expenditures, financing
sources and availability, and the effects of regulation (including environmental regulation) and
competition. Although we believe that the expectations reflected in such forward-looking
statements are based on reasonable assumptions, we can give no assurance that our expectations will
be achieved. As forward-looking statements, these statements involve risks, uncertainties and
other factors that could cause actual results to differ materially from the expected results and,
accordingly, such results may differ from those expressed in any forward-looking statements made
by, or on behalf of, the Company. These risks, uncertainties and other factors include
uncertainties affecting real estate businesses generally (such as entry into new leases, renewal of
leases and dependence on tenants ability to pay rent), risks relating to our ability to maintain
and increase property occupancy and rental rates, risks relating to construction or development
activities, acquisitions, dispositions, possible environmental liabilities, risks relating to
leverage and debt service (including availability of financing on terms acceptable to us and
sensitivity of our operations and financing arrangements to fluctuations in interest rates),
dependence on the primary markets in which our properties are located, the existence of complex
regulations relating to our tax status and the potential adverse impact of market interest rates on
the market price for our securities. We assume no obligation to update or supplement
forward-looking statements that become untrue because of subsequent events. Our cash resources are limited. As of December 31, 2004, our unrestricted cash resources were approximately $1,799,000 and our
marketable securities available for sale were approximately $90,000. Our marketable securities
represented 10,000 common shares of Stellent, Inc. and 100 shares of Century Realty Trust. The
NASDAQ closing quote on February 17, 2005 was $8.30 per common share of Stellent, Inc. and $16.34
per common share of Century Realty Trust. We are dependent on our existing cash resources and our
marketable securities to meet our liquidity needs because cash from operations is not sufficient to
meet our operating requirements. We have a history of losses. We have reported net losses for each year since our inception. We have an accumulated deficit of 4




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approximately $23.7 million as of December 31, 2004. There can be no assurance that we will
become profitable in the future. We have approximately $2.8 million in debt secured by Richton Trail. Our declaration of trust and bylaws have no limitation on the amount of debt that we may incur in
the purchase, sale, development or expansion of any property. Richton Trail secures approximately
$2.8 million of outstanding mortgage debt. In the future, we may incur additional indebtedness to
finance other acquisitions and development projects. Our debt service requirements may reduce
funds available for operations and future business opportunities, and may increase our
vulnerability to adverse general economic and industry conditions and competition. We need additional capital to execute our business plan and may not be able to obtain it. We need additional equity and debt financing to execute our value-added business plan to grow.
Additional financing may have unacceptable terms or may not be available at all for reasons
relating to:  
    Our limited operating history;
    Our inability to meet our business plan; and
    Lenders or investors view of real estate operating companies with a focus
 on one segment of real estate or small-capitalized companies. If adequate financing is not available, we may not be able to acquire additional properties or
develop new properties. Failure to obtain this financing will materially and adversely affect our
strategy. Any additional capital offerings could dilute our existing shareholders, and we expect
that as we grow, our existing shareholders will be diluted significantly. We will be subject to risks with debt financing. Our business plan relies on debt financing. There are numerous risks associated with debt
financing including:  
    We must generate cash to service our debt;
    An increase in interest expense would adversely affect our cash flow, our ability
to make future distributions to our shareholders and the value of our shares;
    We may not be able to finance necessary capital expenditures for renovations
and other improvements on favorable terms or at all; and
    Our apartment complex is mortgaged to secure payment of indebtedness, and
if we are unable to meet mortgage payments, the property could be foreclosed
with a consequent loss of income and asset value to us. Our focus on multi-family residential property may not be beneficial. In the past several years, our real estate focus was to acquire and develop office and industrial
properties. Richton Trail is a multi-family residential property, a segment of real estate on
which we intend to focus. Since the latter part of 2003, we have been actively seeking and
reviewing multi-family residential companies, portfolios and properties, including affordable
housing complexes, for potential acquisition. We are currently engaged in discussions with
potential sellers, but have not entered into any definitive purchase agreements for any of these
properties. There can be no assurance that we will be able to enter into a definitive purchase
agreement or that we will be able to close a transaction once a definitive purchase agreement is
signed. Even if our management is successful in closing a transaction, investors may not value the
transaction in the same manner as we did, and 5




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investors may not value a portfolio of the same type of properties as highly as they would value
portfolios consisting of diverse properties. We may not be able to manage our growth effectively. Our business plan envisions significant growth. This growth will require increased investment in
management and professionals, personnel, financial and management systems and controls and
facilities, which could cause operating results to vary significantly from quarter to quarter and
could negatively impact our financial results. Any difficulty or significant delay in the
implementation or operation of existing or new systems or integration of new personnel could
adversely affect our ability to manage growth and our cash flow. James C. Mastandrea controls a significant percentage of our shares. Mr. Mastandrea, our Chairman of the Board, Chief Executive Officer and President, is a member and
the manager of Paragon Real Estate Development, LLC and John J. Dee, our Chief Financial Officer
and a trustee, is also a member of that entity. Of the 696,078
preferred shares issued to
Mr. Mastandrea and Mr. Dee under their restricted share agreements, 534,668 preferred shares were
converted during 2003, into 12,233,738 common shares and the balance of 161,410 preferred shares
remain outstanding. Mr. Mastandrea and Mr. Dee assigned their common and preferred shares to
Paragon Real Estate Development, LLC. Mr. Mastandrea also purchased 25,000 common shares on the
open market in 2004. In addition, Hampton Court Associates owns 813,938 units in Paragon Real
Estate, LP, which may be converted into cash, or at our option, 18,623,715 common shares at any
time after July 1, 2007. Mr. Mastandrea is the general partner of Hampton Court Associates and
owns directly or indirectly 325,575 of these units, which may be converted into 7,449,481 common
shares or cash, at our discretion. If Mr. Mastandrea caused Hampton Court Associates to redeem all
of the limited partnership units in Paragon Real Estate, LP, and we elected to convert such units
into common shares, and if the preferred shares held by Paragon Real Estate Development, LLC were
converted into common shares, then including the other common shares held by Paragon Real Estate
Development, LLC, and if all exercisable options were exercised, Mr. Mastandrea would own or have
the right to vote approximately 74.8% of our common shares. Consequently, he would have the
ability to approve some matters requiring the vote of shareholders which may result in corporate
action with which you do not agree. Mr. Mastandrea has the right to appoint a majority of our board of trustees. Under restricted share agreements, Mr. Mastandrea will have the right to appoint five trustees to
our board as long as Paragon Real Estate Development, LLC owns either:  
    a majority of the preferred shares; or
    40% or more of the sum of the restricted shares issued to Mr. Mastandrea
and Mr. Dee and the common shares issued to them upon conversion of their
restricted preferred shares into restricted common shares. Even if these conditions are not met, Mr. Mastandreas appointment right will continue until March
4, 2013; provided that if Mr. Mastandrea remains as our Chairman or Chief Executive Officer on that
date, the right to appoint five trustees will continue until the time Mr. Mastandrea is no longer
our Chairman or Chief Executive Officer. Although Mr. Mastandrea has not exercised this right in
the election of trustees, he may exercise it any time in the future. Mr. Mastandrea and Mr. Dee have conflicts of interest. James C. Mastandrea is our Chairman of the Board, Chief Executive Officer and President. We are
the general partner of Paragon Real Estate, LP, our operating partnership, and Mr. Mastandrea, as
our Chief Executive Officer, therefore, oversees the day to day operations of the operating
partnership. Mr. Mastandrea owns directly or indirectly limited partnership units totaling 40% of
the operating
partnership. Because of his different positions, Mr. Mastandrea faces conflicts of interest in
making 6




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determinations regarding the Paragon operating partnership. Mr. Mastandreas interests may
differ from the interests of our shareholders and the other limited partners, including different
and more adverse tax consequences than holders of our common or preferred shares upon the sale of
Richton Trail, the refinancing of Richton Trails debt, or in connection with any proposed tender
offer or merger involving us. Therefore, we and Mr. Mastandrea, as partners in the Paragon
operating partnership, may have different objectives regarding the appropriate terms of any such
transaction.
John J. Dee is our Senior Vice President, Chief Financial Officer and a trustee. Mr. Mastandrea
and Mr. Dee may have a conflict of interest with respect to their obligations as officers and
trustees to the extent we attempt or the Paragon operating partnership attempts to enforce the
terms of the Paragon operating partnership agreement or any other agreement to which we and either
or both
Mr. Mastandrea and Mr. Dee are parties. The failure to enforce the material terms of any such
agreement, particularly indemnification provisions and the remedy provisions for breaches of
representations and warranties or failures to perform covenants, could result in a substantial
monetary loss to or otherwise could have a material adverse effect on us and our shareholders. Mr. Mastandrea has additional conflicts of interest because he owns the management company that
manages Richton Trail and his spouse, who is President and CEO of the management company,
supervises the on-site property management employees. Mid Illinois Realty Corp., an Illinois corporation, is owned by Mr. Mastandrea and is the
management company that manages Richton Trail. Mr. Mastandreas spouse is President and CEO of Mid
Illinois Realty and supervises the on-site property employees who manage the daily operations of
Richton Trail. The existing management fee is 4.5% of gross revenues collected, excluding expense
reimbursements and forfeited security deposits. While the contract to manage Richton Trail,
including the management fee, is at a competitive market rate for similar services with an
unrelated company, it was not negotiated at arms-length. We cannot provide any assurance that a
contract with an independent third party could not be negotiated upon terms more favorable to us.
In addition,
Mr. Mastandrea owns another company, MDC Realty Corporation, an Illinois corporation, which is
reimbursed, at cost, for the payroll costs of the employees at Richton Trail that are processed by
MDC Realty through an unaffiliated payroll services provider. MDC Realty does not charge Richton
for these services. As our Chairman of the Board, Chief Executive Officer and President, and
because we are the general partner of the Paragon operating partnership that contracts with Mid
Illinois Realty and MDC Realty, Mr. Mastandrea faces conflicts of interest in making determinations
regarding the management of Richton Trail and the enforcement of the terms of the Richton Trail
management agreement. As the Company acquires more properties, it intends to use local third party
management companies until we are able to provide management services ourselves. There can be no
assurances that we will be able to provide management services for our properties, or after
management services are handled internally that we will operate our properties more efficiently or
effectively than third party management companies. We may face competition from other business interests of Mr. Mastandrea. Mr. Mastandrea owns a combined mixed-use shopping plaza and office facility in suburban Chicago,
Illinois. We do not believe that this property will compete with our apartment complex; however,
it is possible that this mixed-use facility may compete with us in the future in the event we
invest in a similar property in close proximity to it. We are dependent on a small number of key senior professionals and the loss of any of these
professionals could adversely affect our results and may, in turn, negatively affect the market
price of our common shares. The loss of professionals, particularly a senior professional with a broad range of contacts in an
industry, could materially and adversely affect our operating results. Among the key professionals
on whom we depend, and whose loss could have a material adverse effect on our business, are Mr.
Mastandrea, Mr. Dee and Mr. Jack Kuhn our Sr. Vice President  Chief Property Management &
Development Officer. We believe that personal relationships with potential investors, lenders and
sellers of real estate properties and projects are an important component of our business plan.
These 7




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relationships depend in part upon the individual employees who represent us. We will face
competition for experienced real estate professionals. We cannot assure you that losses of key
personnel due to competition or otherwise will not occur. The board of trustees has the ability to effect changes to our major policies, including our
investment policy, without the vote of shareholders. Our major policies, including policies with respect to acquisitions, mergers, financing, growth,
debt capitalization, recapitalization of the equity structure and distributions will be determined
by our board of trustees. The board of trustees may amend or revise these and other policies from
time to time without the vote of the shareholders. Accordingly, the shareholders will have no
direct control over changes in our policies which may not fully serve the interests of all of our
shareholders. We cannot sell Richton Trail for ten years without Mr. Mastandreas consent. We are precluded by the Paragon partnership agreement from selling the Richton Trail apartment
buildings for ten years without the consent of Mr. Mastandrea. Mr. Mastandreas right to consent
may present him with a conflict of interest. Shareholders could experience possible future dilution through the issuance of additional shares or
partnership interests. As a result of growth relating to acquisitions financed with the issuance of additional preferred
or common shares or interests in the Paragon operating partnership or any similar entity of ours,
you could experience significant future dilution. We cannot estimate how much dilution will occur,
but anticipate that it would be significant. We currently do not plan to distribute dividends to the holders of our shares. Unless we again become a real estate investment trust, we intend to retain earnings in order to
fund the operation and expand our business. Accordingly, we do not intend to pay cash dividends on
our common or preferred shares. Payment of future cash dividends, if any, and the amounts thereof
will be dependent upon our earnings, financial requirements and other factors deemed relevant by
our board of trustees. Our real estate assets are located in only one market. All of our existing properties are located in Illinois. Assuming no other property acquisitions
under our business plan, our financial performance is dependent upon economic conditions in this
state and the specific local market where the property is located. Like other real estate markets,
this market has experienced economic downturns in the past. Such slowdowns can lead companies to
lay off employees, which might cause individuals to move or miss rent payments. Declines in the
economy of the Illinois real estate market could adversely affect our operations or cash flow and
ability to meet ongoing obligations, pay distributions to our shareholders, if in the future we
elect to pay cash dividends on our common shares, and adversely impact the value of our shares. Real Estate Risks We face competition from numerous real estate entities with greater resources than ours. We compete for the acquisition of properties with many entities, including, among others,
publicly-traded REITs, life insurance companies, pension funds, partnerships and individual
investors. Many competitors have substantially greater financial and personnel resources than we
do. Competition may reduce the number of suitable acquisition opportunities offered to us and
increase the bargaining power of property owners seeking to sell. In addition, certain competitors
may be willing to accept lower returns on their investments. If competitors prevent us from buying
properties that may be targeted for acquisition, our business plan may be adversely impacted, as
will our capital appreciation
and value. 8




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Because real estate is illiquid, we may not be able to sell properties when appropriate. Real estate investments generally cannot be sold quickly. As we grow in accordance with our
business plan, this illiquidity will limit our ability to alter our portfolio, whether necessary to
sell our properties, to raise capital, or in response to changes in economic or other conditions.
In addition, the sale price of any disposition may not recoup or exceed the amount of our
investment. Our operating costs may rise, which could reduce our cash flow. As we expand, our operating costs may increase as a percentage of our revenue as a result of rising
costs and the heightened awareness of possible terrorist attacks. As a direct result of the
September 11, 2001 terrorist attacks, costs have increased for building security, property/casualty
and liability insurance, and property maintenance. We may not be able to pass along the increased
costs associated with such increased building security to our tenants, which could reduce our cash
flow. The possibility of future terrorist attacks has caused increases in the cost of premiums for
insurance coverage. Furthermore, in light of recently-adopted securities laws and regulations and
the additional responsibility given to audit committees as a result, we may experience increased
costs in our directors and officers liability insurance premiums and fees for auditors and other
independent third parties hired by the audit committee to fulfill its expanded responsibilities. Because of rising costs in general, we might experience increases in our property maintenance
costs, such as for cleaning, electricity, real estate taxes and heating, ventilation and air
conditioning. If operating expenses increase, the availability of other comparable apartment
complexes in our specific geographic market may limit our ability to increase rents, which could
reduce our cash flows and limit our ability to make distributions to shareholders, if in the future
we elect to pay cash dividends on our common shares. New development and acquisitions may not produce results in accordance with our expectations and
may require development and renovation costs exceeding our estimates. Our real estate investment strategy is to grow by acquiring well located, under-performing
multi-family residential properties and repositioning them through renovation, leasing, improved
management and branding. Once made, our investments may not produce results in accordance with our
expectations. Our actual renovation and improvement costs to bring an acquired property up to
market standards or to bring units of an existing property up to standards for a tenant may exceed
our estimates. Risks associated with these activities include:  
    the unavailability of financing;
    construction costs exceeding original estimates;
    construction and lease-up delays resulting in increased debt service
and construction costs;
    complications in obtaining necessary zoning, occupancy and other
governmental permits; and
    a lack of acceptance of our value added strategy by investors or tenants. In addition, acquisitions and development projects require a significant amount of managements
time which could divert managements attention away from the daily operation of our business. Financially distressed tenants may limit our ability to realize the value of our investments. Following a tenants lease default, we may experience delays in enforcing our rights as a landlord
and may incur substantial costs in protecting our investment and recovering lease and other
payments owed to us. In addition, a tenant may seek bankruptcy law protection, which could relieve
the tenant from its obligation to make lease payments. 9




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We may be unable to renew leases or relet units as leases expire. If tenants fail to renew their leases upon expiration, we may be unable to relet the subject unit.
Even if the tenants do renew their leases or we can relet the units, the terms of renewal or
reletting (including the cost of any upgrades) may be less favorable than current lease terms. Some potential losses are not fully covered by insurance or may not be covered by insurance at all. We carry comprehensive liability, fire, extended coverage and rental loss insurance on our
property. We believe the policy specification and insured limits of these policies are adequate
and appropriate. However, there are types of losses, such as losses from casualties associated
with civil unrest, acts of God, including natural disasters, and acts of war that generally are not
insured. As a consequence of the possibility of terrorist attacks in the future, we may be unable to renew
or duplicate our current insurance coverage in adequate amounts. In addition, insurance companies
may no longer offer coverage against certain types of losses, such as losses due to terrorist acts
and toxic mold, or if offered, these types of insurance may be prohibitively expensive. Should an
uninsured loss or a loss in excess of insured limits occur, we could lose all or a portion of the
capital we have invested in a property, as well as the anticipated future revenue from the
property. Inflation, changes in building codes and ordinances, environmental considerations, and
other factors also might make it unfeasible to use insurance proceeds to replace a property after
it has been damaged or destroyed. Under these circumstances, the insurance proceeds received by us
might not be adequate to restore our economic position with respect to that property. In such an
event, we may nevertheless remain obligated for any mortgage debt or other financial obligations
related to the property. We cannot provide assurance that material losses in excess of insurance
proceeds will not occur in the future.
If any of our properties experience a catastrophic loss, the loss could seriously disrupt our
operations, delay revenue and result in large expenses to repair or rebuild the property, if we are
able to make the repairs or rebuild the property at all. These events could adversely affect our
cash flow and ability to make distributions to shareholders. The ownership of real estate is subject to numerous risks generally. The underlying value of our real estate investments and our income and our ability to make future
distributions to our shareholders are dependent upon our ability to operate rental properties in a
manner sufficient to maintain or increase cash available for future distribution, if any. Income
from the properties may be adversely affected by:  
    changes in national economic conditions;
    changes in local market conditions due to changes in general or local economic
conditions and neighborhood characteristics;
    changes in interest rates and in the availability, cost and terms of mortgage
funds;
    impact of present or future environmental legislation and compliance with
environmental laws;
    ongoing need for capital improvements, particularly in older properties;
    more attractive lease incentives offered by competitors in similar markets;
    increased market demand for newer properties;
    changes in real estate tax rates and other operating expenses;
    adverse changes in governmental rules and fiscal policies;
    adverse changes in zoning laws; and
    other factors which are beyond our control. 10




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Liability for environmental matters could adversely affect our financial position. Under various federal, state, and local environmental laws, a current or previous owner or operator
of real property may be liable for the costs of removal or remediation of hazardous or toxic
substances on, under or in the property. These laws often impose liability whether or not the
owner or operator caused or knew of the presence of the hazardous or toxic substances and whether
or not the storage of such substances was in violation of a tenants lease. The owner or operator
is not always in a position to know what a tenant stores in its apartment. In addition, the
presence of hazardous or toxic substances, or the failure to remediate such property, may adversely
affect our ability to lease any or all of a property and our ability to borrow using the
contaminated property as collateral. In connection with the ownership of any property, we are
potentially liable for any cleanup costs and these costs may be substantial. Our assessments of our existing properties have not revealed any environmental liability that we
believe would have a material adverse effect on our business, assets or results of operations, nor
are we aware of any such environmental liability. We also intend to condition future acquisitions
on successful environmental assessments. Nevertheless, it is possible that our past and future
assessments will not reveal all environmental liabilities or that there are existing or future
material environmental liabilities of which we will be unaware. Compliance with applicable laws, rules and regulations, including the Americans with Disabilities
Act, can be costly. All places of public accommodation are required to meet certain federal requirements, including but
not limited to those associated with the Americans with Disabilities Act. A number of additional
federal, state and local laws exist that also may require modifications to our present and future
properties or restrict certain further renovations thereof, with respect to access thereto by
disabled persons. Although we believe that our existing property is substantially in compliance with present
requirements, future legislation may impose additional burdens or restrictions on owners with
respect to access by disabled persons. Although the costs of compliance with any additional
legislation are not currently ascertainable, the costs could be substantial. Limitations or
restrictions on the completion of certain renovations may also limit application of our investment
strategy in certain instances or reduce overall returns on our investments. We may not be able to meet the American Stock Exchanges continued listing qualifications. While our common shares are currently listed on the American Stock Exchange, we may not be able to
meet the American Stock Exchanges continued listing qualifications in the future and we received a
letter on December 1, 2004 from the American Stock Exchange notifying the Company that we are not
in compliance with continued listing requirements of the exchange. Specifically, we are not in
compliance due to shareholders equity of less than $2.0 million and losses from continuing
operations and net losses in the three most recent years, as well as shareholders equity of less
than $4.0 million and losses from continuing operations and net losses in the four most recent
years. We submitted a plan to the exchange proposing actions we will take within 12 months to bring the
Company into compliance with the exchanges listing standards. In February 2005, the exchange
determined that Paragons plan makes a reasonable demonstration for the Company to regain
compliance with the exchanges listing standards by December 2, 2005, the end of the plan period.
If the Company is not in compliance with the listing standards at the end of the plan period, or
does not make progress consistent with the plan, Paragons common shares would be subject to
delisting proceedings. Even though the Company has fallen below the listing standards of the
exchange, the exchange is continuing Paragons listing on an extension. In addition, our common shares are thinly traded and trading volumes fluctuate significantly. 11




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The average trading volume for the year ended December 31, 2004 was approximately 40,000 common
shares per day. As a result, investors may have difficulty selling our common shares at generally
prevailing prices. Advantageous transactions may be prevented. Certain provisions contained in our declaration of trust and bylaws and under federal and Maryland
laws may have the effect of discouraging a third party from making any acquisition proposal for us.
For example, such provisions may  
    deter attractive tender offers for our shares, or
    deter purchases of large blocks of our shares, thereby limiting the
opportunity for our shareholders to receive a premium for their
 shares over then-prevailing market prices. Possible issuances of future series of preferred shares. Pursuant to our declaration of trust, our board of trustees has the authority to fix the rights,
preferences, privileges and restrictions, including voting rights, of unissued shares and to issue
those shares without any further vote or action by the shareholders. The rights of the holders of
our common shares will be subject to, and may be adversely affected by, the rights of the holders
of any series of preferred shares that may be issued in the future. 
 Item 2. Description of Property As of December 31, 2004, we owned one residential apartment complex, Richton Trail, consisting of
12 three-story apartment buildings containing a total 72 units, which we acquired on July 1, 2003.
The apartment buildings were built in 1978, 1979 and 1982, were refurbished in the late 1980s and
again in the 1990s. They are situated in a suburb of Chicago on 3.21 acres, or 139,884 square
feet, of land. Each building has its own parking lot and contains six apartment units, with a
combined total of 60 two-bedroom apartments and 12 one-bedroom apartments. Richton Trail contains 56,040 square feet of net rentable area and 74,196 square feet of above
grade gross building area. The property has generated rental revenue of approximately $609,000 in
2004, and for the year ended December 31, 2004, 99.0% of the property, or in excess of 71 units,
were rented. Tenants lease obligations are generally on a year-to-year basis. Richton Trail must
maintain approximately 81% of the apartments rented in order to achieve the necessary cash flow to
operate the property with its current expenses and liabilities. We currently have no plans for any
significant improvements at Richton Trail because the property has been maintained in the past and
it is at or near full occupancy. Paragon Real Estate, LP, an operating partnership of which we are sole general partner and own a
1.0% interest, owns Richton Trail. Hampton Court Associates owns the remaining 99.0% interest of
Paragon Real Estate, LP. Because we are the sole general partner of Paragon Real Estate, LP, we
consolidate Richton Trail in our financial statements and show separately amounts for minority
interest for Hampton Court Associates, which is the only limited partner. Hampton Court Associates
ownership interest in Paragon Real Estate, LP is 813,938 restricted limited partnership units, each
redeemable after July 1, 2007 for cash, or at our option, 22.881 of our common shares. Paragon is also the sole member of Paragon Housing LLC, which is the general partner of River West
Apartments Limited Partnership (River West). River West is a single asset entity owning an
apartment complex of 30 units. We do not consolidate Paragon Housing LLC with Paragons financial
statements because we do not have sufficient equity at risk for Paragon Housing LLC to finance its
activities without additional subordinated financial support. Our exposure is limited to 12




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Paragon Housing LLCs $100 capital contribution in River West, and we and Paragon Housing LLC are
not obligated on any of the liabilities of River West. On October 1, 2003, we closed on the sale of our 92.9% general partnership interest in four
commercial properties. Proceeds from the sale of these properties, net of closing costs and the
mortgage balances assumed by the purchaser, were approximately $1,601,000. The proceeds from the
sale were paid in a combination of approximately $801,000 in cash and 2,859,765 of our common
shares at an average closing price for the 30 calendar days prior to June 27, 2003 of $0.28. Also
as a result of the sale, approximately $318,000 representing cash from the commercial real estate
properties was released from mortgage related restrictions and made available for operations. Investments in Real Estate Depreciation and Insurance Coverages Depreciation expense on our apartment buildings is computed using the straight line method based on
a useful life of 40 years. We believe we have adequate insurance coverage for our real estate property. Mortgage Loan Richton Trail has a mortgage loan with an independent lender. The mortgage loan had an original
balance of $2.8 million with a fixed interest rate of 5.87% for a term of 10 years. The monthly
principal and interest payments are approximately $18,000, based on a 25-year amortization
schedule. The balance due at maturity in 2013 will be approximately $2.1 million. The mortgage
loan payable was approximately $2,763,000 as of December 31, 2004. 
 Item 3. Legal Proceedings In the normal course of business, we may be involved in legal actions arising from the ownership
and administration of our properties. In our opinion, the liabilities, if any, that may ultimately
result from such legal actions are not expected to have a materially adverse effect on our
consolidated financial position, operations or liquidity. We are not currently involved in any
legal actions. 
 Item 4. Submission of Matters to a Vote of Security Holders No matters were submitted to a vote of security holders during the fourth quarter of 2004. 
 PART II 
 Item 5. Market for Common Equity, Related Shareholder Matters and Issuer Purchases of Equity
Securities. Our common shares began trading on the American Stock Exchange on October 28, 1999 under the symbol
RPP. On June 30, 2003 we changed our name to Paragon Real Estate Equity and Investment Trust.
As a result of our name change our common shares now trade under the new symbol PRG on the
American Stock Exchange. As discussed above under Risk Factors, we received a letter from the
American Stock Exchange notifying the Company that it is not in compliance with continued listing
requirements of the exchange. In February 2005, we received another letter from the exchange in
which it determined that Paragons plan submitted to the exchange in December 2004, makes a
reasonable demonstration for the Company to be in compliance by December 2, 2005, the end of the
plan period. Even though the Company has fallen below the exchanges listing standards, the
exchange is presently continuing Paragons listing on an extension. Our Class A Preferred Shares began trading on the American Stock Exchange on October 28, 1999 13




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under the symbol RPP.A. In May 2003, we offered preferred shareholders a one-time incentive to
exchange preferred shares into common shares, which expired June 30, 2003. Through that exchange
offer, preferred shareholders exchanged 1,174,120 of the preferred shares, or nearly 81%, for
26,865,042 common shares. After the exchange offer was completed, the remaining preferred shares
held by investors not affiliated with Paragon had an aggregate market value below $1 million and
therefore no longer met the minimum requirement for listing on the American Stock Exchange, as set
forth in the American Stock Exchanges Company Guide.This requirement was disclosed in the proxy
statement as well as our intent not to seek another trading market for the preferred shares. The
exchange suspended trading of the preferred shares and the Securities and Exchange Commission
removed the preferred shares from listing and registration in accordance with Section 12 of the
Securities and Exchange Act of 1934. Preferred shareholders retain the right to convert each of
their shares for 3.448 common shares. The preferred shares are now on the Over the Counter Market
with the symbol PRGYP. The table below shows the range of the high and low sale prices for our common shares as reported
on the American Stock Exchange. The quotations shown represent interdealer prices without
adjustment for retail markups, markdowns or commissions, and may not reflect actual transactions. High
    
    
    Low20044th Quarter
    
    $
    0.20
    
    
    $
    0.063rd Quarter
    
    $
    0.24
    
    
    $
    0.112nd Quarter
    
    $
    0.22
    
    
    $
    0.121st Quarter
    
    $
    0.37
    
    
    $
    0.1820034th Quarter
    
    $
    0.34
    
    
    $
    0.183rd Quarter
    
    $
    0.39
    
    
    $
    0.192nd Quarter
    
    $
    0.39
    
    
    $
    0.131st Quarter
    
    $
    0.20
    
    
    $
    0.11
 On February 17, 2005, the last reported sales price of our common shares on the American Stock
Exchange was $0.13. The number of holders of record of our common shares was approximately 300 as
of February 17, 2005 and we estimate we have approximately 1,200 beneficial holders of common
interests as of that same date. Dividend Policy We have not declared or paid dividends on our common shares since the fourth quarter of 1999, and
we do not anticipate paying dividends on our common shares in the foreseeable future. Declaration
or payment of dividends, if any, in the future, will be at the discretion of the board of trustees
and will depend on our then current financial condition, results of operations, capital
requirements and other factors deemed relevant by the board of trustees. On June 30, 2003, the holders of our preferred shares consented to waive the dividend that would
otherwise have been payable in May 2003 and to eliminate any future dividends that would have been
payable under the terms of our preferred shares. The waiver was sought in connection with a
one-time incentive exchange offer under which we offered to exchange each of our preferred shares
for 22.881 common shares. The exchange offer was completed on June 30, 2003. Preferred Share Conversions No preferred shares were converted during the fourth quarter of 2004. 14




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Item 6. Managements Discussion and Analysis or Plan of Operation Overview Paragon Real Estate Equity and Investment Trust, (the Company, Paragon, we, our, or us)
is a real estate company that primarily acquires, owns and operates multi-family residential
properties. As of December 31, 2004, we owned a 1.0% interest in Paragon Real Estate, LP, the
operating partnership that owns Richton Trail Apartments (Richton Trail), an apartment complex
containing 72 units. Hampton Court Associates owns the remaining 99.0% interest in Paragon Real
Estate, LP. We are the sole general partner of Paragon Real Estate, LP and Hampton Court
Associates is the limited partner. Hampton Court Associates ownership interest in Paragon Real
Estate, LP is 813,938 restricted limited partnership units, each unit redeemable after July 1, 2007
for cash, or at our option, 22.881 of our common shares. Paragon is also the sole member of Paragon Housing LLC, which is the general partner of River West
Apartments Limited Partnership (River West). River West is a single asset entity owning an
apartment complex of 30 units. We do not consolidate Paragon Housing LLC with Paragons financial
statements because we do not have sufficient equity at risk for Paragon Housing LLC to finance its
activities without additional subordinated financial support. Our exposure is limited to Paragon
Housing LLCs $100 capital contribution in River West, and we and Paragon Housing LLC are not
obligated on any of the liabilities of River West. Brief History The Company was formed on March 15, 1994 as a Maryland real estate investment trust (REIT). We
operated as a traditional real estate investment trust by buying, selling, owning and operating
commercial and residential properties through December 31, 1999. In February 2000, former management of the Company purchased a software technology company. As a
result of the operations of the technology company commencing in 2000, the Company did not meet the
Internal Revenue Code qualifications to be a REIT for federal tax purposes. In July 2001, former
management sold the software technology company, but continued marketing the software product. In
2002, the Company discontinued the operations of the technology segment. Although Paragon is no
longer a REIT for federal tax purposes, we can elect REIT status effective for 2005. We are
continuing to evaluate our tax status to take advantage of our tax loss carryforwards before
electing to be a REIT again. Recent Developments in 2004 and Executive Overview On March 4, 2003, James C. Mastandrea and John J. Dee signed exclusive employment agreements with
the Company, and were joined by Jack R. Kuhn in July 2004. Mr. Mastandrea is our Chairman, Chief
Executive Officer and President and Mr. Dee is our Chief Financial Officer, Senior Vice President
and a trustee. Mr. Kuhn is our Sr. Vice President  Chief Property Management and Development
Officer, responsible for overseeing, managing and directing all property management and development
activities. At the June 30, 2003 annual meeting, shareholders approved several proxy proposals to
reposition the Company, of which the most significant were the following:  (1)
    A one-time incentive exchange offer to holders of our preferred shares to exchange each
preferred share for 22.881 common shares, and elimination of the
preferred share dividend
to conserve cash for operations and acquisitions;(2)
    The July 1, 2003 acquisition of Richton Trail, a suburban Chicago apartment complex
owned by a partnership of which Mr. Mastandrea is the general partner, for 813,938
restricted limited partnership units of Paragon Real Estate, LP, convertible after four years
into cash, or at our option, common shares at the rate of one partnership unit for 22.881
common shares. 15




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(3)
    The October 1, 2003 sale of our four commercial properties located in Minnesota to
former members of management for cash of approximately $801,000 plus $318,000 released from
mortgage related restrictions and the return of 2,859,765 of our common shares; and(4)
    The election of five trustees, resulting in the board of trustees being comprised of
four independent trustees and two trustees who are also executive officers. Due to the sale of our four commercial properties, the revenues and expenses of those properties
were reclassified as discontinued operations for 2003. Our management team and board of trustees have formulated a value-added business strategy focused
on acquiring well located, underperforming multi-family residential properties and repositioning
them through renovation, leasing, improved management and branding. During 2004 and the latter
part of 2003, management has been pursuing this strategy by actively seeking and reviewing of
multi-family residential companies, portfolios and properties, including affordable housing
complexes. While we made offers to some of the sellers, low interest rates for debt financing have
had the effect of increasing sale prices for these types of properties and we did not enter into
any definitive purchase agreements in 2004. Additionally in December 2004, we formed Paragon
Housing LLC, a limited liability company in which we are the sole member and have a $100
investment. Paragon Housing LLC is the general partner of another unrelated limited partnership
owning a residential apartment complex of 30 units, which is qualified under Section 42 of the
Internal Revenue Code to receive low income housing tax credits. We are currently engaged in
discussions with potential sellers, but have not entered into any definitive purchase agreements
for any of these properties. There can be no assurance that we will be able to enter into a
definitive purchase agreement or that we will be able to close a transaction once a definitive
purchase agreement is signed. Even if our management is successful in closing a transaction,
investors may not value the transaction in the same manner as we did, and investors may not value a
portfolio of the same type of properties as highly as they would value portfolios consisting of
diverse properties. Forward-Looking Information The following is a discussion of our results of operations for the years ended December 31, 2004
and 2003 and financial condition, including  
    Explanation of changes in the results of operations in the Consolidated Statements
of Operations for the year ended December 31, 2004 compared to the year ended
December 31, 2003.
    Our critical accounting policies and estimates that require our subjective judgment and
are important to the presentation of our financial condition and results of operations.
    Our primary sources and uses of cash for the year ended December 31, 2004, and how
we intend to generate cash for long-term capital needs.
    Our current income tax status. This section contains forward-looking statements, as defined in the Private Securities Litigation
Reform Act of 1995, that are based on our current expectations, estimates and projections about
future events and financial trends affecting the financial condition and operations of our
business. Forward-looking statements can be identified by the use of words such as may, will,
should, expect, estimate or comparable terminology. Forward-looking statements are
inherently subject to risks and uncertainties, many of which we cannot predict with accuracy and
some of which we might not even anticipate. Although we believe that the expectations, estimates
and projections reflected in these forward-looking statements are based on reasonable assumptions
when they are made, we can give no assurance that these expectations, estimates and projections can
be achieved. Future events and actual results may differ materially from those discussed in the
forward-looking statements. The Company
assumes no obligation to update or supplement forward-looking statements that become untrue 16




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because of subsequent events. Factors that could cause actual results to differ materially from
managements current expectations include, but are not limited to, changes in general economic
conditions, changes in local real estate conditions (including rental rates and competing
properties), changes in the economic conditions affecting industries which employ tenants residing
in our property, our failure to lease unoccupied units or to re-lease occupied units upon
expiration of leases in accordance with the our projections, changes in prevailing interest rates,
the cost or general availability of equity and debt financing, unanticipated costs associated with
the acquisition and integration of our acquisitions, our ability to obtain adequate insurance for
terrorist acts, demand for tenant services beyond those traditionally provided by landlords, and
potential liability under environmental or other laws. Please see the section Risk Factors on
previous pages for other factors which could affect our Company. Comparison of the years ended December 31, 2004 and 2003 Revenues from Continuing Operations As a result of the October 1, 2003 sale of our 92.9% general partnership interest in the operating
partnership that held our four commercial real estate properties, rental revenues and interest
income and other income related to these properties were reclassified to discontinued operations
for the year ended December 31, 2003. Richton Trail, which we acquired on July 1, 2003, is
included in continuing operations. Rental revenue of approximately $609,000 for the year ended December 31, 2004 represents twelve
months revenue for Richton Trail and the rental revenue of approximately $288,000 for the year
ended December 31, 2003 represents only six months revenue for Richton Trail, which was acquired on
July 1, 2003. Interest income and other income increased by approximately $32,000 or 166.7% to approximately
$51,000 for the year ended December 31, 2004 compared to the year ended December 31, 2003. The
increase is primarily due to the increase in cash and cash equivalents, as a result of the
disposition of the commercial properties and the refinancing of Richton Trail in the fourth quarter
of 2003. Expenses from Continuing Operations Total expenses increased from approximately $1,223,000 for the year ended December 31, 2003 to
approximately $1,558,000 for the year ended December 31, 2004, a net increase of $335,000 as
described below. As a result of the October 1, 2003 sale of our 92.9% general partnership interest in the four
commercial Minnesota properties, property taxes and insurance, depreciation and amortization,
interest and management fees related to these properties were reclassified to discontinued
operations. Richton Trail, which we acquired on July 1, 2003, is included in continuing
operations, as follows: Years ended December 31,
    
    
    IncreaseRichton Trail
    
    2004
    
    
    2003
    
    
    (decrease)Property, operating and
maintenance
    
    $
    218,000
    
    
    $
    88,000
    
    
    $
    130,000Property taxes and insurance
    
    
    101,000
    
    
    
    48,000
    
    
    
    53,000Depreciation and amortization
    
    
    87,000
    
    
    
    57,000
    
    
    
    30,000Interest
    
    
    166,000
    
    
    
    66,000
    
    
    
    100,000Management fees
    
    
    28,000
    
    
    
    13,000
    
    
    
    15,000Totals Richton Trail
    
    
    600,000
    
    
    
    272,000
    
    
    
    328,000General and administrative
    
    
    958,000
    
    
    
    951,000
    
    
    
    7,000Total Expenses
    
    $
    1,558,000
    
    
    $
    1,223,000
    
    
    $
    335,000
 17




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The increases in expenses shown above, except for general and administrative explained in the
following paragraph, are mainly due to twelve months of Richton Trail operations in 2004 compared
to only six months in 2003. Other differences between the full year 2004 and annualized 2003
include an increase of approximately $34,000 in interest expense due to the refinancing of Richton
Trail, an increase of approximately $11,000 in legal costs related to collections and evictions,
and an increase in utilities due to the seasonal nature of heating costs of approximately $10,000. General and administrative expenses increased from approximately $951,000 for the year ended
December 31, 2003 to approximately $958,000 for the year ended December 31, 2004. The increase of
approximately $7,000 was the result of an increase of approximately $81,000 in legal costs related
to litigation with former management and legal costs related to the pursuit of new deals. In
addition we had increased travel costs related to the pursuit of new deals of approximately $32,000
and increased rent costs of approximately $14,000. The rent is a non-cash cost paid through the
issuance of restricted shares. The increased costs were partially offset by decreased compensation
and related costs of approximately $89,000 representing non-cash severance costs incurred in 2003,
net of increased costs in 2004 including approximately $118,000 of non-cash costs paid through the
issuance of restricted shares. Other lower costs include reduced director and officer liability
insurance and other insurance costs of approximately $13,000, and reduced public company mailing
and related costs of approximately $18,000. General and administrative costs represent approximately 61% of total costs. General and
administrative costs are a large percent of total costs because we have only one property and
continue to actively seek and review potential acquisitions to build our portfolio. Loss from operations before minority interests As a result of the above, loss from operations before minority interests decreased from
approximately $917,000 for the year ended December 31, 2003 to approximately $898,000 for the year
ended December 31, 2004. Loss allocated to minority interests Loss allocated to minority interests decreased from approximately $149,000 for the year ended
December 31, 2003 to approximately $82,000 for the year ended December 31, 2004, primarily as a
result of the October 2003 sale of our partnership interest in our commercial properties offset,
and in part, by the July 2003 acquisition of our partnership interest in Richton Trail. Loss from operations As a result of the above, loss from operations increased from approximately $768,000 for the year
ended December 31, 2003 to approximately $816,000 for the year ended December 31, 2004. Gain on sale of marketable securities The gain on sale of marketable securities of approximately $136,000 for the year ended December 31,
2003 was a result of our sale of 30,000 common shares of Stellent, Inc. at an average price of
$8.30 per share. Loss from continuing operations Loss from continuing operations increased from approximately $632,000 for the year ended
December 31, 2003 to approximately $816,000 for the year ended December 31, 2004. Discontinued operations Loss from discontinued operations of our commercial properties, net of tax, was approximately $0 and 18




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$458,000 for the years ended December 31, 2004 and 2003, respectively. The loss in 2003
included $350,000 representing tenant improvements, leasing commission and professional fees spent
on the commercial properties prior to their sale without an increase in proceeds. The discontinued
operations were a result of the sale of our 92.9% general partnership interest in the four
commercial properties on October 1, 2003. Current management did not consider these properties,
comprised of small office/industrial facilities, to be core assets for the new value-added business
plan. Therefore, the commercial properties were sold to raise cash for short term operations and
for future acquisitions. As a result of the sale of our commercial properties on October 1, 2003, we received cash of
approximately $801,000, and approximately $318,000 of additional cash was released from mortgage
related restrictions and made available for operations. Net loss attributable to Common Shareholders Based on the above, the net loss attributable to common shareholders decreased from approximately
$1,090,000 for the year ended December 31, 2003 to approximately $816,000 for the year ended
December 31, 2004. Critical Accounting Policies and Estimates Our Consolidated Financial Statements are prepared in accordance with generally accepted accounting
principles, which require us to make certain estimates and assumptions. A summary of our
significant accounting policies is provided in Note 3 to our Consolidated Financial Statements.
The following section is a summary of certain aspects of those accounting policies that both
require our most subjective judgment and are most important to the presentation of our financial
condition and results of operations. It is possible that the use of different estimates or
assumptions in making these judgments could result in materially different amounts being reported
in our Consolidated Financial Statements. Impairment of Long-Lived Assets We recognize an impairment loss on a real estate asset if the assets carrying amount exceeds its
fair value and is non-recoverable. First, to determine if impairment may exist, we review our
properties and identify those, if any, which have had either an event of change or event of
circumstances warranting further assessment of recoverability. Next, we estimate the fair value of
those properties on an individual basis through either independent appraisals or by capitalizing
the expected net operating income. These amounts are then compared to the propertys depreciated
cost to determine whether an impairment exists. We compute the expected net operating income using
certain estimates and assumptions for revenues and expenses. As a result, these estimates and
assumptions impact the amount of impairment loss that we recognize. In 2003, we recognized a
provision for loss on the four commercial properties of $350,000 for tenant improvements, leasing
commissions and professional fees spent on the properties prior to their sale without an increase
in proceeds. Real Estate Investments When we acquire real estate properties, we allocate the components of these acquisitions using
relative fair values computed using our estimates and assumptions. These estimates and assumptions
affect the amount of costs allocated between land and different categories of building
improvements. The allocations impact depreciation expense and gain or loss recorded on sale of
real estate. When we acquired Richton Trail, we allocated 80% of the acquisition price to building
and 20% to land, based on our judgment of the relative values of the two components and as
supported by standard industry practice. The acquisition price was from a market appraisal. Valuation Allowance of Deferred Tax Asset We account for income taxes using the liability method under which deferred tax assets and
liabilities are determined based on differences between the financial reporting and tax bases of
assets and liabilities 19




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using enacted tax rates in effect for the period in which the differences are expected to
affect taxable income. At December 31, 2004, we have net operating losses totaling approximately
$11.0 million and capital losses of approximately $0.6 million. While these losses created a
deferred tax asset of approximately $4.9 million, a valuation allowance of $4.9 million was applied
against this asset because of the uncertainty of whether we will be able to use these loss
carryforwards, which will expire in varying amounts through the year 2024. Liquidity and Capital Resources Cash provided by operations, equity transactions, and borrowings from affiliates and lending
institutions have generally provided the primary sources of liquidity to the Company.
Historically, the Company has used these sources to fund operating expenses, satisfy its debt
service obligations and fund distributions to shareholders. In 2003, as part of the one-time
incentive exchange offer for holders of preferred shares to convert to common shares, our
shareholders approved eliminating the preferred dividend, which allows us to use that cash for
current operations and future growth of the Company. Cash Flows As of December 31, 2004, our unrestricted cash resources were approximately $1,799,000 and our
marketable securities available for sale were approximately $90,000, comprised of 10,000 common
shares of Stellent, Inc. and 100 shares of Century Realty Trust. The NASDAQ closing quote on
February 17, 2005 was $8.30 per common share of Stellent, Inc. and $16.34 per common share of
Century Realty Trust. We are dependent on our existing cash resources and the Stellent, Inc. shares
to meet our liquidity needs because cash from operations are not sufficient to meet our operating
requirements. During the year ended December 31, 2004, the Companys cash balance decreased by approximately
$419,000 from approximately $2,219,000 at December 31, 2003 to approximately $1,799,000 at December
31, 2004. Cash was used primarily for (i) continuing operations of approximately $344,000 which
included the receipt of a deposit on a development site of $250,000, (ii) improvements to real
estate properties of approximately $26,000, and (iii) payments on mortgage loans of approximately
$49,000. Cash used for continuing operations is negatively impacted by general and administrative costs that
represent approximately 61% of total costs. General and administrative costs are a large percent of
total costs because we have only one property and continue to actively seek and review potential
acquisitions to build our portfolio. Future Obligations Because the cash flow from our properties is not expected to fully fund our future liquidity
requirements, we have reduced our material future obligations. At December 31, 2004, future
obligations include the mortgage on the apartment complex and the employment contracts for our
executive officers.  
    The mortgage is being paid by the cash flow from Richton Trail. The property has
been well maintained and managed, and has had historical occupancy in the range
of 95% to 100% even prior to our ownership. So long as Richton Trail maintains
approximately 81% occupancy, it will generate the cash flow needed to pay its
current expenses and the mortgage debt service. We intend to keep the property as
close to 100% occupancy as possible and do not foresee any market conditions that
would show a decline in occupancy or rents during the coming year. Also, no major
improvements are planned at the property for next year.
    Each of the three employment contracts has a salary requirement of only $60,000
per year. The Company has the benefit of three highly qualified executives in the 20




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##### Table of Contents



real estate industry, each with previous experience with a publicly traded company,
for salaries that are well below market levels. As the Company grows and appreciates
in value, our executive officers expect to share in the growth of the Company, along
with our other shareholders, because each executive has a significant number of
common shares, and to earn higher levels of compensation. Long Term Liquidity and Operating Strategies We historically have financed our long term capital needs, including acquisitions, as follows:  
    Borrowings from new loans;
    Additional equity issuances of our common and preferred shares; and
    Proceeds from the sales of our real estate and technology segment. During the first half of 2003, we put into place a new management team and shareholders elected
five new Trustees. Paragon has developed a value-added business plan that is primarily focused on
acquiring well located, under-performing multi-family residential properties, including affordable
housing complexes, and repositioning them through renovation, leasing, improved management, and
branding. This strategy, while unique to public companies, is common among private companies on
both a local and limited regional basis. Paragons investments will be in properties, portfolios
and companies with value-added programs. Paragon intends to raise equity through public and
private offerings. We will also use joint venture structures for property and portfolio
acquisitions, and tax-deferred operating partnership units, convertible into a separate class of
common shares, for acquisitions of companies. Failure to obtain external sources of capital or to
find sellers willing to exchange their properties for tax-deferred partnership units will
materially and adversely affect our strategy and will materially and adversely affect our
operations, liquidity and financial results. Paragons investment advantages, compared to private
companies, include our potential ability to access capital and to offer sellers a tax-deferred exit
alternative to exchange their properties for partnership units with opportunities for both
liquidity and share appreciation. Our cash resources are sufficient to meet our current overhead
for approximately two years while we identify and pursue potential acquisitions. Current Tax Status At December 31, 2004, we have net operating losses of approximately $11.0 million. While these
losses created a deferred tax asset, a valuation allowance was applied against the asset because of
the uncertainty of whether we will be able to use these loss carry forwards, which will expire in
varying amounts through the year 2024. We, and certain of our subsidiaries, are also subject to certain state and local income, excise and
franchise taxes. The provision for state and local taxes has been reflected in general and
administrative expense in the consolidated statements of operations and has not been separately
stated due to its insignificance. Interest Rates and Inflation For the past several years, interest rates have declined, and many financial experts and economists
have predicted that interest rates reached bottom in 2003. Lower interest rates have led to higher
selling prices for established real estate properties, the type that we intend to buy. Purchasers
of properties have been able to place a larger amount of debt on their acquisitions because the
lower interest rates have lowered the monthly mortgage payments. Interest rates started to
increase during 2004, which should lead to slightly lower prices for real estate properties and to
higher borrowing rates. The interactions between an increase in interest rates and a decrease in
selling prices of properties cannot be measured with any certainty. Paragon will continue to
pursue its value-added 21




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##### Table of Contents



business plan during 2005. The economics of transactions, including price,
current cash flow,
existing debt, cost of new funds for acquiring the properties, and potential for increased value,
will be reviewed closely prior to making any acquisitions. We were not significantly affected by inflation during the periods presented in this report due
primarily to the relative low nationwide inflation rates. Off-Balance Sheet Arrangements We have no off-balance sheet arrangements that have, or are likely to have a current or future
material effect on our financial condition, changes in financial condition, revenues or expenses,
results of operations, liquidity, capital expenditures or capital resources. 
 Item 7. Financial Statements The required audited consolidated financial statements of the Company are included herein
commencing on page F-1. 
 Item 8. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure None 
 Item 8a. Disclosure Controls and Procedures As of December 31, 2004, the date of this report, James M. Mastandrea, our Chief Executive Officer
and President, and John J. Dee, our Chief Financial Officer and Senior Vice President, evaluated
the effectiveness of the design and operation of the Companys disclosure controls and procedures
pursuant to Rule 13a-15(b) under the Securities Exchange Act of 1934. Based upon this evaluation,
Messrs. Mastandrea and Dee concluded that, as of December 31, 2004, our disclosure controls and
procedures are effective to ensure that material information relating to the Company and our
consolidated subsidiaries is recorded, processed, summarized and reported in a timely manner. Further, there were no significant changes in the internal controls or, to our knowledge, in other
factors that could significantly affect such controls subsequent to December 31, 2004. 
 Item 8b. Other Information None. 22




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##### Table of Contents



PART III 
 Item 9. Trustees and Executive Officers of the Registrant The names, ages and positions of our trustees and executive officers are as follows: ExpirationName
    
    Age
    
    Position
    
    of TermJames C. Mastandrea
    
    
    61
    
    
    President, Chief
Executive Officer and
Chairman
    
    
    2006John J. Dee
    
    
    53
    
    
    Senior Vice President,
Chief Financial Officer
and
Trustee
    
    
    2007Jack R. Kuhn
    
    
    57
    
    
    Sr. Vice President -
Chief Property Management
& Development Officer
    
    Not applicableDaryl J. Carter
    
    
    49
    
    
    Trustee
    
    
    2005Daniel G. DeVos
    
    
    46
    
    
    Trustee
    
    
    2006Paul T. Lambert
    
    
    52
    
    
    Trustee
    
    
    2007Michael T. Oliver
    
    
    61
    
    
    Trustee
    
    
    2005
 Board of Trustees and Executive Officers The business experience, principal occupations and employment, as well as the periods of service,
of each of our trustees and executive officers during at least the last five years are set forth
below. James C. Mastandreahas served as President and Chairman of the Board of Trustees since March 4,
2003 and as Chief Executive Officer since April 7, 2003. In May 1998, Mr. Mastandrea returned as
Chairman and Chief Executive Officer to MDC Realty Corporation, Chicago, Illinois, which he founded
in 1978 and had used for the development of over $500 million of real estate projects until 1993.
From July 1993 to December 1993, Mr. Mastandrea was President of First Union Real Estate
Investments, a NYSE listed real estate investment trust headquartered in Cleveland, Ohio. From
January 1994 until his departure in May 1998, he was Chairman of the Board of Trustees and Chief
Executive Officer of First Union. During his tenure at First Union, Mr. Mastandrea and his
management team substantially grew the assets of the company from $495 million at the beginning of
1994 to $934 million at the end of 1997, along with commensurate growth in net operating income and
funds from operations. In 1999, Mr. Mastandrea formed Eagles Wings Aviation Corporation, where he
served as Chief Executive Officer, to purchase a troubled aviation services business. At the time
of the purchase, the business was in default on its debt obligations. Following the September 11,
2001 terrorist attacks, the business was further adversely affected. In March 2002, Eagles Wings
filed for protection under Chapter 11 of the federal bankruptcy laws. Mr. Mastandrea has been the
general partner of Hampton Court Associates, L.P. since its formation in 1983. Mr. Mastandrea is a
director of Cleveland State University Foundation Board and Chairman of the nominating committee,
and a director and a member of the real estate committee of University Circle Inc., Cleveland,
Ohio. He is a member of National Association of Real Estate Investment Trusts (NAREIT), Pension
Real Estate Association (PREA), and National Multifamily Housing Association (NMHA). 23




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##### Table of Contents



John J. Deehas served as a trustee and Senior Vice President since March 4, 2003, and as Chief
Financial Officer since April 7, 2003. Prior to Mr. Dees joining Paragon, from 2002 to 2003, he
was Senior Vice President and Chief Financial Officer of MDC Realty Corporation, Cleveland, Ohio,
an affiliate of MDC Realty Corporation, Chicago, Illinois. From 2000 to 2002, Mr. Dee was Director
of Finance and Administration for Frantz Ward, LLP, Cleveland, Ohio, a Cleveland-based law firm
with approximately 100 employees. From 1978 to 2000, Mr. Dee held various management positions
with First Union Real Estate Investments (NYSE), most recently as Senior Vice President and Chief
Accounting Officer from 1996 to 2000. Mr. Dee is licensed as a CPA (non-practicing) in the State
of Ohio. Jack R. Kuhnjoined Paragon as Senior Vice President and Chief Property Management and Development
Officer on July 19, 2004. Mr. Kuhns responsibilities include overseeing all of Paragons property
management and development activities. Prior to joining Paragon, from 1985 to June 2004, Mr. Kuhn
was an Executive Vice President of Forest City Enterprises (NYSE), and President of Forest City
Management. Forest City is a $5 billion diversified real estate development and Management Company
located in Cleveland, Ohio, with commercial and residential properties throughout the country. At
Forest City, Mr. Kuhn was directly responsible for all of the property management and development
properties in 13 states, particularly during Forest Citys substantial growth. Mr. Kuhn is a member
of the Urban Land Institute (ULI), Builders Owners and Managers Association (BOMA), International
Council of Shopping Centers (ICSC); and a board member of United Way, Shoes for Kids, and Salvation
Army. Daryl J. Carterhas served as a trustee since June 30, 2003. Mr. Carter is Co-Chairman and Chief
Investment Officer of Capri Capital, Irvine, California, an affiliated company of Charter Mac
Mortgage Capital. Capri Capital is a diversified real estate financial services firm that Mr.
Carter co-founded in 1992. Capri Capital has $7 billion in assets under management, including
investments in commercial mortgages, mezzanine capital, and equity investments in Fannie Mae,
Freddie Mac and HUD/FHA programs, along with equity and mezzanine capital investments on behalf of
various public, private and labor funds. Mr. Carter serves as a Director of Catellus Development
Corporation (NYSE), San Francisco, California, a publicly held real estate investment trust. Mr.
Carter is a member of the Pension Real Estate Association (PREA), a Trustee and Vice Chairman of
the Urban Land Institute (ULI), a Board Member and Chair of the Finance Committee of the National
Multifamily Housing Association (NMHA), and a member of the Commercial Board of Governors of the
Mortgage Bankers Association. Daniel G. DeVoshas served as a trustee since March 4, 2003. Mr. DeVos is Chairman of the Board
and Chief Executive Officer of DP Fox Ventures, LLC, a diversified management enterprise with
investments in real estate, transportation, and sports teams. In addition, Mr. DeVos is the
majority owner of the Grand Rapids Rampage (AFL), Grand Rapids Griffins (AHL) and has ownership
interests in the Orlando Magic (NBA). Mr. DeVos is a director of Alticor, Inc., the parent of Amway
Corporation, located in Ada, Michigan, and the Orlando Magic (NBA). From 1994 to 1998, Mr. DeVos
served as a trustee of First Union Real Estate Investments (NYSE). Paul T. Lamberthas served as a trustee since November 1998. Mr. Lambert serves as the Chief
Executive Officer of Lambert Capital Corporation. He served on the Board of Directors and was the
Chief Operating Officer of First Industrial Realty Trust, Inc. (NYSE) from its initial public
offering in October 1994 to the end of 1995. Mr. Lambert was one of the largest contributors to
the formation of First Industrial and one of its founding shareholders. Prior to forming First
Industrial, Mr. Lambert was managing partner for The Shidler Group, a national private real estate
investment company. Prior to joining Shidler, Mr. Lambert was a commercial real estate developer
with Dillingham Corporation and, prior to that, was a consultant with The Boston Consulting Group. 24




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##### Table of Contents



Michael T. Oliverhas served as a trustee since March 4, 2003. Mr. Oliver is the State Investment
Officer of Real Estate and Private Equity Investments of the Alaska State Pension Board of the
Alaska State Pension Fund, Juneau, Alaska, a position he has held since August 2000. Prior to
joining the Alaska State Pension Board, Mr. Oliver was a consultant from March 1998 to July 2000 to
MPAC Capital Markets, Seattle, Washington, and a consultant to several Asian governments concerning
laws governing REITs. From April 1996 to March 1998, Mr. Oliver was Chairman of RERC Capital
Markets, LLC, Chicago, Illinois. From March 1987 to February 1996, he was Chairman of Heitman/PRA
Securities Advisors, Inc. and President of its Real Estate Fund. Prior to March 1987 and since
1967, Mr. Oliver held positions at real estate companies raising capital and making direct
investments in real estate, and at investment banking firms analyzing real estate companies and
raising capital. The board of trustees has determined that each of Messrs. Carter, DeVos, Lambert and Oliver do not
have a material relationship with Paragon that would interfere with the exercise of independent
judgment and are independent as defined by the applicable rules of the American Stock Exchange.
Mr. Oliver is the chairman of Paragons audit committee and serves as the committees financial
expert. Mr. Carter is the chairman of the management, organization and compensation committee.
All four independent trustees are on the audit committee and the management, organization and
compensation committee. Code of Ethics On January 14, 2004, our Board of Trustees adopted a code of conduct and ethics that applies to all
officers, trustees and employees of Paragon, including our principal executive officer, principal
financial officer and principal accounting officer. Upon written request to the Company, we will
provide a copy of our Code of Conduct and Ethics without charge. Section 16(a) Beneficial Ownership Reporting Compliance Section 16(a) of the Securities Exchange Act of 1934 requires the Companys officers, trustees and
persons who own more that 10% of our common shares to file reports of ownership and changes in
ownership with the Securities and Exchange Commission. Officers, Trustees and greater than 10%
shareholders are required by regulation to furnish us with copies of all Section 16(a) forms they
file. Separate Form 4s filed by Messrs. Mastandrea and Dee, each reporting an award of restricted shares
and share options, were not filed on a timely basis. Based solely on review of the copies of the
forms furnished to us, or written representations that no Annual Statements of Beneficial Ownership
of Securities on Form 5 were required to be filed, we believe that for the fiscal year ended
December 31, 2004, all other Section 16(a) filing requirements applicable to its officers, trustees
and greater than 10% shareholders were complied with in 2004. 
 Item 10. Executive Compensation The following table sets forth the compensation paid to our CEO for the years ended December 31,
2004, 2003, and 2002. Name and Principal
    
    
    
    
    
    
    
    
    
    Restricted Stock
    
    
    Securities UnderlyingPosition
    
    Year
    
    
    Salary(1)
    
    
    Awards
    
    
    OptionsJames C. Mastandrea
    
    
    2004
    
    
    $
    60,000
    
    
    $
    66,000
    (2)
    
    
    150,000
    (3)Chief
Executive Officer,
    
    
    2003
    
    
    $
    49,615
    (4)
    
    $
    1,044,117
    (5)
    
    
    President
and Chairman
    
    
    2002
    
    
    
    
    
    
    
    
    
    
    
    
   (1)
    
    No bonuses or other compensation were paid for the years ended December 31, 2004, 2003,
and 2002.(2)
    
    Represents 300,000 restricted common shares issued on January 2, 2004. The value per
share on the issue date was $0.22 per share. Half of the restricted shares vest in five
years or earlier upon Paragons share price being equal to 25




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##### Table of Contents



or exceeding $1.00 per share for 20 consecutive trading days. The remaining half of the
restricted shares vest when funds from operations doubles compared to the four consecutive
quarters preceding the grant date, or when Paragons share price is 50% higher compared to
the average closing price for the five trading days preceding the grant date.(3)
    
    Options were granted January 2, 2004 at an exercise price of $0.27 per common share,
representing 110% of the average of the closing price for the common shares for 10 days
preceding the grant date. The options vest one-third on each January 2nd of 2005, 2006,
and 2007, and are exercisable until January 2, 2009.(4)
    
    Amount represents base annual salary of $60,000 for the period from March 4, 2003
through December 31, 2003.(5)
    
    Represents 348,039 preferred shares issued on June 30, 2003 at a closing price of $3.00
per preferred share. Subsequent to the one-time incentive exchange offer to the preferred
shares which concluded on June 30, 2003, the preferred shares were delisted from the
American Stock Exchange in September 2003 because the market value of preferred shares held
by non-affiliates was below the $1 million requirement of the exchange. Of the 348,039
preferred shares issued to Mr. Mastandrea, 267,334 preferred shares were converted into
6,116,869 common shares on June 30, 2003 and 80,705 preferred shares remain outstanding as
of December 31, 2003 and are convertible into 1,846,611 common shares. The total of
7,963,480 common shares had a value of $1,751,966 based on the closing price of $0.22 per
share on December 31, 2003. Options/SAR Grants In Last Fiscal Year Options for 150,000 common shares were granted on January 2, 2004 to James C. Mastandrea, our Chief
Executive Officer and President. One third of the options vest on each January 2nd of 2005, 2006,
and 2007. The following table summarizes the terms of the grant. OPTIONS/SAR GRANTS IN LAST FISCAL YEAR
Individual Grants Number of
    
    
    % of TotalSecurities
    
    
    Options/Underlying
    
    
    SARSOptions/
    
    
    Granted to
    
    
    Exercise orSARS
    
    
    Employees
    
    
    Base
    
    
    ExpirationName
    
    Granted
    
    
    in Fiscal Year
    
    
    Price ($/Sh)
    
    
    DateJames C. Mastandrea
Chief Executive Officer,
President and Chairman
    
    
    150,000
    
    
    
    26.1
    %
    
    $
    0.27
    
    
    
    1/2/2009
 Option/SAR value at Fiscal Year End The following table summarizes the value of options held by Mr. Mastandrea at December 31, 2004,
none of which were in-the-money. Aggregated Option/SAR Exercises in Last Fiscal Year
And FY-End Option/SAR Values Number ofSecurities
    
    
    Value ofUnderlying
    
    
    UnexercisedUnexercised
    
    
    In-the-MoneyOptions/
    
    
    Options/Shares
    
    
    
    
    
    
    SARs
    
    
    SARsAcquired
    
    
    
    
    
    
    at FY End
    
    
    at FY-Endon
    
    
    Value
    
    
    (#)
    
    
    ($)Exercise
    
    
    Realized
    
    
    Exercisable/
    
    
    Exercisable/Name
    
    (#)
    
    
    ($)
    
    
    Unexercisable
    
    
    UnexercisableJames C. Mastandrea
Chief Executive Officer,
President and Chairman
    
    
    
    
    
    
    
    
    
    
     / 150,000
    
    
    
     / 
 26




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##### Table of Contents



Employment Agreements The employment agreement with the former chief executive officer provided for an annual salary of
$150,000. The severance provision of this agreement provided for him to receive 95,541 preferred
shares in lieu of a $300,000 severance payment for his resignation. The number of shares issued
was based on two times his annual salary with the price of the preferred shares based on the
average closing price for the 30 calendar days prior to March 1, 2003. For his services from April
7, 2003 until June 15, 2003, he received compensation based on an annual salary of $60,000. The employment agreement with James C. Mastandrea provides for an annual salary of $60,000
effective as of March 4, 2003 and in connection therewith, Mr. Mastandrea was appointed as Chief
Executive Officer on April 7, 2003. The initial term of Mr. Mastandreas employment is for two
years and may be extended for terms of one year through his 70th birthday. Mr.
Mastandreas base annual salary may be adjusted from time to time, except that the adjustment may
not be lower than the preceding years base salary. The employment agreement provides that Mr.
Mastandrea will be entitled to base salary and bonus at the rate in effect before any termination
for a period of three years in the event that his employment is terminated without cause by us or
for good reason by
Mr. Mastandrea. Effective June 30, 2003, we issued 696,078 preferred shares valued at approximately $2.4 million to
Messrs. Mastandrea and Dee pursuant to separate restricted share agreements. On June 30, 2003,
534,668 preferred shares were converted at a factor 22.881 into 12,233,739 common shares. Under the
restricted share agreement for each of Mr. Mastandrea and Mr. Dee, the restricted shares vest upon
the later of the following dates:  
    the date our gross assets exceed $50.0 million, or
    50% of the restricted shares will vest on March 4, 2004; 25% of the shares will vest on
March 4, 2005, and the remaining 25% of the shares will vest on March 4, 2006. Compensation of Trustees Effective October 28, 2003, each trustee who is not an officer of the Company receives a retainer
of $5,000 per annum, $500 per meeting for each meeting attended in person, $100 per meeting for
each meeting attended via teleconference, 25,000 options as to common shares which are to vest one
year after issuance and to expire 90 days after the term of the trustee ends and 50,000 restricted
common shares that will vest one year after their issuance. Effective June 15, 2004, 100,000
options at an exercise price of $0.18 per common share and 200,000 restricted common shares were
issued. During the year ended December 31, 2004, trustees were paid approximately $27,000 for retainers and
meetings for 2004, and, as of December 31, 2003, the Company had accrued $19,000 for retainers and
meetings for 2003, which was subsequently paid in 2004. 
 Item 11. Security Ownership of Management and Certain Beneficial Owners The following table includes certain information with respect to the beneficial ownership of our
shares by: (i) each person known by us to own more than 5% in interest of the outstanding shares;
(ii) each of the trustees and each nominee for trustee; (iii) each of our executive officers; and
(iv) all of the trustees and executive officers as a group. Except as otherwise noted, the person
or entity named has sole voting and investment power over the shares indicated. 27




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##### Table of Contents



The table shows ownership as of February 17, 2005. Total Common SharesCommon Shares (2)
    
    
    Preferred Shares (3)
    
    
    and Units (2) (4)Name and Address (1)
    
    Number
    
    
    Percent (5)
    
    
    Number
    
    
    Percent (5)
    
    
    Number
    
    
    Percent (5)James C. Mastandrea
    
    
    15,566,537
    (6)
    
    
    51.2
    %
    
    
    161,410
    (15)
    
    
    58.0
    %
    
    
    37,883,474
    (17)
    
    
    71.8
    %Paragon Real Estate
Development, LLC
    
    
    12,233,738
    (7)
    
    
    40.3
    %
    
    
    161,410
    (15)
    
    
    58.0
    %
    
    
    15,926,960
    (18)
    
    
    46.7
    %John J. Dee
    
    
    3,057,799
    (8)
    
    
    10.0
    %
    
    
    
    (16)
    
    
    
    
    
    
    3,057,799
    (19)
    
    
    10.0
    %Loeb Partners Corporation
    
    
    3,135,349
    (9)
    
    
    10.3
    %(9)
    
    
    
    
    
    
    
    
    
    
    3,135,349
    (9)
    
    
    10.3
    %(9)Paul T. Lambert
    
    
    2,483,619
    (10)
    
    
    8.2
    %
    
    
    
    
    
    
    
    
    
    
    2,483,619
    (10)
    
    
    8.2
    %Jack R. Kuhn
    
    
    552,000
    (11)
    
    
    1.8
    %
    
    
    
    
    
    
    
    
    
    
    552,000
    (11)
    
    
    1.8
    %Daryl J. Carter
    
    
    125,000
    (12)
    
    
    *
    
    
    
    
    
    
    
    
    
    
    
    125,000
    (12)
    
    
    *Daniel G. DeVos
    
    
    125,000
    (12)
    
    
    *
    
    
    
    
    
    
    
    
    
    
    
    125,000
    (12)
    
    
    *Michael T. Oliver
    
    
    125,000
    (12)
    
    
    *
    
    
    
    
    
    
    
    
    
    
    
    125,000
    (12)
    
    
    *All trustees and
current executive
officers as a group (13)
    
    
    17,018,537
    (14)
    
    
    55.6
    %
    
    
    161,410
    
    
    
    58.0
    %
    
    
    39,335,474
    (20)
    
    
    74.3
    %
   *
    
    Indicates less than one percent(1)
    
    The address of all beneficial owners listed, except for Loeb Partners Corporation, is our
corporate headquarters located at 1240 Huron Road, Suite 301, Cleveland, Ohio 44115. The address of
Loeb Partners Corporation is 61 Broadway, New York, NY, 10006.(2)
    
    Based on 30,380,850 common shares, not including 2,859,765 shares held in treasury. For each
trustee and executive officer, also includes common shares he has the right to acquire through share
options that are or will become exercisable as of April 18, 2005.(3)
    
    Based on 278,455 preferred shares outstanding as of February 17, 2005, which convert to 4,096,793
common shares as follows: 161,410 preferred shares are each convertible into 22.881 common shares and
117,045 preferred shares are each convertible into 3.448 common shares.(4)
    
    For James C. Mastandrea includes (i) 30,380,850 common shares, not including 2,859,765 shares held
in treasury; (ii) 50,000 exercisable options to purchase common shares; (iii) 278,455 preferred
shares, which convert to 4,096,793 common shares; and (iv) 813,938 restricted limited partnership
units which may be converted into 18,623,715 common shares or cash, at our discretion, any time after
July 1, 2007.(5)
    
    The ownership percents total more than 100% due to more than one person or entity being considered
the beneficial owner of the same shares, in accordance with SEC regulations for this table.(6)
    
    Includes: (i) 2,308,619 common shares held by Mr. Lambert and 399,180 common shares held by a
former trustee which each of Mr. Mastandrea and Mr. Dee has the right to vote; (ii) 250,000 restricted
common shares issuable to an independent third party which Mr. Mastandrea has the right to vote; (iii)
12,233,738 common shares held by Paragon Real Estate Development, LLC, of which Mr. Mastandrea is the
managing member; (iv) 300,000 restricted common shares; (v) 50,000 exercisable options to purchase
common shares; and (vi) 25,000 common shares owned by Mr. Mastandrea purchased on the open market.(7)
    
    Mr. Mastandrea is the managing member of Paragon Real Estate Development, LLC. and these shares
are also included in Mr. Mastandreas common shares.(8)
    
    Includes: (i) 2,308,619 common shares held by Mr. Lambert and 399,180 common shares held by a
former trustee which each of Mr. Mastandrea and Mr. Dee has the right to vote; (ii) 300,000 restricted
common shares and (iii) 50,000 exercisable options to purchase common shares. Does not include
12,233,738 common shares held by Paragon Real Estate Development, LLC, of which Mr. Dee is a member.(9)
    
    Based solely on information in the Schedule 13D filed on February 11, 2005 by Loeb Partners
Corporation with the SEC listing the following entities and quantities of shares owned: Loeb
Arbitrage Fund 1,970,002 shares; Loeb Partners Corporation 148,480 shares; Loeb Offshore Fund Ltd.
184,967 shares; Robert Grubin 581,000 shares; and other affiliates of Loeb Partners Corporation
250,900 shares. The Schedule 13D showed an ownership percentage of 9.37%, based on 33,441,000 common
shares. The ownership percentage of 10.3% shown in the table above is based 28




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##### Table of Contents



on 30,380,850 common
shares outstanding, which does not include 2,859,765 shares held in treasury.(10)
    
    Includes: (i) options to purchase 75,000 common shares; (ii) 100,000 restricted common shares; and
(iii) 766,354 common shares held by Lambert Equities II, LLC, of which Mr. Lambert is the controlling
majority member and sole manager. Mr. Lambert has signed a proxy allowing each of Mr. Mastandrea and
Mr. Dee the right to vote 2,308,619 common shares that he owns.(11)
    
    Includes 500,000 restricted common shares, and 52,000 common shares owned by Mr. Kuhn purchased on
the open market.(12)
    
    Includes 100,000 restricted common shares and exercisable options to purchase 25,000 common shares.(13)
    
    Includes seven named persons.(14)
    
    Includes: (i) 2,308,619 common shares held by Mr. Lambert and 399,180 common shares held by a
former trustee which each of Mr. Mastandrea and Mr. Dee has the right to vote; (ii) 250,000 restricted
common shares issuable to an independent third party which Mr. Mastandrea has the right to vote; (iii)
12,233,738 common shares held by Paragon Real Estate Development, LLC, of which Mr. Mastandrea is the
managing member; (iv) 1,500,000 restricted common shares; (v) 250,000 exercisable options to purchase
common shares; (vi) 25,000 common shares owned by Mr. Mastandrea purchased on the open market; and
(vii) 52,000 common shares owned by Mr. Kuhn purchased on the open market.(15)
    
    Represents shares held by Paragon Real Estate Development, LLC, of which Mr. Mastandrea is the
managing member. Each preferred share is convertible into 22.881 common shares.(16)
    
    Does not include 161,410 preferred shares held by Paragon Real Estate Development, LLC, of which
Mr. Dee is a member.(17)
    
    Includes: (i) 2,308,619 common shares held by Mr. Lambert and 399,180 common shares owned by a
former trustee which each of Mr. Mastandrea and Mr. Dee has the right to vote; (ii) 250,000 restricted
common shares issuable to an independent third party which Mr. Mastandrea has the right to vote; (iii)
12,233,738 common shares held by Paragon Real Estate Development, LLC, of which Mr. Mastandrea is the
managing member; (iv) 300,000 restricted common shares; (v) 50,000 exercisable options to purchase
common shares; (vi) 18,623,715 common shares issuable upon the conversion of 813,938 limited
partnership units of Paragon Real Estate, L.P., our operating partnership, held by Hampton Court
Associates, L.P., of which Mr. Mastandrea is the general partner; (vii) 3,693,222 common shares
issuable upon conversion of 161,410 preferred shares held by Paragon Real Estate Development, LLC; and
(viii) 25,000 common shares owned by Mr. Mastandrea purchased on the open market.(18)
    
    Includes 3,693,222 common shares issuable upon conversion of 161,410 preferred shares. These
shares are also included in Mr. Mastandreas total shares.(19)
    
    Includes: (i) 2,308,619 common shares held by Mr. Lambert and 399,180 common shares held by a
former trustee which each of Mr. Mastandrea and Mr. Dee has the right to vote; (ii) 300,000 restricted
common shares; and (iii) 50,000 exercisable options to purchase common shares. Does not include
12,233,738 common shares or 161,410 preferred shares held by Paragon Real Estate Development, LLC, of
which Mr. Dee is a member.(20)
    
    Includes: (i) 2,308,619 common shares held by Mr. Lambert and 399,180 common shares owned by a
former trustee which each of Mr. Mastandrea and Mr. Dee has the right to vote; (ii) 250,000 restricted
common shares issuable to an independent third party which Mr. Mastandrea has the right to vote; (iii)
12,233,738 common shares held by Paragon Real Estate Development, LLC, of which Mr. Mastandrea is the
managing member; (iv) 1,500,000 restricted common shares; (v) 250,000 exercisable options to purchase
common shares; (vi) 18,623,715 common shares issuable upon the conversion of 813,938 limited
partnership units of Paragon Real Estate, LP, our operating partnership, held by Hampton Court
Associates, LP, of which Mr. Mastandrea is the general partner; (vii) 3,693,222 common shares issuable
upon conversion of 161,410 preferred shares held by Paragon Real Estate Development, LLC; (viii)
25,000 common shares owned by Mr. Mastandrea purchased on the open market; and (ix) 52,000 common
shares owned by Mr. Kuhn purchased on the open market. 29




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##### Table of Contents



Equity Compensation Plan Information Number of securitiesNumber of
    
    
    Weighted-
    
    
    remaining availablesecurities to be
    
    
    average exercise
    
    
    for future issuanceissued upon
    
    
    price of
    
    
    under equityexercise of
    
    
    outstanding
    
    
    compensation plansoutstanding
    
    
    options,
    
    
    (excluding securitiesEquity Compensation Plans
    
    options, warrants
    
    
    warrants and
    
    
    reflected in columnApproved/ Not Approved by Security
    
    and rights
    
    
    rights
    
    
    (a))Holders
    
    (a)
    
    
    (b)
    
    
    (c)Equity compensation plans approved by
security holdersFormer Share Option PlanOptions for common shares
    
    
    54,387
    
    
    $
    5.37
    
    
    
    2004 Share Option PlanRestricted common shares
    
    
    1,100,000
    
    
    $
    Options for common shares
    
    
    780,000
    
    
    $
    0.531,880,000
    
    
    $
    0.22
    
    
    
    1,620,000Equity compensation plans not approved
by security holdersCommon shares
    
    
    1,500,000
    
    
    $
    Warrants for common shares
    
    
    47,500
    
    
    $
    5.371,547,500
    
    
    $
    0.16
    
    
    
    Total all plans  Common shares
    
    
    3,481,887
    
    
    $
    0.28
    
    
    
    1,620,000 Preferred shares
    
    
    
    
    
    $
    
 In addition to the above plans, we entered into an agreement dated March 4, 2003 and approved
by the shareholders on June 30, 2003 with Mr. Mastandrea, Mr. Dee and Paragon Real Estate
Development, LLC of which Mr. Mastandrea is the managing member, and Mr. Dee is a member. Pursuant
to this agreement, we may issue up to $26.0 million in our common shares to Paragon Real Estate
Development, LLC in exchange for it and its members procuring future acquisition, development and
re-development real estate transactions for Paragons benefit. This agreement is intended to serve
as incentive for Mr. Mastandrea and Mr. Dee to increase our assets and net operating income in the
future. The exact number of common shares that would be issued to Paragon Real Estate Development,
LLC will be calculated in accordance with a formula based on the type of project that they present
to us. The formula for a particular real estate transaction would be calculated by dividing (i)
estimated net operating income to be generated from the real estate transaction for the first year
following its consummation by (ii) the capitalization rate used in the real estate transaction,
less the applicable basis point factor. The applicable basis point factor is defined as: 75
basis points for the acquisition of an existing operating property, 87.5 basis points for the
acquisition of a re-development property, and 100 basis points for the acquisition of a development
property. We would issue our common shares to Paragon Real Estate Development, LLC only upon the
closing of the real estate transaction. For each transaction, Mr. Mastandrea would be allocated
half of the common shares and Mr. Dee would be allocated the other half. All of the common shares
would be held by Paragon Real Estate Development, LLC for the benefit of its owners. 
 Item 12. Certain Relationships and Related Transactions Management Fees During 2003, we had a property management agreement with Hoyt Properties, Inc. (Hoyt Properties),
an entity controlled by our former chairman of the board, which served as property manager of the 30




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##### Table of Contents



commercial properties owned by us. In connection with the agreement, Hoyt Properties managed the
day-to-day operations of properties owned by us and received a management fee for this service.
Management fees paid to Hoyt Properties were $0 and approximately $49,000 for the years ended
December 31, 2004 and 2003, respectively. On October 1, 2003, we sold our four commercial
properties managed by Hoyt Properties. As a result, these management fees are included in
discontinued operations. James C. Mastandrea, our Chairman, Chief Executive Officer and President, is the general partner of
Hampton Court Associates and owns two companies which provide services to Richton Trail. Mid
Illinois Realty Corp. manages Richton Trail and MDC Realty Corp. is reimbursed, at cost, for
Richton Trials payroll related costs. The related management fees included in years ended
December 31, 2004 and December 31, 2003 were approximately $28,000 and $13,000, respectively.
Reimbursement, at cost, for the payroll related costs paid and
accrued for the years ended
December 31, 2004 and December 31, 2003 were approximately $59,300 and $30,700, respectively. As
the Company acquires more properties, it intends to use local third party management companies
until we are able to provide management services ourselves. Leasing Commissions During the year ended December 31, 2003, we paid a leasing commission of approximately $18,000 to
Hoyt Properties in connection with two new leases for a total of approximately 21,000 square feet.
On October 1, 2003 we sold our four commercial properties managed by Hoyt Properties. As a result,
these leasing commissions, net of accumulated amortization are included in discontinued operations. Rental Expense During the years ended December 31, 2004 and 2003, we recognized rental expense of $0 and
approximately $8,000, respectively, related to office space leased from Hoyt Properties. 
 Item 13. Exhibits, List and Reports on Form 8-K (a) Exhibits ExhibitNumber
    
    Exhibit Description2.1
    
    Asset Contribution Agreement among Hampton Court Associates, L.P., Paragon Real Estate, L.P.,
and the Company (filed as Exhibit 2.1 with the Companys Current Report on Form 8-K filed on
March 5, 2003 and incorporated herein by reference)2.2
    
    Additional Contribution Agreement between the Company and Paragon Real Estate Development, LLC
(filed as Exhibit 2.7 with the Companys Current Report on Form 8-K filed on March 5, 2003 and
incorporated herein by reference)2.3
    
    Modification Agreement between the Company and Paragon Real Estate Development, LLC (filed as
Exhibit 2.8 with the Companys Current Report on Form 8-K filed on March 5, 2003 and
incorporated herein by reference)2.4
    
    Amendment No. 1 to the Agreement of Limited Partnership of Wellington Properties Investments,
L.P. among the Company and the Limited Partners named therein (filed as Exhibit 2.9 with the
Companys Current Report on Form 8-K filed on March 5, 2003 and incorporated herein by
reference)
 31




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##### Table of Contents



ExhibitNumber
    
    Exhibit Description2.5
    
    Closing Agreement dated June 27, 2003 among the Company, Hampton Court Associates, L.P., Hoyt
Properties, Inc. and WLPT Funding LLC (filed as Exhibit 2.5 with the Companys Current Report
on Form 8-K filed on July 15, 2003 and incorporated herein by reference)3.1
    
    Articles of Amendment and Restatement of the Declaration of Trust of the Company (filed as
Exhibit 3.1 with the Companys Registration Statement on Form SB-2/A filed on October 14, 1999
and incorporated herein by reference)3.2
    
    Articles of Amendment of Declaration of Trust of the Company (filed as Exhibit 2.3 with the
Companys Current Report on Form 8-K filed on July 15, 2003 and incorporated herein by
reference)3.3
    
    Articles Supplementary to the Declaration of Trust of the Company (filed as Exhibit 3.1 with
the Companys Current Report on Form 8-K filed on July 23, 2004 and incorporated herein by
reference)3.4
    
    Amended and Restated Bylaws of the Company (filed as Exhibit 3.2 with the Companys
Registration Statement on Form SB-2/A filed on October 14, 1999 and incorporated herein by
reference)3.5
    
    Amendment No. 1 to the Amended and Restated Bylaws of the Company (filed as Exhibit 3.4 with
the Companys Quarterly Report on Form 10-QSB for the quarter ended June 30, 2003 and
incorporated herein by reference)4.1
    
    Voting and Stock Restriction Agreement among the Company, Steven B. Hoyt, Duane H. Lund, Paul
T. Lambert, John J. Dee, James C. Mastandrea, and Paragon Real Estate Development, LLC (filed
as Exhibit 2.2 with the Companys Current Report on Form 8-K filed on March 5, 2003 and
incorporated herein by reference)10.1
    
    Employment Agreement of James C. Mastandrea (filed as Exhibit 2.3 with the Companys Current
Report on Form 8-K filed on March 5, 2003 and incorporated herein by reference)
(1)10.2
    
    Employment Agreement of John J. Dee (filed as Exhibit 2.4 with the Companys Current Report on
Form 8-K filed on March 5, 2003 and incorporated herein by reference) (1)10.3
    
    Restricted Share Agreement of James C. Mastandrea (filed as Exhibit 2.5 with the Companys
Current Report on Form 8-K filed on March 5, 2003 and incorporated herein by reference)
(1)10.4
    
    Restricted Share Agreement of John J. Dee (filed as Exhibit 2.6 with the Companys Current
Report on Form 8-K filed on March 5, 2003 and incorporated herein by reference)
(1)10.5
    
    Employment Agreement of Jack R. Kuhn dated July 19, 2004 (filed as Exhibit 10.1 with the
Companys Registration Statement on Form S-8 filed on July 23, 2004 and incorporated herein by
reference) (1)10.6
    
    Agreement of Limited Partnership of Paragon Real Estate, L.P. (filed as Exhibit 2.2 with the
Companys Current Report on Form 8-K filed on July 15, 2003 and incorporated herein by
reference)
 32




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##### Table of Contents



ExhibitNumber
    
    Exhibit Description10.7
    
    2004 Share Option Plan of the Company (filed as Exhibit 4.1 with the Companys Registration
Statement on Form S-8 filed on July 23, 2004 and incorporated herein by reference)14
    
    Code of Conduct and Ethics (filed as Exhibit 14 with the Companys Annual Report on Form 10-KSB
for the year ended December 31, 2003 and incorporated herein by reference)31.1
    
    Section 302 Certification pursuant to the Sarbanes-Oxley Act of 2002  Chief Executive Officer
(2)31.2
    
    Section 302 Certification pursuant to the Sarbanes-Oxley Act of 2002  Chief Financial Officer
(2)32.1
    
    CEO/CFO Certification under Section 906 of Sarbanes-Oxley Act of 2002 (2)
   (1)
    
    Indicates a management contract or compensatory plan or arrangement(2)
    
    Filed or furnished herewith (b) Reports On Form 8-K On December 4, 2004 we filed with the Securities and Exchange Commission a Current Report on Form
8-K dated December 1, 2004 reporting our receipt of a letter from the American Stock Exchange
notifying the Company that it is not in compliance with continued listing requirements of the
exchange. 
 Item 14. Principal Accountant Fees and Services The aggregate fees billed by the principal independent registered public accountants (Boulay,
Heutmaker, Zibell & Co., P.L.L.P.) to the Company for the fiscal years ended December 31, 2004 and
2003 are as follows: % Approvedby AuditCategory
    
    Year
    
    
    Fees
    
    
    CommitteeAudit Fees
    
    
    2004
    
    
    $
    67,150
    
    
    
    100
    %2003
    
    
    $
    56,400
    
    
    
    100
    %Audit-Related Fees
    
    
    2004
    
    
    $
    
    
    
    
    100
    %2003
    
    
    $
    4,100
    
    
    
    100
    %Tax Fees
    
    
    2004
    
    
    $
    6,900
    
    
    
    100
    %2003
    
    
    $
    All Other Fees
    
    
    2004
    
    
    $
    2003
    
    
    $
    
 Policy for pre-approval of Audit and Permissible Non-Audit Services of Independent Auditors Before the independent auditors are engaged by the Company to render audit or non-audit services,
the Audit Committee approves the engagement. 33




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##### Table of Contents



SIGNATURES In accordance with the requirements of the Exchange Act of 1934, the registrant caused this report
to be signed on its behalf by the undersigned, thereunto duly authorized. Paragon real estate equity and investment trustBy:
    
    /s/ James C. MastandreaDate: February 17, 2005
    
    
    
    James C. MastandreaChief Executive OfficerParagon real estate equity and investment trustBy:
    
    /s/ John J. DeeDate: February 17, 2005
    
    
    
    John J. DeeChief Financial Officer
 KNOW ALL PERSON BY THESE PRESENTS, that each person whose signature appears below constitutes and
appoints John J. Dee, jointly and severally, his attorneys-in-fact, each with the power of
substitution, for him in any and all capacities, to sign any amendments to this Report on Form
10-KSB and to file the same, with exhibits thereto and other documents in connection therewith,
with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said
attorney-in-fact, or his substitute or substitutes, may do or cause to be done by virtue hereof. In accordance with Section 13 or 15(d) of the Securities Act of 1934, the Company has duly caused
this report to be signed on its behalf by the undersigned, thereunto duly authorized. PARAGON REAL ESTATE EQUITY AND INVESTMENT TRUST Signature
    
    Title
    
    Date/s/ James C. Mastandrea
    
    Trustee, Chief Executive Officer andJames C. Mastandrea
    
    President
    
    February 17, 2005/s/ John J. Dee
    
    Trustee, Senior Vice President andJohn J. Dee
    
    Chief Financial Officer
    
    February 17, 2005/s/ Daryl J. CarterDaryl J. Carter
    
    Trustee
    
    February 17, 2005/s/ Daniel G. DeVosDaniel G. DeVos
    
    Trustee
    
    February 17, 2005/s/ Paul T. LambertPaul T. Lambert
    
    Trustee
    
    February 17, 2005/s/ Michael T. OliverMichael T. Oliver
    
    Trustee
    
    February 17, 2005
 34




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##### Table of Contents



PARAGON REAL ESTATE EQUITY AND INVESTMENT TRUST AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS PageReport of Independent Registered Public Accounting Firm
    
    
    F-2Consolidated Balance Sheet as of December 31, 2004
    
    
    F-3Consolidated Statements of Operations  Years ended December 31, 2004 and December 31, 2003
    
    
    F-4Consolidated Statements of Shareholders Equity  Years ended December 31, 2004 and December 31, 2003
    
    
    F-5Consolidated Statements of Cash Flows  Years ended December 31, 2004 and December 31, 2003
    
    
    F-6Notes to Consolidated Financial Statements
    
    
    F-7
 F-1




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##### Table of Contents



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Trustees and Shareholders of
Paragon Real Estate Equity and Investment Trust and Subsidiaries: We have audited the accompanying consolidated balance sheet of Paragon Real Estate Equity and
Investment Trust and Subsidiaries as of December 31, 2004, and the related consolidated statements
of operations, shareholders equity, and cash flows for the years ending December 31, 2004 and
2003. These consolidated financial statements are the responsibility of the Companys management.
Our responsibility is to express an opinion on these consolidated financial statements based on our
audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the consolidated financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and
disclosures in the consolidated financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by management, as well as evaluating the
overall consolidated financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all
material respects, the financial position of Paragon Real Estate Equity and Investment Trust and
Subsidiaries as of December 31, 2004, and the results of their operations and their cash flows for
the years ending December 31, 2004 and 2003 in conformity with U.S. generally accepted accounting
principles. /s/ Boulay, Heutmaker, Zibell & Co. P.L.L.P. Minneapolis, Minnesota
February 9, 2005 F-2




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##### Table of Contents



Paragon Real Estate Equity and Investment Trust and Subsidiaries 
 Consolidated Balance Sheet
 December 31, 2004
 AssetsInvestments in real estate:Land
    
    $
    797,682Buildings and improvements
    
    
    3,197,967Furniture, fixtures and equipment
    
    
    21,2344,016,883Accumulated depreciation and amortization
    
    
    (121,837
    )Net investments in real estate
    
    
    3,895,046Cash and cash equivalents
    
    
    1,799,362Marketable securities, net
    
    
    89,948Restricted cash
    
    
    106,186Accounts receivable, net
    
    
    8,276Other assets, net
    
    
    116,291Total Assets
    
    $
    6,015,109Liabilities and Shareholders EquityLiabilities:Mortgage loan
    
    $
    2,763,272Accounts payable and accrued expenses
    
    
    261,875Security deposits
    
    
    56,449Total liabilities
    
    
    3,081,596Minority interest in consolidated subsidiary
    
    
    2,167,509Commitments and ContingenciesShareholders equity:Preferred Shares  $0.01 par value,
10,000,000 authorized: 278,455 Class A
cumulative convertible shares issued and
outstanding, $10.00 per share liquidation
preference
    
    
    2,785Common Shares  $0.01 par value,
100,000,000 authorized; 33,240,615 shares
issued and outstanding
    
    
    332,406Additional paid-in capital
    
    
    28,333,203Accumulated other comprehensive income, net
unrealized gain on marketable securities
    
    
    51,273Accumulated deficit
    
    
    (24,561,494
    )Treasury shares, at cost, 2,859,765 shares
    
    
    (800,735
    )Unearned compensation and trustees fees
    
    
    (2,591,434
    )Total shareholders equity
    
    
    766,004Total Liabilities and Shareholders Equity
    
    $
    6,015,109
 The accompanying notes are an integral part of the consolidated financial statements. F-3




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##### Table of Contents



Paragon Real Estate Equity and Investment Trust and Subsidiaries 
 Consolidated Statements of Operations
 For the year ended December 31,2004
    
    
    2003RevenuesRental revenue
    
    $
    609,389
    
    
    $
    287,762Interest and other
    
    
    50,639
    
    
    
    18,986Total revenues
    
    
    660,028
    
    
    
    306,748ExpensesProperty, operating and maintenance
    
    
    217,441
    
    
    
    88,278Property taxes and insurance
    
    
    101,285
    
    
    
    48,043Depreciation and amortization
    
    
    87,105
    
    
    
    56,869Interest
    
    
    166,487
    
    
    
    66,013General and administrative
    
    
    958,311
    
    
    
    951,367Management fees
    
    
    27,611
    
    
    
    12,884Total expenses
    
    
    1,558,240
    
    
    
    1,223,454Loss from operations before loss allocated to
minority interest
    
    
    (898,212
    )
    
    
    (916,706
    )Loss allocated to minority interest
    
    
    81,988
    
    
    
    148,609Loss from operations
    
    
    (816,224
    )
    
    
    (768,097
    )Gain on sale of marketable securities
    
    
    
    
    
    
    136,358Loss from continuing operations
    
    
    (816,224
    )
    
    
    (631,739
    )Discontinued operations:Loss from discontinued operations of commercial
properties
    
    
    
    
    
    
    (457,874
    )Net loss attributable to Common Shareholders
    
    $
    (816,224
    )
    
    $
    (1,089,613
    )Net loss attributable to Common Shareholders per
Common Share: Basic and Diluted
    
    $
    (0.02
    )
    
    $
    (0.06
    )Weighted average number of Common Shares outstanding
    
    
    32,993,966
    
    
    
    18,171,689Comprehensive loss:Net Loss
    
    $
    (816,224
    )
    
    $
    (1,089,613
    )Other comprehensive income:Unrealized gain (loss) on marketable securities
    
    
    (10,427
    )
    
    
    34,500Comprehensive loss
    
    $
    (826,651
    )
    
    $
    (1,055,113
    )
 The accompanying notes are an integral part of the consolidated financial statements. F-4




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##### Table of Contents



Paragon Real Estate Equity and Investment Trust 
 Consolidated Statements of Shareholders Equity
 For the years ended December 31, 2004 and 2003
 Accumulated othercomprehensiveincome, net
    
    
    
    
    
    
    
    
    
    
    UnearnedClass A
    
    
    
    
    
    
    Additional
    
    
    unrealized gain (loss)
    
    
    
    
    
    
    Cost of Shares
    
    
    compensationPreferred
    
    
    Common
    
    
    Paid-in
    
    
    on marketable
    
    
    Accumulated
    
    
    held in
    
    
    and trusteesShares
    
    
    Shares
    
    
    Capital
    
    
    securities
    
    
    Deficit
    
    
    Treasury
    
    
    fees
    
    
    TotalBalance at December 31, 2002
    
    $
    6,633
    
    
    $
    45,176
    
    
    $
    25,595,216
    
    
    $
    27,200
    
    
    $
    (22,613,294
    )
    
    $
    (39,769
    )
    
    $
    
    
    
    $
    3,021,162Unrealized income on marketable securities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    34,500
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    34,500Issuance of preferred shares
    
    
    955
    
    
    
    
    
    
    
    299,045
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    300,000Restricted preferred share grants issued
    
    
    6,961
    
    
    
    
    
    
    
    2,398,010
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,404,971
    )
    
    
    Restricted common share grants issued
    
    
    
    
    
    
    2,500
    
    
    
    60,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (62,500
    )
    
    
    Cost of 2,859,765 common shares acquired for
treasury
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (800,735
    )
    
    
    
    
    
    
    (800,735
    )Cancellation of 15,300 treasury shares
    
    
    
    
    
    
    
    
    
    
    (39,769
    )
    
    
    
    
    
    
    
    
    
    
    39,769
    
    
    
    
    
    
    
    Conversion of preferred shares to common
shares
    
    
    (11,755
    )
    
    
    268,698
    
    
    
    (256,943
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Adjustment to minority interest resulting
from operations of the operating partnership
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (42,363
    )
    
    
    
    
    
    
    
    
    
    
    (42,363
    )Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,089,613
    )
    
    
    
    
    
    
    
    
    
    
    (1,089,613
    )Balance at December 31, 2003
    
    $
    2,794
    
    
    $
    316,374
    
    
    $
    28,055,559
    
    
    $
    61,700
    
    
    $
    (23,745,270
    )
    
    $
    (800,735
    )
    
    $
    (2,467,471
    )
    
    $
    1,422,951Restricted common share grants issued
    
    
    
    
    
    
    17,000
    
    
    
    295,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (312,000
    )
    
    
    Restricted common share grants cancelled
    
    
    
    
    
    
    (3,500
    )
    
    
    (66,333
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    69,833
    
    
    
    Restricted common share grants issued for rent
    
    
    
    
    
    
    2,500
    
    
    
    49,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    51,500Conversion of preferred shares to common
shares
    
    
    (9
    )
    
    
    32
    
    
    
    (23
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Unrealized loss on marketable securities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (10,427
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (10,427
    )Amortization of unearned compensation and
trustee fees
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    118,204
    
    
    
    118,204Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (816,224
    )
    
    
    
    
    
    
    
    
    
    
    (898,212
    )Balance at December 31, 2004
    
    $
    2,785
    
    
    $
    332,406
    
    
    $
    28,333,203
    
    
    $
    51,273
    
    
    $
    (24,561,494
    )
    
    $
    (800,735
    )
    
    $
    (2,591,434
    )
    
    $
    766,004
 The accompanying notes are an integral part of the consolidated financial statements. F-5




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##### Table of Contents



Paragon Real Estate Equity and Investment Trust and Subsidiaries 
 Consolidated Statements of Cash Flows
 For the year ended December 31,2004
    
    
    2003Cash flows from operating activitiesNet loss
    
    $
    (816,224
    )
    
    $
    (1,089,613
    )Adjustments to reconcile net loss to net cash used in
continuing operations:Discontinued operations:Commercial properties, net of tax
    
    
    
    
    
    
    457,874Compensation costs paid through the issuance of
Class A Preferred Shares
    
    
    
    
    
    
    300,000Compensation costs paid through amortization of
restricted Common Shares issued
    
    
    118,204
    
    
    
    Rent expense paid by issuing restricted common shares
    
    
    51,500
    
    
    
    Depreciation and amortization
    
    
    87,105
    
    
    
    56,869Loss allocated to minority interests
    
    
    (81,988
    )
    
    
    (148,609
    )Gain on sale of marketable securities
    
    
    
    
    
    
    (136,358
    )Net change in assets and liabilities:Accounts receivable
    
    
    1,534
    
    
    
    (9,811
    )Restricted cash
    
    
    (9,104
    )
    
    
    (97,082
    )Other assets, net
    
    
    247,241
    
    
    
    (257,096
    )Accounts payable and accrued expenses
    
    
    60,385
    
    
    
    18,760Rents received in advance and security deposits
    
    
    (2,283
    )
    
    
    14,973Net cash used in continuing operations
    
    
    (343,630
    )
    
    
    (890,093
    )Cash flows from investing activitiesAcquisition and additions to real estate properties
    
    
    (25,642
    )
    
    
    (46,509
    )Cash proceeds from disposition of commercial properties
    
    
    
    
    
    
    1,119,344Cash proceeds from sale of marketable securities
    
    
    
    
    
    
    248,858Purchase of marketable securities
    
    
    (1,176
    )
    
    
    Net cash provided by (used in) investing
activities
    
    
    (26,818
    )
    
    
    1,321,693Cash flows from financing activitiesProceeds from refinance of mortgage loan
    
    
    
    
    
    
    1,286,363Payments on mortgage loan
    
    
    (48,864
    )
    
    
    (18,485
    )Deferred financing costs paid
    
    
    
    
    
    
    (54,542
    )Net cash provided by (used in) financing
activities
    
    
    (48,864
    )
    
    
    1,213,336Net cash used in discontinued operationsCommercial properties
    
    
    
    
    
    
    (455,527
    )Net cash used in discontinued operations
    
    
    
    
    
    
    (455,527
    )Net increase (decrease) in cash and cash equivalents
    
    
    (419,312
    )
    
    
    1,189,409Cash and cash equivalentsBeginning of period
    
    
    2,218,674
    
    
    
    1,029,265End of period
    
    $
    1,799,362
    
    
    $
    2,218,674
 The accompanying notes are an integral part of the consolidated financial statements. F-6




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##### Table of Contents



Paragon Real Estate Equity and Investment Trust and Subsidiaries 
 Notes to Consolidated Financial Statements Note 1  Organization Paragon Real Estate Equity and Investment Trust (the Company, Paragon, we, our, or us) is
a real estate company, which primarily acquires, owns and operates multi-family residential real
estate properties. As of December 31, 2004, we owned a 1.0% interest in Paragon Real Estate, LP,
the operating partnership that owns Richton Trail Apartments (Richton Trail), an apartment
complex containing 72 units. Hampton Court Associates owns the remaining 99.0% interest in Paragon
Real Estate, LP. Because we are the sole general partner of Paragon Real Estate, LP, we consolidate
Richton Trail in our financial statements and show separately amounts for minority interest for
Hampton Court Associates, which is the only limited partner. Hampton Court Associates ownership
interest in Paragon Real Estate, LP is 813,938 restricted limited partnership units, each
redeemable after July 1, 2007 for cash, or at our option, 22.881 of our common shares. Paragon is also the sole member of Paragon Housing LLC, which is the general partner of River West
Apartments Limited Partnership (River West). River West is a single asset entity owning an
apartment complex of 30 units. We do not consolidate Paragon Housing LLC with Paragons financial
statements because we do not have sufficient equity at risk for Paragon Housing LLC to finance its
activities without additional subordinated financial support. Our exposure is limited to Paragon
Housing LLCs $100 capital contribution in River West, and we and Paragon Housing LLC are not
obligated on any of the liabilities of River West. We owned four commercial real estate investments through an operating partnership, Wellington
Properties Investments, LP, of which we were the sole general partner and owned an approximate
92.9% interest. On October 1, 2003, we completed the sale of our 92.9% general partnership
interest, resulting in the sale of the commercial properties. Note 2  Basis of Presentation Minority interest at December 31, 2004 represents approximately a 99.0% aggregate partnership
interest in Paragon Real Estate, LP held by Hampton Court Associates for its partners. The Company
is the sole general partner of Paragon Real Estate, LP and owns the remaining 1.0% interest. After
July 1, 2007, the limited partners may redeem, in whole or in part, their Paragon Real Estate, LP
units for cash. When these units are offered for redemption in cash, we may, at our option, elect
to convert the limited partnership units into our common shares. The conversion ratio would be
22.881 common shares for each limited partnership unit, or 18,623,715 common shares. The cash
redemption price would be the cash value of the common shares into which the limited partnership
units could have been converted. We report our investments using the consolidated method of accounting as we own the outstanding
voting interests and can control operations for Paragon Real Estate, LP. In the consolidation
method, the accounts of these entities are combined with our accounts. All significant
intercompany transactions are eliminated in consolidation. Note 3  Summary of Significant Accounting Policies Use of Estimates in the Preparation of Financial Statements In order to conform with generally accepted accounting principles, management, in preparation of
our consolidated financial statements, is required to make estimates and assumptions that affect
the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities
as of December 31, 2004, and the reported amounts of revenues and expenses for the years ended
December 31, 2004 and 2003. Actual results could differ from those estimates. Significant
estimates include the valuation of investments in real estate,
marketable securities, deferred F-7




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##### Table of Contents



taxes and a related valuation allowance, and these significant
estimates, as well as other estimates and assumptions, may change in the near term. Investments in Real Estate Our investments in real estate assets are reported at the lower of cost or estimated net realizable
value. We periodically review our properties for impairment and provide for a provision if impairments are
determined. First, to determine if impairment may exist, we review our properties and identify
those, if any, which have had either an event of change or event of circumstances warranting
further assessment of recoverability. Then, we estimate the fair value of those properties on an
individual basis based on an independent appraisal, capitalizing the expected net operating income,
or applying various other valuation factors. Such amounts are then compared to the propertys
depreciated cost to determine whether an impairment exists. In accordance with Statement of Financial Accounting Standard (SFAS) No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets (SFAS 144), impairment of investments in real estate
exists when the carrying amount of the investments exceeds its fair value and is non-recoverable.
Fair value of these assets is the amount an asset could be bought or sold in a current transaction
between willing parties. Further, SFAS 144 defines a component of a company to be the operations
that can be clearly distinguished from the rest of the company, and then requires elimination from
our continuing operations for those assets held for sale or disposed of. Accordingly, one of the
impacts of our adoption of SFAS 144 is that revenues and expenses associated with our commercial
properties sold on October 1, 2003 are classified as discontinued operations on our Consolidated
Statements of Operations for all periods reported. During the quarter ended June 30, 2003, we recorded non-recurring real estate expense in the amount
of $350,000. This expense represented $280,000 of tenant improvements, $31,000 of leasing
commissions and $39,000 of professional expense incurred on our commercial properties located in
Minnesota. The sale of our 92.9% general partnership interest in these commercial properties
closed on October 1, 2003 and the amount of proceeds received was not increased as a result of
these expenditures. As a result of the sale on October 1, 2003, we have included these costs in
discontinued operations of commercial properties. Depreciation expense is computed using the straight-line method based on the following useful
lives: YearsBuilding and improvements
    
    40Furniture, fixtures and equipment
    
    3-7
 Expenditures for ordinary maintenance and repairs are expensed to operations as incurred and
significant renovations and improvements that improve or extend the useful life of the asset are
capitalized and depreciated over their estimated useful life. When a property is sold or retired, the costs and related accumulated depreciation are removed from
the accounts and the resulting gain or loss, together with the related historical operating
results, are included in discontinued operations. Cash and cash equivalents Cash and cash equivalents include all cash and liquid investments that mature three months or less
from when they are purchased. Cash equivalents are reported at cost, which approximates fair
value. We maintain our cash in bank accounts in amounts that may exceed federally insured limits
at times. We also maintained cash of approximately $18,000 at December 31, 2004 in a money market account that was not federally
insured. Cash of approximately $49,000 is classified as restricted at December 31, 2004 because it
is held in an escrow account of the mortgage lender for the payment of property taxes and
insurance, and cash of approximately F-8




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##### Table of Contents



$57,000 is classified as restricted at December 31, 2004
because it is held as security deposits for the tenants at Richton
Trail. Accounts Receivable Our accounts receivable of approximately $8,000 are reported net of a reserve for bad debts of
approximately $2,000. Other Assets As of December 31, 2004 other assets of approximately $116,000 include approximately $60,000 of
prepaid insurance, deferred financing costs of approximately $48,000 (net of accumulated
amortization) incurred to obtain and secure mortgage debt financing, approximately $5,000 prepaid
natural gas for Richton Trail, and approximately $3,000 prepaid legal fees. Other assets are
carried at cost, less accumulated amortization. The deferred financing costs of approximately $54,000 are being amortized over the life of the
respective loans on a straight-line basis. Accumulated amortization related to deferred financing
costs as of December 31, 2004 was approximately $6,000. Revenue Recognition Revenues from rental property are recognized when due from tenants. Leases are generally for terms
of one year or less. Stock Based Compensation At December 31, 2004, we had one stock-based employee and trustee compensation plan, which is
described more fully in Note 8. During the year ended December 31, 2004, we issued options as to
575,000 common shares under this plan and further issued 1,700,000 restricted common share grants
under this plan. In 2004 we cancelled 350,000 restricted share grants. During the year ended
December 31, 2003, we issued options as to 100,000 common shares and restricted share grants as to
250,000 common shares under this plan. The Company accounted for the grants of options and
restricted shares using the intrinsic value method of Accounting Principles Board (APB) Opinions
No. 25, Accounting for Stock Issued to Employees and related interpretations. No stock-based
employee compensation cost is reflected in net loss for options granted, as all options granted had
an exercise price equal to the market value of the underlying common stock on the date of grant.
Stock-based employee compensation cost of approximately $118,000 is reflected in net loss for the
year ended December 31, 2004. The Company has adopted the disclosure only provisions of both SFAS
No. 123, Accounting for Stock-Based Compensation and SFAS No. 148, Accounting for Stock-Based
Compensation  Transition and Disclosure. Pursuant to the requirements of SFAS No. 148, the
following are the pro forma net loss amounts for 2004 and 2003, as if the compensation cost for the
options granted to the trustees had been determined based on the fair value at the grant date: F-9




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##### Table of Contents



For the twelve month periods endedDecember 31,2004
    
    
    2003Net loss attributable to Common Shareholders
    
    $
    (816,224
    )
    
    $
    (1,089,613
    )Add: Stock-based employee compensation
expense included in reported net loss, net
of related tax effects
    
    
    118,204
    
    
    
    Deduct: Total stock-based employee
compensation expense determined under fair
value based method for all awards, net of
related tax effects
    
    
    158,704
    
    
    
    22,000Pro forma net loss attributable to Common
Shareholders
    
    $
    (856,724
    )
    
    $
    (1,111,613
    )Net loss attributable to Common
Shareholders per Common Share:Basic and Diluted  as reported
    
    $
    (0.02
    )
    
    $
    (0.06
    )Basic and Diluted  pro forma
    
    $
    (0.03
    )
    
    $
    (0.06
    )
 The assumptions
made in estimating the fair value of the options on the grant date based upon the
Black-Scholes option-pricing model are as follows: 2004
    
    2003Risk-free interest rate
    
    3.40% and 5.06%
    
    4.66%Volatility
    
    176.5% and 171.1%
    
    172.69%Dividend yield
    
    0.00%
    
    0.00%Life expectancy
    
    10 years
    
    10 years
 Income Taxes Because we are no longer a REIT for federal income tax purposes, we now account for income taxes
using the liability method under which deferred tax assets and liabilities are determined based on
differences between the financial reporting and tax bases of assets and liabilities using enacted
tax rates in effect for the period in which the differences are expected to affect taxable income.
Valuation allowances are established when necessary to reduce deferred tax assets to the amount
expected to be realized. We are eligible to re-elect REIT status as of January 1, 2005. We are
continuing to evaluate our tax status to take advantage of our tax loss carryforwards before
electing to be a REIT again. At December 31, 2004, we have net operating losses totaling approximately $11.0 million and capital
losses of approximately $0.6 million. While these losses created a deferred tax asset, a valuation
allowance was applied against the asset because of the uncertainty of whether we will be able to
use these loss carry forwards, which will expire in varying amounts through the year 2024. We are also subject to certain state and local income, excise and franchise taxes. The provision
for state and local taxes has been reflected in general and administrative expense in the
consolidated statements of operations and has not been separately stated due to its insignificance. Fair Value of Financial Instruments Our financial instruments include cash and cash equivalents, marketable securities and a mortgage
loan. The fair values of the financial instruments were not materially different from their
carrying or contract values at
December 31, 2004. F-10




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##### Table of Contents



Segment Disclosure In
June 1997, the Financial Accounting Standards Board (FASB) issued SFAS No. 131,
Disclosures
about Segments of an Enterprise and Related Information. This Statement requires that a public
company report financial and descriptive information about its reportable operating segments.
Generally, financial information is required to be reported on the basis that it is used internally
for evaluating segment performance and deciding how to allocate resources to segments. Management
views the Company as a single segment, which acquires, owns and operates rental real estate.
During 2003 we sold our commercial real estate resulting in the revenues and expenses of these
properties being classified as discontinued operations for the year ended December 31, 2003. Recent Accounting Pronouncements In
December 2004, the FASB issued SFAS No. 123(R), Share-based Payment.
This Statement requires
all entities to recognize compensation expense in an amount equal to the fair value of share-based
payments granted to employees. The Statement is effective for the first reporting period, interim
or annual, beginning after December 15, 2005. The
Company is currently evaluating the effects of this Statement, and does expect it to have a
material impact on the financial condition or operating results of the Company. In
December 2003, the FASB issued Interpretation No. 46(R), Consolidation of
Variable Interest Entities (FIN 46(R)).
FIN 46(R) provides guidance on possible
consolidation of entities in
which equity investors do not have the characteristics of a controlling financial interest or do
not have sufficient equity at risk for the entity to finance its activities without additional
subordinated financial support. We
have reviewed our consolidation of Paragon Real Estate, LP under FIN 46(R) and believe that it
does not apply. Accordingly, consolidation will be continued under previously issued accounting
standards. Paragon
Housing LLC, an Ohio limited liability company, was created on December 13, 2004 with
Paragon Real Estate Equity and Investment Trust as the sole member. We have reviewed Paragon
Housing LLCs agreements with River West Apartments Limited Partnership (River West) and
determined that the agreements do not give us the characteristics of a controlling financial
interest and we do not have sufficient equity at risk for the entity to finance its activities
without additional subordinated financial support. Therefore we will not consolidate Paragon
Housing LLC into our financial statements. The following describes our involvement with River West:  a)
    On December 28, 2004, Paragon Housing LLC became the general partner of River West.b)
    River West Apartments Limited Partnership is a single asset entity owning an apartment
complex of 30 units in Milford, IA, which is qualified under section 42 of the Internal
Revenue Code to receive low income housing tax credits.c)
    Paragon Housing LLCs maximum exposure to loss is limited to its $100 capital
contribution. It is not obligated on any of the liabilities of the partnership and will not
receive any fees. Note 4  Commercial and Residential Real Estate Properties 2003 Disposition of Investments in Real Estate On October 1, 2003, we closed on the sale of our 92.9% general partnership interest in four
commercial properties. Proceeds from the sale of these properties, net of closing costs and the
mortgage balances assumed by the purchaser, were approximately $1,601,000. The proceeds from the
sale were paid in a combination of approximately $801,000 in cash and 2,859,765 of our common
shares at an average closing price for the 30 calendar days prior to June 27, 2003 of $0.28. Also
as a result of the sale, approximately $318,000 representing cash from the commercial real estate
properties was released from mortgage related restrictions and made
available for operations. F-11




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##### Table of Contents



2003 Acquisition of Investments in Real Estate Effective as of July 1, 2003, we closed the acquisition of Richton Trail, a residential apartment
complex located near Chicago, Illinois, following approval by our shareholders of the transaction
on June 30, 2003. Our operating partnership, Paragon Real Estate, LP, acquired Richton Trail along
with the associated mortgage from Hampton Court Associates, a partnership controlled by James C.
Mastandrea, its general partner and our Chairman, Chief Executive Officer and President. In
consideration for transferring Richton Trail, Hampton Court Associates received 813,938 restricted
limited partnership units of Paragon Real Estate, LP. Each unit is redeemable after four years for
cash, or at our option, 22.881 of our common shares. We are the general partner of Paragon Real
Estate, LP. Note 5  Marketable Securities Our investments in marketable securities are available-for-sale, as of December 31, 2004, and
represent 10,000 common shares of Stellent, Inc. and 100 common shares of Century Realty Trust. As of December 31, 2004, our marketable securities had a fair market value of approximately $90,000
(based upon the NASDAQ closing quote of $8.82 per share for Stellent, Inc. and $17.49 per share for
Century Realty Trust on December 31, 2004). We recorded an unrealized loss on marketable
securities during 2004 of approximately $10,000, resulting in a balance of approximately $51,000 in
shareholders equity for unrealized gain on marketable securities. The NASDAQ closing quote on February 17, 2005 was $8.30 per common share of Stellent, Inc. and
$16.34 per common share of Century Realty Trust. As of December 31, 2003, we owned 10,000 shares of Stellent, Inc., which had a fair market value of
approximately $99,000 (based upon the NASDAQ closing quote of $9.92 per share on December 31,
2003). We recorded an unrealized gain on marketable securities during 2003 of $34,500, resulting
in a balance of $61,700 in shareholders equity for unrealized gain on marketable securities. During the year ended December 31, 2003, we sold 30,000 shares of Stellent, Inc. at an average
price of $8.30 per share and recognized a gain on the sale of these shares totaling approximately
$136,000. We recognize gain or loss on the sale of marketable securities based upon the first-in-first-out
method. Note 6  Pro Forma Consolidated Financial Information (Unaudited) The following pro forma condensed consolidated financial information presented below is as if the
disposition of our 92.9% general partnership interest in our commercial properties (closed October
1, 2003) and the acquisition of the Richton Trail (closed July 1, 2003) had occurred on January 1,
2003. The pro forma financial information is not necessarily indicative of the results that
actually would have occurred if the disposition and acquisition had been consummated on January 1,
2003, nor does the pro forma information purport to represent the results of operations for future
periods. For the year ended December 31, 2003, all revenues and expenses associated with the
commercial properties have been recorded as discontinued operations. For the year endedDecember 31, 2003Pro forma total revenue
    
    $
    608,000Pro forma loss from continuing operations
    
    $
    742,000Pro forma loss attributable to Common Shareholders
    
    $
    742,000Pro forma loss per Common Share: Basic and Diluted
    
    $
    0.02
 F-12




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##### Table of Contents



Note 7  Mortgage Loan In connection with the acquisition of Richton Trail, we assumed a mortgage loan payable of
approximately
$1.5 million, which had a maturity date of October 1, 2012. Payments were required monthly in the
amount of approximately $13,000, which represented principal and interest at 7.25%. On October 31, 2003, we completed the refinance of Richton Trail with an independent lender. The
mortgage
loan payable of $2.8 million has a fixed interest rate of 5.87% for a term of 10 years. The monthly
principal and interest payments are approximately $18,000 based on a 25-year amortization schedule.
The balance due at maturity in 2013 will be approximately $2.2 million. The net proceeds from the
loan were approximately $1.3 million. The mortgage loan payable was approximately $2,763,000 as of
December 31, 2004. The mortgage loan matures as follows: Year ending December 31,2005
    
    $
    52,3342006
    
    
    55,5352007
    
    
    58,9322008
    
    
    62,0922009
    
    
    66,334Thereafter
    
    
    2,468,045$
    2,763,272
 Note 8  Shareholders Equity Preferred Shares During 1999, we issued 785,037 Class A Cumulative Convertible Preferred Shares (preferred shares)
to the public. Each of the preferred shares is entitled, at all meetings of shareholders, to 3.448
votes, the number of common shares into which they are convertible, subject to adjustment for stock
splits and similar events. The preferred shares are entitled to vote as a class on certain matters
that affect their respective rights. The preferred shares bear a liquidation value of $10.00 per
share and originally accrued a dividend equal to $0.475 per share, payable every six months. The
preferred shares are convertible into 3.448 common shares subject to certain formulas. We have the
right to redeem the preferred shares. Proceeds from the issuance of the preferred shares, net of
underwriters discount and total offering expenses, were approximately $6.7 million. Since the
original issuance and prior to the exchange offer on June 30, 2003, a total of 121,746 preferred
shares were converted into 419,779 common shares. Effective April 7, 2003, we issued 95,541 preferred shares to the former chief executive officer in
connection with his resignation in lieu of a $300,000 payment required by the terms of his
employment agreement dated March 4, 2003 and recorded compensation expense of $300,000 as a result
of the issuance and employment termination. In May 2003, we offered preferred shareholders a one-time incentive to exchange preferred shares
into common shares, which expired June 30, 2003. Through that exchange offer, preferred
shareholders exchanged 1,174,120 of the preferred shares, or nearly 81%, for 26,865,042 common
shares. After the exchange offer was completed, the remaining preferred shares held by investors
not affiliated with Paragon had an aggregate market value below $1 million and therefore no longer
met the minimum requirement for listing on the American Stock Exchange, as set forth in Section
1202(b) of the American Stock Exchanges Company Guide.This requirement was disclosed in the
proxy statement as well as our intent not to seek another trading market for the preferred shares.
The Exchange suspended trading of the preferred shares and the Securities and Exchange Commission
removed the preferred shares from listing and registration in accordance with Section 12 of the
Securities and Exchange Act of 1934. Preferred shareholders retain the right to convert each of
their shares for 3.448 common shares. The preferred shares are on the Over the Counter Market with
the symbol PRGYP. F-13




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On June 30, 2003, the holders of our preferred shares consented to waive the dividend that would
otherwise have been payable in May 2003 and to eliminate any future dividends that would have been
payable under the terms of our preferred shares. The waiver was sought in connection with a
one-time incentive exchange offer under which we offered to exchange each of our preferred shares
for 22.881 common shares. Effective June 30, 2003, we issued 696,078 preferred shares valued at approximately $2.4 million to
Messrs. Mastandrea and Dee pursuant to separate restricted share agreements. Under each restricted
share agreement, the restricted shares vest upon the later of the following dates:  
    the date our gross assets exceed $50.0 million, or
    348,038 restricted shares vested on March 4, 2004; 174,020 shares will vest on
March 4, 2005 and the remaining 174,020 shares will vest on March 4, 2006. During the first quarter of 2004, 935 preferred shares were converted to 3,224 common shares and
during the fourth quarter of 2003, 1,400 preferred shares were converted to 4,827 common shares,
both at a conversion rate of 3.448 common shares for each preferred share. On October 1, 2003 we completed the sale of our 92.9% general partnership interest in our four
commercial properties. A portion of the proceeds from the sale was paid in 2,859,765 of our common
shares at an average closing price for the 30 calendar days prior to June 27, 2003 of $0.28 or
approximately $801,000. These shares are recorded at cost in the accompanying consolidated balance
sheet under treasury shares. Common Shares Restricted Common Shares On June 30, 2003, our shareholders approved the issuance of additional common shares to Paragon
Real Estate Development, LLC for James C. Mastandrea, our Chief Executive Officer and President,
and John J. Dee, our Chief Financial Officer and Senior Vice President, to encourage them to
substantially grow the asset base, net operating income, funds from operations, net value, and
share value of Paragon. We will issue restricted common shares if they locate and close on our
behalf future acquisition, development or re-development transactions. Any of these transactions
would be subject to approval by our board of trustees. The maximum number of common shares they
may receive under the additional contribution agreement is limited to a total value of $26 million
based on the average closing price of the common shares for 30 calendar days preceding the closing
of any acquisition. The common shares will be restricted until we achieve the five-year proforma
income target for the acquisition, as approved by the board of trustees, and an increase of 5% in
Paragons net operating income and funds from operations. The restricted shares would vest
immediately upon any shift in ownership, as defined in the agreement. On October 28, 2003, our board of trustees approved the issuance of 50,000 restricted commons
shares to each of our four trustees who are not officers of the Company. The restricted shares were
issued effective as of October 28, 2003 and vested on October 28, 2004. The market value of the
shares on the date of grant was $44,000. Following each annual meeting, trustees serving on our
board who are not officers of the company will receive similar grants of restricted shares. On December 16, 2003, our board of trustees approved the issuance of 50,000 restricted commons
shares to an employee hired June 16, 2003. The employee terminated employment in 2004 and the
restricted shares have been cancelled. On December 16, 2003, our board of trustees approved the issuance of 500,000 restricted common
shares to Paragons landlord for 4,000 square feet of fully furnished office space, including all
utilities, phone, high speed internet, equipment usage, copying, presentation packaging and
preliminary design planning for our proposed projects for two years. Half of the shares were to be
issued in March of 2004 and half are to be issued in March 2005. The shares have restrictions as
to voting and transfer. A proxy will be signed when the shares are issued F-14




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##### Table of Contents



granting Mr. Mastandrea the right to vote the shares during the ownership of the landlord or if
transferred in a block sale. The shares are restricted from being transferred or sold for four
years from the date of issuance, and thereafter have volume limits on the number of shares that may
be sold daily in the open market or transferred in a block sale. The market value of the office
space and services for two years was estimated at $103,000. On January 2, 2004 our board of trustees approved the issuance of 300,000 restricted common shares
each to James C. Mastandrea, our Chief Executive Officer and President, John J. Dee, our Chief
Financial Officer and Senior Vice President and to an employee that terminated employment in 2004.
Half of the restricted shares vest in five years or earlier if Paragons share price rises to $1.00
per share. The remaining half vests when funds from operations has doubled or when Paragons share
price is 50% higher compared to the average trading price for the five days preceding the grant
date. The market value of the restricted common shares on the date of the grant was $198,000. The
300,000 restricted shares previously issued to the employee who terminated in 2004 were cancelled. On June 15, 2004 following our annual meeting, 50,000 restricted commons shares were issued to each
of our four trustees who are not officers of the Company as part of their compensation for serving
on Paragons board and committees. The restrictions will be removed from the shares after 12 months
from the date of issuance. The market value of the restricted common shares on the date of the
grant was $36,000. Effective July 19, 2004, our board of trustees approved a commitment to issue a total of 1.0
million restricted common shares to a new officer of the Company. The initial grant of 500,000
restricted shares will vest half of the shares in four years and the second half in five years.
Additional grants of 125,000 restricted common shares will be made annually for the next four years
beginning on the anniversary date of his employment with vesting effective four years after each
grant date. The market value of the 500,000 restricted common shares issued on the date of the
grant was $65,000. Effective December 1, 2004, our board of trustees approved the issuance of 100,000 restricted
common shares to a new employee of the Company. Half of the shares will vest in four years and the
second half will vest in five years. The market value of the 100,000 restricted common shares
issued on the date of the grant was $13,000. The total number of restricted common shares issued in the year ended December 31, 2004 was
1,700,000 shares plus 250,000 shares to be issued, and in the year ended December 31, 2003 was
250,000. Warrants On March 5, 1998, we issued a warrant to Credit Suisse First Boston Mortgage LLC in connection with
the refinancing of debt. The warrant provides for the right to purchase 47,500 common shares at a
price of $5.37 per common share and is exercisable at any time through March 5, 2008. The warrant
remains unexercised as of December 31, 2004. In connection with the issuance of preferred shares on October 28, 1999, we issued to a
representative of the underwriters a warrant to purchase 35,500 preferred shares at a price of
$10.00 per share. The warrant was exercisable through November 2, 2004 and expired unexercised. Options On May 27, 1998, in accordance with our former stock option plan (Former Plan) we granted options
as to 54,387 Common Shares to then existing employees and trustees. The options remain unexercised
and are exercisable on any date through May 26, 2008 at a price of $5.37 per share. On November 16, 1998, we adopted the 1998 Share Option Plan. In 2004 the board of trustees
unanimously recommended and the shareholders approved amendments to our 1998 Share Option Plan to
increase the number of shares available for grant from 3,166,666 to 3,500,000 and to conform it
with current tax regulations (2004 F-15




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##### Table of Contents



Plan). The 2004 Plan provides for the granting of share
options to officers, trustees and employees at a price
determined by a formula in the 2004 Plan agreement. The options are to be exercisable over a
period of time determined by the 2004 Plan committee, but no longer than ten years after the grant
date. Compensation resulting from the share options is initially measured at the grant date based
on fair market value of the shares. In connection with employment agreements entered into during 1999 and in accordance with the 1998
Share Option Plan, we issued options to purchase 80,000 Common Shares at $2.90 per share to each of
our former chief executive officer and former president. The former chief executive officers
options were returned to the Company in 2003 and the former presidents options expire on December
31, 2005. Effective May 15, 2002 we issued 50,000 options to each of our five trustees with a price of $0.45
per share. The options can be exercised six months after issuance and expire 90 days after the
trustees term ends. On September 30, 2003, 200,000 options expired and were returned to the
Company. Effective October 28, 2003 we issued 25,000 options to each of our four independent trustees, who
are not executive officers of the Company, at a price of $0.22 per share. The options can be
exercised six months after issuance and expire 90 days after the trustees term ends. Effective January 2, 2004 we issued 150,000 options each to James C. Mastandrea, our Chief
Executive Officer and President, John J. Dee, our Chief Financial Officer and Senior Vice
President, and an employee that terminated employment in 2004. The options have an exercise price
of $0.27 per share and vest one-third on each of January 2, 2005, 2006, and 2007. The options
expire on the earlier of January 2, 2009 or 90 days after leaving the employ of the Company. Effective January 2, 2004 we issued 25,000 options to an employee at an exercise price of $0.22 per
share. The employee terminated employment in 2004 and the options were cancelled. Effective June 15, 2004, we issued 25,000 options to each of our four independent trustees, who are
not executive officers of the Company, with a price of $0.18 per share. The options can be
exercised six months after issuance and expire 90 days after the trustees term ends. The following table summarizes the Companys option activity for the years ended December 31, 2004
and 2003: Options
    
    
    Weightedto Purchase
    
    
    AverageCommon
    
    
    Exercise Price
    
    
    Range of ExerciseShares
    
    
    per Share
    
    
    Price per ShareOutstanding at January 1, 2003
    
    
    464,387
    
    
    $
    1.87
    
    
    $
    0.45-$5.375Granted
    
    
    100,000
    
    
    $
    0.22
    
    
    $
    0.22Expired/terminated
    
    
    (280,000
    )
    
    $
    1.15
    
    
    $
    0.45 - $2.90Outstanding at December 31, 2003
    
    
    284,387
    
    
    $
    2.00
    
    
    $
    0.22 - $5.375Granted
    
    
    575,000
    
    
    $
    0.25
    
    
    $
    0.18 - $0.27Expired/terminated
    
    
    (25,000
    )
    
    $
    0.22
    
    
    $
    0.22Outstanding at December 31, 2004
    
    
    834,387
    
    
    $
    .85
    
    
    $
    0.18 - $5.37Exercisable at December 31, 2003
    
    
    184,387
    
    
    $
    2.96
    
    
    $
    0.45 - $5.375Exercisable at December 31, 2004
    
    
    284,387
    
    
    $
    2.00
    
    
    $
    0.22 - $5.37
 F-16




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The following tables summarize exercisable options outstanding as of December 31, 2004 and
December 31, 2003: Exercisable Options as of December 31, 2004Weighted AverageNumber of Options
    
    
    RemainingRange of Exercise
    
    Outstanding and
    
    
    Contractual Life
    
    Weighted AveragePrices
    
    Exercisable
    
    
    (in years)
    
    Exercise Price$5.37
    
    
    54,387
    
    
    3.4
    
    $
    5.37$2.90
    
    
    80,000
    
    
    1.0
    
    $
    2.90$0.45
    
    
    50,000
    
    
    1.2
    
    $
    0.45$0.22
    
    
    100,000
    
    
    1.2
    
    $
    0.22$0.22 to $5.37
    
    
    284,387
    
    
    1.6
    
    $
    2.00
 Exercisable Options as of December 31, 2003Weighted AverageNumber of Options
    
    
    RemainingRange of Exercise
    
    Outstanding and
    
    
    Contractual Life
    
    Weighted AveragePrices
    
    Exercisable
    
    
    (in years)
    
    Exercise Price$5.37
    
    
    54,387
    
    
    4.4
    
    $
    5.37$2.90
    
    
    80,000
    
    
    2.0
    
    $
    2.90$0.45
    
    
    50,000
    
    
    1.3
    
    $
    0.45$0.45 to $5.37
    
    
    184,387
    
    
    2.3
    
    $
    2.96
 Note 9  Discontinued Operations On October 1, 2003 we sold our 92.9% general partnership interest in our commercial properties.
The results of operations for these properties are presented in the accompanying Consolidated
Statement of Operations as Income/Loss from discontinued operations.
The following is a summary of the income from discontinued operations of our commercial properties
for the years ended December 31, 2004 and 2003. Year ended December 31,2004
    
    
    2003Revenues
    
    $
    
    
    
    $
    1,007,813Operating expenses
    
    
    
    
    
    
    (444,995
    )Depreciation and amortization
    
    
    
    
    
    
    (157,735
    )Interest expense
    
    
    
    
    
    
    (251,900
    )General and administrative
    
    
    
    
    
    
    (305,087
    )Non-recurring real estate expenses
    
    
    
    
    
    
    (305,970
    )Income (loss) from discontinued operations
    
    $
    
    
    
    $
    (457,874
    )
 Note 10  Loss Per Share The Company has adopted the SFAS No. 128, Earnings Per Share (EPS) for all periods presented
herein. Net loss per weighted average common share outstanding  basic and diluted  are computed
based on the weighted average number of common shares F-17




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##### Table of Contents



outstanding for the period. The weighted
average number of common shares outstanding for the years ended December 31, 2004 and 2003 was
32,993,966 and 18,171,689, respectively. Common share equivalents of approximately 23.6 million and
23.4 million as of December 31, 2004 and December 31, 2003, respectively, include outstanding
convertible preferred shares, warrants, stock options and
limited partnership units, and are not included in net loss per weighted average common share
outstandingdiluted as they would be anti-dilutive. For the year ended December 31,2004
    
    
    2003NumeratorNet loss from continuing operations
    
    $
    (816,224
    )
    
    $
    (631,739
    )Discontinued operations of commercial properties, net of tax
    
    
    
    
    
    
    (457,874
    )Net loss attributable to Common Shareholders
    
    $
    (816,224
    )
    
    $
    (1,089,613
    )DenominatorWeighted average Common Shares outstanding at December 31,
2004 and December 31, 2003 - Basic and Diluted
    
    
    32,993,966
    
    
    
    18,171,689Basic and Diluted EPSNet loss from continuing operations
    
    $
    (0.02
    )
    
    $
    (0.03
    )Discontinued operations of commercial properties, net of tax
    
    
    
    
    
    
    (0.03
    )Net loss attributable to Common Shareholders  Basic and
Diluted
    
    $
    (0.02
    )
    
    $
    (0.06
    )
 Note 11  Dividends/Distributions On June 30, 2003, the holders of our preferred shares consented to waive the dividend that would
otherwise have been payable in May 2003 and to eliminate any future dividends that would have been
payable under the terms of our preferred shares. The waiver was sought in connection with the
one-time incentive exchange offer under which we offered to exchange each of our preferred shares
for 22.881 common shares. No cash distributions were declared during 2004 and 2003 with respect to the common shares. Note 12  Income taxes There was no income tax provision for the years ended December 31, 2004 and 2003. For the year ended December 31,2004
    
    
    2003Current
    
    $
    
    
    
    $
    Deferred
    
    
    
    
    
    
    Total tax provision
    
    $
    
    
    
    $
    
 F-18




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The tax provision differs from the expense that would result from applying Federal statutory rates
as follows: For the year ended December 31,2004
    
    
    2003Tax / (Benefit) at Federal statutory rate
    
    $
    (277,000
    )
    
    $
    (364,000
    )State income tax / (benefit), net of Federal tax effect
    
    
    (53,000
    )
    
    
    (71,000
    )Permanent differences:Disposal of real estate investments
    
    
    
    
    
    
    (338,000
    )Temporary differences:Provision for loss on real estate investments
    
    
    
    
    
    
    (817,000
    )Provision for loss on marketable securities
    
    
    
    
    
    
    (317,000
    )Adjustment to net operating and capital loss carryforwards
    
    
    348,000Change in valuation allowance
    
    
    (18,000
    )
    
    
    1,911,000Other
    
    
    
    
    
    
    1,000Tax provision
    
    $
    
    
    
    $
    
 Deferred tax assets and liabilities consist of the following: At December 31,2004
    
    
    2003Deferred tax assets:Net operating loss carryforwards
    
    $
    4,447,000
    
    
    $
    4,410,000Capital loss carryforward
    
    
    262,000
    
    
    
    317,000Provision for loss on real estate investments
    
    
    
    
    
    
    Provision for loss on marketable securities
    
    
    106,000
    
    
    
    106,000Accrual and other temporary variances
    
    
    29,000
    
    
    
    29,000Valuation allowance
    
    
    (4,844,000
    )
    
    
    (4,862,000
    )Deferred tax liabilities
    
    
    
    
    
    
    Net deferred tax assets
    
    $
    
    
    
    $
    
 Realization of deferred tax assets is dependent upon generation of sufficient future taxable income
and the effects of other loss utilization provisions. Management has determined that sufficient
uncertainty exists regarding the realizability of a significant portion of the net deferred tax
assets and has provided a valuation allowance of $4,844,000 and $4,862,000, against the net
deferred tax assets of the Company as of December 31, 2004 and 2003, respectively. A valuation
allowance is considered to be a significant estimate that may change in the near term. F-19




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At December 31, 2004, the Company had net operating loss carryforwards of approximately $11.0
million and capital loss carryforwards of approximately $0.6 million available to be carried to
future periods. The loss carryforwards expire as follows: Year Expiring
    
    Net Operating Loss
    
    
    Capital Loss2008
    
    $
    
    
    
    $
    649,0002012
    
    
    458,000
    
    
    
    2018
    
    
    739,000
    
    
    
    2019
    
    
    115,000
    
    
    
    2020
    
    
    2,025,000
    
    
    
    2021
    
    
    177,000
    
    
    
    2022
    
    
    592,000
    
    
    
    2023
    
    
    6,085,000
    
    
    
    2024
    
    
    816,000
    
    
    
    Total loss carryforwards
    
    $
    11,007,000
    
    
    $
    649,000
 Note 13  Commitments and Contingencies Liquidity As of December 31, 2004, our unrestricted cash resources were approximately $1,799,000 and our
marketable securities available for sale were approximately $90,000. Our marketable securities
represented 10,000 shares of Stellent, Inc. and 100 shares of Century Realty Trust. The NASDAQ
closing quote on February 17, 2005 was $8.30 per share of Stellent, Inc. and $16.34 per share of
Century Realty Trust. During the year ended December 31, 2003, we sold 30,000 shares of Stellent, Inc. at an average
price of $8.30 per share and recognized a gain on the sale of these shares totaling approximately
$136,000. Net proceeds from these sales were approximately $249,000. Our management team and board of trustees have formulated a value-added business strategy focused
on acquiring well located, underperforming multi-family residential properties and repositioning
them through renovation, leasing, improved management and branding. During 2004 and the latter
part of 2003, management has been pursuing this strategy by actively seeking and reviewing
multi-family residential companies, portfolios and properties, including affordable housing
projects. While we made offers to some of the sellers, low interest rates for debt financing have
had the effect of increasing sale prices for these types of properties and we did not enter into
any definitive purchase agreements in 2004. We are currently engaged in discussions with potential
sellers, but have not entered into any definitive purchase agreements for any of these properties.
There can be no assurance that we will be able to enter into a definitive purchase agreement or
that we will be able to close a transaction once a definitive purchase agreement is signed. Even
if our management is successful in closing a transaction, investors may not value the transaction
in the same manner as we did, and investors may not value a portfolio of the same type of
properties as highly as they would value portfolios consisting of diverse properties. On June 30, 2003, the holders of our preferred shares consented to waive the dividend that would
otherwise have been payable in May 2003 and to eliminate any future dividends that would have been
payable under the terms of our preferred shares. The waiver was sought in connection with a
one-time incentive exchange offer under which we exchanged each of our preferred shares for 22.881
common shares. We are dependent on our existing cash and Stellent, Inc. shares to meet our liquidity needs because
cash from operations is not sufficient to meet our operating requirements. Because the cash flow
from our properties is not expected to fully fund our future liquidity requirements, we have
reduced our material future obligations, which include a mortgage on the apartment complex and the
employment contracts for our three executive officers. The debt service payment is being funded
from the cash flow of the property secured by the mortgage, and the F-20




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current
salary requirements of the employment contracts is only $5,000 per month for each executive
officer. We historically have financed our long-term capital needs, including acquisitions, as follows:  
    Borrowings from new loans;
    Additional equity issuances of our common and preferred shares; and
    Proceeds from the sales of our real estate and technology segment. There can be no assurance that any of the alternatives will be adopted, or if adopted, will be
successful. On October 1, 2003, we closed on the sale of our 92.9% general partnership interest in our four
commercial properties. Proceeds from the sale of these properties, net of closing costs and the
mortgage balances assumed by the purchaser, were approximately $1,601,000. The proceeds from the
sale were paid in a combination of approximately $801,000 in cash and 2,859,765 of our common
shares at an average closing price for the 30 calendar days prior to June 27, 2003 of $0.28. Also
as a result of the sale approximately $318,000 representing cash from the commercial real estate
properties was released from mortgage related restrictions and made available for operations. On October 31, 2003, we completed the refinance of Richton Trail with an independent lender. The
mortgage loan payable of $2.8 million has a fixed interest rate of 5.87% for a term of 10 years
with monthly principal and interest payments of approximately $18,000 based on a 25-year
amortization schedule. The balance due at maturity in 2013 will be approximately $2.1 million.
The net cash proceeds from the loan that were made available for operations were approximately $1.3
million. Employment Agreements The employment agreement with the former chief executive officer provided for an annual salary of
$150,000. The severance provision of this agreement provided for him to receive 95,541 preferred
shares in lieu of a $300,000 severance payment for his resignation. The number of shares issued
was based on two times his annual salary with the price of the preferred shares based on the
average closing price for the 30 calendar days prior to March 1, 2003. For his services from April
7, 2003 until June 15, 2003, he received compensation based on an annual salary of $60,000. The employment agreements with James C. Mastandrea and John J. Dee provide for an annual salary of
$60,000 each effective as of March 4, 2003 and in connection therewith, Mr. Mastandrea was
appointed as Chief Executive Officer and Mr. Dee was appointed as Chief Financial Officer on April
7, 2003. The initial terms of Messrs. Mastandrea and Dees employment are for two years and may be
extended for terms of one year through their 70th birthdays. Messrs. Mastandrea and
Dees base annual salaries may be adjusted from time to time, except that the adjustment may not be
lower than the preceding years base salary. The employment agreements provide that Messrs.
Mastandrea and Dee will be entitled to base salary and bonus at the rate in effect before any
termination for a period of three years in the event that their employment is terminated without
cause by us or for good reason by either Messrs. Mastandrea or Dee. On July 19, 2004, Jack R. Kuhn joined our executive management team as Sr. Vice President  Chief
Property Management and Development Officer responsible for overseeing, managing and directing all
property management and development activities. The employment agreement with Mr. Kuhn provides for an annual salary of $60,000 effective as of
July 19, 2004. The initial term of Mr. Kuhns employment is for one year and may be extended for
terms of one year through his 70th birthday. Mr. Kuhns base annual salary may be
adjusted from time to time, except that the adjustment may not be lower than the preceding years
base salary. The employment agreement provides that Mr. Kuhn will be entitled to base salary and
bonus at the rate in effect before any termination for a period of three years in the event that
his employment is terminated without cause by us or for good reason by Mr. Kuhn. F-21




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Note 14  Related Party Transactions Management Fees of Commercial Properties During 2003, we had a property management agreement with Hoyt Properties, Inc. (Hoyt Properties),
an entity controlled by our former chairman, which served as property manager of the commercial
properties owned by us. In connection with the agreement, Hoyt Properties managed the day-to-day
operations of our commercial properties and received a management fee for this service. Management
fees paid to Hoyt Properties were approximately $49,000 for the year ended December 31, 2003. On
October 1, 2003 we sold our four commercial properties managed by Hoyt Properties. As a result,
these management fees are included in discontinued operations. Richton Trail Acquisition and Management Fees Effective July 1, 2003, we closed the acquisition of our residential apartment complex, Richton
Trail, following approval by our shareholders of the transaction on June 30, 2003. Our operating
partnership, Paragon Real Estate, LP, acquired the residential complex along with the associated
mortgage from Hampton Court Associates, LP, a partnership controlled by James C. Mastandrea, its
general partner and our Chairman, Chief Executive Officer and President. In consideration for
transferring Richton Trail, Hampton Court Associates received 813,938 restricted limited
partnership units of Paragon Real Estate, LP. Each unit is redeemable after four years for cash,
or at our option, 22.881 of our common shares. Mr. Mastandrea also owns two companies that provide services to Richton Trail. Mid Illinois Realty
Corp. manages Richton Trail and MDC Realty Corp. is reimbursed, at cost, for Richton Trails
payroll related costs. The related management fees included in years ended December 31, 2004 and
December 31, 2003 were approximately $28,000 and $13,000, respectively. Reimbursement, at cost,
for the payroll related costs paid and accrued for the years ended December 31, 2004 and December
31, 2003 were approximately $59,300 and $30,700, respectively. As the Company acquires more
properties, it intends to use local third party management companies until we are able to provide
management services ourselves. Leasing Commissions During the year ended December 31, 2003, we paid a leasing commission of approximately $18,000 to
Hoyt Properties in connection with two new leases for a total of approximately 21,000 square feet.
On October 1, 2003 we sold our four commercial properties managed by Hoyt Properties. As a result, these leasing
commissions, net of accumulated amortization are included in discontinued operations. Rental Expense During the year ended December 31, 2003 we recognized rental expense of approximately $8,000,
related to office space leased from Hoyt Properties. F-22




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##### Table of Contents



Note 15  Supplemental Information to Statements of Cash Flows For the year ended December 31,2004
    
    
    2003Interest paid
    
    $
    166,487
    
    
    $
    346,333Supplemental schedule of non-cash investing and financing
activities:The following assets and liabilities were assumed in connection
with the acquisition of Richton TrailAcquisition of residential real estate
    
    $
    
    
    
    $
    (3,986,409
    )Additions to real estate
    
    
    
    
    
    
    (4,832
    )Security deposits
    
    
    
    
    
    
    44,732Mortgage note payable
    
    
    
    
    
    
    1,544,258Minority interest
    
    
    
    
    
    
    2,355,742Acquisition and additions to real estate properties
    
    $
    
    
    
    $
    (46,509
    )The following assets and liabilities were disposed of in
connection with the disposition of commercial propertiesDisposition of real estate
    
    $
    
    
    
    $
    8,134,097Restricted cash
    
    
    
    
    
    
    318,609Deferred costs and other assets
    
    
    
    
    
    
    210,862Mortgage notes payable
    
    
    
    
    
    
    (6,408,825
    )Accounts payable and accrued liabilities
    
    
    
    
    
    
    (289,664
    )Security deposits
    
    
    
    
    
    
    (45,000
    )Treasury shares
    
    
    
    
    
    
    (800,735
    )Cash proceeds from disposition of commercial properties
    
    $
    
    
    
    $
    1,119,344The following liabilities were assumed and disposed of in
connection with the refinance of the mortgage loan of Richton
TrailCash proceeds from new mortgage loan
    
    $
    
    
    
    $
    2,820,000Disposition of previous mortgage loan
    
    
    
    
    
    
    (1,533,637
    )Cash proceeds from refinance of mortgage loan
    
    $
    
    
    
    $
    1,286,363
 F-23