AMERICAN REALTY INVESTORS INC - Quarter Report: 2003 September (Form 10-Q)

FORM 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

x	QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTER ENDED SEPTEMBER 30, 2003

Commission File Number 1-15663

AMERICAN REALTY INVESTORS, INC.

(Exact Name of Registrant as Specified in Its Charter)

Nevada		75-2847135
(State or Other Jurisdiction of Incorporation or Organization)		(I.R.S. Employer Identification No.)

1800 Valley View Lane, Suite 300, Dallas, Texas		75234
(Address of Principal Executive Offices)		(Zip Code)

(469) 522-4200

(Registrant’s Telephone Number, Including Area Code)

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes ¨. No x.

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

APPLICABLE ONLY TO CORPORATE ISSUERS:

Indicate the number of shares outstanding of each of the issuer’s classes of Common Stock, as of the latest practicable date.

Common Stock, $.01 par value		10,645,300
(Class)		(Outstanding at October 31, 2003)*

*	Does not include 746,972 shares issued to and owned by Transcontinental Realty Investors, Inc.

AMERICAN REALTY INVESTORS, INC.

PART I. FINANCIAL INFORMATION

ITEM 1.

FINANCIAL STATEMENTS

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

AMERICAN REALTY INVESTORS, INC.

CONSOLIDATED BALANCE SHEETS

	September 30, 2003			December 31, 2002
	(dollars in thousands, except per share)
Assets
Real estate held for investment	$	1,019,991		$	378,080
Less—accumulated depreciation		<166,652	>		<96,036	>

		853,339			282,044
Real estate held for sale		157,319			181,713
Notes and interest receivable
Performing ($28,416 in 2003 and $34,442 in 2002 from affiliates)		71,976			77,354
Nonperforming ($5,085 in 2003 and $6,838 in 2002 from affiliates)		14,373			7,856

		86,349			85,210
Less—allowance for estimated losses		<4,633	>		<3,077	>

		81,716			82,133
Pizza parlor equipment		13,845			12,557
Less—accumulated depreciation		<5,454	>		<4,562	>

		8,391			7,995
Marketable equity securities, at market value		5,078			209
Cash and cash equivalents		7,451			8,432
Investments in equity investees		4,193			80,990
Goodwill, net of accumulated amortization ($1,763 in 2003 and 2002)		11,858			13,784
Other intangibles, net of accumulated amortization ($810 in 2003 and $773 in 2002)		1,541			1,744
Other assets ($11,130 in 2003 to affiliate)		88,370			50,001

	$	1,219,256		$	709,045

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

AMERICAN REALTY INVESTORS, INC.

CONSOLIDATED BALANCE SHEETS—Continued

	September 30, 2003			December 31, 2002
	(dollars in thousands, except per share)
Liabilities and Stockholders’ Equity
Liabilities
Notes and interest payable ($15,600 in 2002 to affiliates)	$	852,368		$	349,740
Liabilities related to assets held for sale		104,856			125,693
Margin borrowings		25,198			8,558
Accounts payable and other liabilities ($27,207 in 2003 and $41,085 in 2002 to affiliates)		108,576			127,872

		1,090,998			611,863
Minority interest		53,948			19,940
Commitments and contingencies
Stockholders’ equity
Preferred Stock, $2.00 par value, authorized 50,000,000 shares, issued and outstanding
Series A, 3,226,610 shares in 2003 and 3,226,858 shares in 2002 (liquidation preference $32,266), including 900,000 shares in 2003 and 2002 held by subsidiaries		4,653			4,654
Series E, 50,000 shares in 2003 and 2002 (liquidation preference $500)		100			100
Common Stock, $.01 par value, authorized 100,000,000 shares; issued 11,375,127 shares in 2003 and 2002		114			114
Paid-in capital		92,289			93,954
Treasury stock, at cost, 746,972 shares in 2003		<9,924	>		—
Accumulated deficit		<12,564	>		<24,784	>
Accumulated other comprehensive income		<358	>		3,204

		74,310			77,242

	$	1,219,256		$	709,045

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

AMERICAN REALTY INVESTORS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

	For the Three Months Ended September 30,						For the Nine Months Ended September 30,
	2003			2002			2003			2002
	(dollars in thousands, except per share)
Property revenue
Rents	$	49,891		$	18,039		$	116,740		$	52,910
Property operations expenses		34,350			13,244			80,342			40,535

Operating income		15,541			4,795			36,398			12,375

Land operations
Sales		27,551			18,681			39,654			55,980
Cost of sales		12,080			16,097			23,150			38,916
Deferred current gain		—			—			—			11,913
Recognition of previously deferred gains		27			34			19,924			830

Gain on land sales		15,498			2,618			36,428			5,981

Pizza parlor operations
Sales		8,330			8,157			24,267			23,979
Cost of sales		6,592			6,528			19,357			18,821

Gross margin		1,738			1,629			4,910			5,158

Income from operations		32,777			9,042			77,736			23,514

Other income
Interest income		1,795			509			7,431			1,906
Equity in loss of investees		<204	>		<4,790	>		<4,279	>		<14,023	>
Loss on sale of investments in equity investees		—			—			—			<531	>
Other		55			190			307			516

		1,646			<4,091	>		3,459			<12,132	>
Other expenses
Interest		20,925			11,980			51,517			39,180
Depreciation and amortization		7,137			2,134			16,119			5,959
Discount on sale of notes receivable		<1	>		—			1,557			—
General and administrative		6,171			3,322			16,865			9,803
Advisory fee to affiliate		3,740			1,573			8,468			4,825
Net income fee to affiliate		675			—			675			—
Incentive fee to affiliate		1,091			—			1,091			—
Writedown of assets held for sale		—			445			2,352			445
Minority interest		20			436			1,210			1,996

		39,758			19,890			99,854			62,208

Net loss from continuing operations		<5,335	>		<14,939	>		<18,659	>		<50,826	>

Discontinued operations:
Loss from operations		<1,457	>		<154	>		<2,997	>		<3,887	>
Gain on sale of real estate		18,222			15,375			34,041			23,140
Equity in gain <loss> on sale of real estate by equity investees		<165	>		6,616			<165	>		14,896

Net income from discontinued operations		16,600			21,837			30,879			34,149

Net income <loss>		11,265			6,898			12,220			<16,677	>
Preferred dividend requirement		<587	>		<601	>		<1,763	>		<1,801	>

Net income <loss> applicable to Common shares	$	10,678		$	6,297		$	10,457		$	<18,478	>

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

AMERICAN REALTY INVESTORS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS—Continued

	For the Three Months Ended September 30,						For the Nine Months Ended September 30,
	2003			2002			2003			2002
Basic and diluted earnings per share
Net loss from continuing operations	$	<.56	>	$	<1.37	>	$	<1.89	>	$	<4.62	>
Discontinued operations		1.56			1.92			2.85			3.00

Net income <loss> applicable to Common shares	$	1.00		$	.55		$	.96		$	<1.62	>

Weighted average Common shares used in computing earnings per share		10,628,155			11,375,127			10,838,839			11,375,127

Convertible Preferred Stock (2,326,610 shares) and options to purchase 108,750 shares of ARI’s Common Stock were excluded from the computation of diluted earnings per share for the three and nine months ended September 30, 2003, because the effect of their inclusion would be antidilutive.

Convertible Preferred Stock (2,326,858 shares) and options to purchase 186,750 shares of ARI’s Common Stock were excluded from the computation of diluted earnings per share for the three and nine months ended September 30, 2002, because the effect of their inclusion would be antidilutive.

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

AMERICAN REALTY INVESTORS, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

For the Nine Months Ended September 30, 2003

	Series A Preferred Stock			Series E Preferred Stock		Common Stock		Paid-in Capital			Treasury Stock			Accumulated Deficit			Accumulated Other Comprehensive Income/<Loss>			Stockholders’ Equity
	(dollars in thousands, except per share)

Balance, January 1, 2003	$	4,654		$	100	$	114	$	93,954		$	—		$	<24,784	>	$	3,204		$	77,242
Comprehensive income
Unrealized foreign currency translation loss		—			—		—		—			—			—			<445	>		<445	>
Sale of foreign operations		—			—		—		—			—			—			<3,117	>		<3,117	>
Net income		—			—		—		—			—			12,220			—			12,220

																					8,658
Repurchase of Series A Preferred stock		<1	>		—		—		<2	>		—			—			—			<3	>
Common shares held by acquired company		—			—		—		—			<9,924	>		—			—			<9,924	>
Exchange of investments with affiliates		—			—		—		100			—			—			—			100
Preferred dividends
Series A Preferred Stock ($.75 per share)		—			—		—		<1,741	>		—			—			—			<1,741	>
Series E Preferred Stock ($.45 per share)		—			—		—		<22	>		—			—			—			<22	>

Balance, September 30, 2003	$	4,653		$	100	$	114	$	92,289		$	<9,924	>	$	<12,564	>	$	<358	>	$	74,310

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

AMERICAN REALTY INVESTORS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

	For the Nine Months Ended September 30,
	2003			2002
	(dollars in thousands)
Cash Flows From Operating Activities
Net income <loss>	$	12,220		$	<16,677	>
Reconciliation of net income <loss> to net cash used in operating activities
Adjustments to reconcile net income to net cash used in operating activities
Depreciation and amortization		18,281			11,549
Gain on sale of land and real estate		<70,304	>		<29,121	>
Equity in <income> loss of investees		4,279			<873	>
Distributions to minority interest holders		—			30
Loss on sale of investments in equity investees		—			531
Loss allocated to minority interest		<333	>		—
Writedown of assets held for sale		2,352			445
Loss on foreign currency transaction		963			—
Increase in accrued interest receivable		<4,015	>		<927	>
<Increase> decrease in other assets		10,185			<96	>
Increase in accrued interest payable		269			2,541
Increase <decrease> in accounts payable and other liabilities		<759	>		382

Net cash used in operating activities		<26,862	>		<32,216	>

Cash Flows From Investing Activities
Collections on notes receivable		26,015			5,473
Proceeds from sale of notes receivable		26,346			—
Pizza parlor equipment purchased		<1,397	>		<2,034	>
Proceeds from sale of real estate		134,535			69,677
Notes receivable funded		<615	>		<1,965	>
Earnest money deposits		<13,311	>		868
Investment in real estate entities, net of cash acquired		<24,218	>		<2,554	>
Acquisition of real estate		<12,000	>		<1,359	>
Distributions to equity investees		<650	>		—
Payments under interest rate swap contract		<31	>		<199	>
Real estate improvements		<21,425	>		<15,795	>

Net cash provided by investing activities		113,249			52,112

Cash Flows from Financing Activities
Proceeds from notes payable		82,275			80,893
Payments on notes payable		<186,142	>		<95,280	>
Deferred borrowing costs		<5,440	>		<4,684	>
Net <payments to>/advances from affiliates		7,815			20,630
Margin borrowings, net		15,890			<17,100	>
Stock sale profits received from affiliate		—			22
Preferred dividends paid		<1,763	>		<1,778	>
Common dividends paid		—			<25	>
Repurchase of Preferred shares		<3	>		—

Net cash used in financing activities		<87,368	>		<17,322	>

Net <decrease> increase in cash and cash equivalents		<981	>		2,574

Cash and cash equivalents, beginning of period		8,432			709

Cash and cash equivalents, end of period	$	7,451		$	3,283

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

AMERICAN REALTY INVESTORS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS—Continued

	For the Nine Months Ended September 30,
	2003		2002
	(dollars in thousands)
Supplemental Disclosures of Cash Flow Information
Cash paid for interest	$	84,815	$	42,611

Schedule of noncash investing and financing
Notes payable assumed by buyer on sale of real estate	$	43,815	$	56,495
Notes receivable from sale of real estate		46,394		10,321
Disposal of property to satisfy debt		6,000		24,886
Cancellation of Series F Preferred Stock		—		3,969
Note receivable from sale of leasehold interests		—		1,300
Acquisition of property to satisfy debt		2,671		16,268
Assumed debt of seller on purchase of real estate		13,375		9,644
Exchange of interest in note receivable for stock		5,764		—
Note receivable from exchange of stock with affiliate		526		—
Funds collected by affiliate for property financing		1,500		—
Funds collected by affiliate on sale of real estate		4,599		—

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

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1. BASIS OF PRESENTATION

The accompanying Consolidated Financial Statements have been prepared in conformity with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. Dollar amounts in tables are in thousands, except per share amounts. Certain balances for 2002 have been reclassified to conform to the 2003 presentation.

Operating results for the nine month period ended September 30, 2003, are not necessarily indicative of the results that may be expected for the year ending December 31, 2003. For further information, refer to the Consolidated Financial Statements and Notes thereto included in ARI’s Annual Report on Form 10-K for the year ended December 31, 2002 (the “2002 Form 10-K”).

On November 15, 2002, ARI, through wholly-owned subsidiaries, commenced a tender offer for the common shares of Transcontinental Realty Investors, Inc. (“TCI”) and Income Opportunity Realty Investors, Inc. (“IORI”) not already owned by ARI. The tender offer was completed on March 19, 2003. ARI paid $19.00 cash per IORI share and $17.50 cash per TCI share for the stock of non-affiliated stockholders. Pursuant to the tender offer, ARI acquired 265,036 IORI shares and 1,213,226 TCI shares. After the tender offer, ARI owned 64.8% of the outstanding shares of TCI and 62.5% of the outstanding shares of IORI (46.9% owned directly by ARI and 15.6% through TCI’s ownership of IORI shares). ARI began consolidation of TCI’s and IORI’s accounts and operations effective March 31, 2003. The effect of consolidating TCI’s and IORI’s operations from the completion of the tender offer through March 31, 2003 was determined to be immaterial. On June 2, 2003, ARI exchanged all of its 674,971 IORI shares with Basic Capital Management, Inc. (“BCM”), a related party and the contractual advisor to ARI until June 30, 2003, receiving 650,000 TCI shares from BCM. In addition, BCM has executed a promissory note in favor of ARI in the amount of $526,000 (see NOTE 3. “NOTES RECEIVABLE”). After the exchange, ARI owned 72.9% of the outstanding shares of TCI. On June 30, 2003, ARI sold a participating interest in $5.8 million of its $15.5 million line of credit receivable from One Realco Corporation (“One Realco”) to BCM, receiving 314,141 TCI shares from BCM (see NOTE 3. “NOTES RECEIVABLE”). After the transaction, ARI owned 76.8% of the outstanding shares of TCI. ARI no longer directly owns any IORI shares. At September 30, 2003, ARI owned 18.4% of IORI through TCI’s ownership of IORI shares. ARI ceased consolidation of IORI’s accounts and operations effective June 2, 2003.

The following pro forma information reflects the results of operations for ARI as though the consolidation of TCI’s operations had begun on January 1 of each year presented.

	Three Months Ended September 30,		Nine Months Ended September 30,
	2002		2003		2002
Revenue, as reported	$	44,877	$	144,961	$	132,869
Revenue, pro forma		73,103		174,269		174,611
Net income <loss>, as reported		6,898		12,220		<16,677	>
Net income <loss>, pro forma		6,173		11,287		<16,309	>
Earnings per share:
Basic, as reported	$	.55	$	.96	$	<1.62	>
Basic, pro forma	$	.49	$	.88	$	<1.59	>
Diluted, as reported	$	.55	$	.96	$	<1.62	>
Diluted, pro forma	$	.49	$	.88	$	<1.59	>

On June 30, 2003, ARI sold its 74.31% interest in Realty Advisors Korea, Ltd. (“RAK”) to Realty Advisors, Inc. (“Realty Advisors”), a related party. The sales price was $6.0 million. Realty Advisors also paid ARI $600,000, representing 10% interest on the $6.0 million price paid by ARI to purchase the 74.31% interest in RAK in 2002. The $6.0 million sales price reduced ARI’s affiliate debt. The $600,000 interest was received in cash in August 2003. ARI ceased consolidation of RAK’s accounts and operations effective June 30, 2003.

Effective July 1, 2003, Prime Asset Management, Inc. (“Prime”) became the advisor to ARI and TCI. Prime is owned by Realty Advisors (79%) and Syntek West, Inc. (“Syntek West”) (21%), related parties. Syntek West is owned by Gene Phillips. Effective August 18, 2003, Prime changed its name to Prime Income Asset Management, Inc. On October 1, 2003, Prime Income Asset Management, LLC (“Prime LLC”), which is 100% owned by Prime, replaced Prime as the advisor to ARI and TCI.

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued

NOTE 1. BASIS OF PRESENTATION (Continued)

debt guarantees and ARI’s continuing ownership interest in MRI, management has determined that this should be accounted for as a financing transaction. In September 2003, ARI sold the note to Syntek West for $2.3 million, plus accrued but unpaid interest, to reduce affiliate debt. No gain or loss was recorded in this transaction.

Recent accounting pronouncements. In January 2003, the FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities” (“FIN 46”), which requires the consolidation of variable interest entities, as defined. FIN 46 is applicable to financial statements to be issued by ARI after 2003; however, disclosures are required currently if ARI expects to consolidate any variable interest entities. ARI does not currently believe that any entities will be consolidated as a result of FIN 46.

In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” This statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires the issuer to classify a financial instrument that is within the scope of the standard as a liability if such financial instrument embodies an obligation of the issuer. The adoption of SFAS No. 150 is not expected to require ARI to reclass any financial instruments currently on its balance sheet.

Stock-based employee compensation. Accounting Principles Board Opinion No. 25 “Accounting for Stock Issued to Employees,” and related Interpretations are utilized by management in accounting for the option plans. All share options issued have exercise prices equal to the market price of the shares at the dates of grant. Accordingly, no compensation cost has been recognized for the option plans. Had compensation cost for the option plans been determined based on the fair value at the grant dates consistent with the method of Statement of Financial Accounting Standards No. 123 “Accounting for Stock-Based Compensation,” net income (loss) and net income (loss) per share would have been the pro forma amounts indicated below.

	Three Months Ended September 30,				Nine Months Ended September 30,
	2003		2002		2003		2002
	(dollars in thousands, except per share amounts)
Net income <loss>, as reported	$	11,265	$	6,898	$	12,220	$	<16,677	>
Deduct: Total stock-based employee compensation expense determined under fair value based methods for all awards, net of related tax effects		—		—		19		18

Pro forma net income <loss>	$	11,265	$	6,898	$	12,201	$	<16,695	>

Income <loss> per share:
Basic, as reported	$	1.00	$	.55	$	.96	$	<1.62	>
Basic, pro forma	$	1.00	$	.55	$	.96	$	<1.62	>
Diluted, as reported	$	1.00	$	.55	$	.96	$	<1.62	>
Diluted, pro forma	$	1.00	$	.55	$	.96	$	<1.62	>

NOTE 2. REAL ESTATE

In 2003, ARI purchased the following properties:

Property	Location	Units/Acres	Purchase Price		Net Cash Paid		Debt Incurred			Interest Rate		Maturity Date
*First Quarter*
Apartments
Capitol Hill⁽¹⁾	Little Rock, AR	156 Units	$	1,904	$	615	$	1,289		5.50	%	10/44

*Second Quarter*
Apartments
Breakwater Bay⁽¹⁾	Beaumont, TX	176 Units		1,979		383		1,554		5.50		08/44
Longwood	Long Beach, MS	200 Units		6,349		334		6,349	⁽²⁾	7.60		04/12

Land
Pulaski	Pulaski County, AR	21.9 Acres		2,000		695		1,400		6.50		05/05

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued

Property

Location

Units/Acres

Purchase
Price

Net
Cash
Paid

Debt
Incurred

Interest
Rate

Maturity
Date

Third Quarter

Land

Sheffield Village

Grand Prairie, TX

13.9 Acres

1,500

632

975

5.50

%⁽³⁾

09/04

Fourth Quarter

Land

Travelers⁽⁴⁾

Farmers Branch, TX

202.0 Acres

25,000

1,947

22,802

—

⁽⁵⁾

10/06

⁽¹⁾	Land purchased for apartment construction.

⁽²⁾	Assumed debt of seller.

⁽³⁾	Variable interest rate

⁽⁴⁾	Purchased from IORI.

⁽⁵⁾	No stated interest rate.

In February 1990, ARI sold the Bridgeview Plaza Shopping Center, located in LaCrosse, Wisconsin, providing purchase money financing of $5.0 million in the form of a wrap mortgage. In 1996, the first lienholder called a default under the ARI wrap note, and directed future payments be made directly to them. ARI began legal proceedings against the first lienholder. In December 1999, ARI sold the note to BCM at its carrying value of $489,000, retaining the right to receive any amounts collected by BCM in excess of the amount paid, plus accrued interest. In 2002, ARI prevailed in its litigation and ARI’s lien on the property was restored. The borrower continued in default, and ARI foreclosed on the property in March 2003. The property was subsequently sold to TCI. See NOTE 8. “RELATED PARTY TRANSACTIONS.”

In 2002, ARI purchased the following property:

Property	Location	Sq.Ft./ Units/Acres	Purchase Price		Net Cash Paid		Debt Incurred			Interest Rate		Maturity Date
*First Quarter*
Shopping Center
Plaza on Bachman Creek⁽¹⁾	Dallas, TX	80,278 Sq.Ft.	$	3,103	$	—	$	—		—		—

*Second Quarter*
Apartments
Pinecrest⁽²⁾	North Augusta, SC	120 Units		2,986		—		1,423	⁽³⁾	8.75	%	03/03
Tiberon Trails⁽²⁾	Merrillville, IN	376 Units		12,000		—		6,417	⁽³⁾	9.00		07/06

Shopping Center
Alta Mesa⁽²⁾	Ft. Worth, TX	59,933 Sq.Ft.		4,000		—		1,804	⁽³⁾	10.43		10/04

Land
Pioneer Crossing	Austin, TX	79.4 Acres		1,165		1,213		—		—		—
Willow Springs	Beaumont, CA	20.7 Acres		140		146		—		—		—

⁽¹⁾	Exchanged with TCI for the Oaktree Village Shopping Center, Rasor land parcel and Lakeshore Villas land parcel.

⁽²⁾	Property received from BCM for forgiveness of debt.

⁽³⁾	Assumed debt of seller.

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued

In 2003, ARI sold the following properties:

Property	Location	Units/Sq.Ft./ Acres/Rooms	Sales Price		Net Cash Received/ (Paid)			Debt Discharged			Gain/ (Loss) on Sale
*First Quarter*
Apartments
Bay Anchor	Panama City, FL	12 Units	$	369	$	—		$	291		$	143
Georgetown	Panama City, FL	44 Units		1,175		323			789	⁽³⁾		72
Northside Villas	Tallahassee, FL	81 Units		5,575		1,806			2,784			915
Rolling Hills	Tallahassee, FL	134 Units		5,061		1,361			2,785			1,182
Seville	Tallahassee, FL	62 Units		2,795		—			2,360			489

Shopping Centers
Bridgeview Plaza	LaCrosse, WI	116,008 Sq.Ft.		8,700		—			—			8,700	⁽¹⁾
Cullman	Cullman, AL	92,466 Sq.Ft.		2,000		—			2,650	⁽³⁾		1,118	⁽¹⁾

Office Building
4135 Beltline Road	Addison, TX	90,000 Sq.Ft.		4,358		—			2,858	⁽³⁾		178	⁽²⁾

Land
Katrina	Palm Desert, CA	89.3 Acres		8,550		<410	>		2,840			<40	>
Nashville	Nashville, TN	8.8 Acres		235		<11	>		217			114

Hotel
Grand Hotel Sofia	Sofia, Bulgaria	136 Rooms		24,750		6,258			4,209	⁽³⁾		49	⁽⁴⁾

*Second Quarter*
Apartments
Greenbriar	Tallahassee, FL	50 Units		1,700		594			976			1,025
Lake Château	Thomasville, GA	98 Units		1,600		460			1,033			147
Pinecrest	North Augusta, SC	120 Units		2,707		1,136			1,429			<304	>
Regency	Lincoln, NE	106 Units		4,880		838			3,179			2,815
Willow Wick	North Augusta, SC	104 Units		2,707		255			1,943			1,140

Industrial Warehouses
McLeod	Orlando, FL	110,914 Sq.Ft.		5,450		2,980			1,902			2,805
Tricon	Atlanta, GA	570,877 Sq.Ft.		13,084		3,364			9,395			5,579

Land
Mason Goodrich	Houston, TX	8.0 Acres		210		—	⁽⁵⁾		—			<149	>
Mason Goodrich	Houston, TX	1.6 Acres		209		12			169			113
Mason Goodrich	Houston, TX	7.7 Acres		900		36			764			466
Solco-Valley Ranch	Farmers Branch, TX	6.1 Acres		1,999		<90	>⁽⁷⁾		—			529

Hotel
Clarion KC Airport ⁽⁶⁾	Kansas City, MO	196 Rooms		5,312		—			4,888	⁽³⁾		<101	>

*Third Quarter*
Apartments
Landing & Marina	Pensacola, FL	52 Units		1,825		576			1,162			492
Lincoln Court	Dallas, TX	55 Units		3,038		1,834			1,208			1,149
Quail Creek	Lawrence, KS	95 Units		4,700		1,188			3,260			1,683
Stone Oak	San Antonio, TX	252 Units		6,930		3,670			2,699			4,490

Office Buildings
Bonita Plaza	Bonita, CA	47,777 Sq.Ft.		8,034		1,698			5,944			2,798
Encino Executive Plaza	Encino, CA	177,211 Sq.Ft.		37,040		1,947			33,145	⁽³⁾		<67	>

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued

Property	Location	Sq. Ft./ Rooms/Units/ Acres	Sales Price		Net Cash Received/ (Paid)			Debt Discharged			Gain/ (Loss) on Sale
*Third Quarter* (Continued)
Shopping Centers
Oak Tree Village	Lubbock, TX	45,623 Sq.Ft.	$	3,366	$	1,527		$	1,328		$	820
Sheboygan	Sheboygan, WI	74,532 Sq.Ft.		1,225		669			569			181
Westwood	Tallahassee, FL	149,855 Sq.Ft.		8,950		5,045			1,880			5,787

Land
Nashville	Nashville, TN	1.1 Acres		201		9			170			135
Palm Desert	Palm Desert, CA	25.1 Acres		2,600		<88	>⁽⁹⁾		—			797
Pioneer Crossing	Austin, TX	367.4 Acres		22,500		4,948			—			13,916
Vista Ridge	Lewisville, TX	14.5 Acres		2,250		713			1,343			622

Hotels
City Suites	Chicago, IL	45 Rooms		4,806		89			4,081	⁽³⁾		943	⁽⁸⁾
Majestic	Chicago, IL	52 Rooms		3,550		66			2,448	⁽³⁾		704	⁽⁸⁾
Williamsburg Hospitality House	Williamsburg, VA	296 Rooms		19,500		250			12,332	⁽³⁾		1,731	⁽⁸⁾
Willows	Chicago, IL	55 Rooms		5,144		95			4,054	⁽³⁾		978	⁽⁸⁾

*Fourth Quarter*
Apartments
Summerfield	Orlando, FL	224 Units		9,415		4,845			4,476			4,268

Land
Keller	Tarrant County, TX	30.0 Acres		2,800		2,676			—			2,439
Pioneer Crossing	Austin, TX	343.7 Acres		8,136		3,479			—			2,197

⁽¹⁾	Sold to TCI to satisfy debt. Gain deferred until sale to unrelated party.

⁽²⁾	Sold to Tacco Office Investors, Inc., a related party. Gain deferred until sale to unrelated party.

⁽³⁾	Debt assumed by purchaser.

⁽⁴⁾	Includes recognition of $3.1 million of accumulated foreign currency translation gains.

⁽⁵⁾	Cash of $210,000 was received by BCM and applied to ARI’s affiliate debt.

⁽⁶⁾	Sold to One Realco Hotel Investors, Inc. (“One Realco Hotel”), a related party.

⁽⁷⁾	Cash of $2.0 million was received by BCM and applied to ARI’s affiliate debt.

⁽⁸⁾	Sold to One Realco Hotel. Gain deferred until sale to unrelated party.

⁽⁹⁾	Cash of $2.6 million was received by Prime and applied to ARI’s affiliate debt.

In 2002, ARI sold the following properties:

Property	Location	Units/ Acres/Sq.Ft.	Sales Price		Net Cash Received/ (Paid)			Debt Discharged			Gain/(Loss) on Sale
*First Quarter*
Apartments
Mallard Lake⁽¹⁾	Greensboro, NC	336 Units	$	14,400	$	—		$	7,362		$	—
Villas	Plano, TX	208 Units		8,525		3,701			4,023			5,615

Land
Katrina	Palm Desert, CA	2.1 Acres		1,323		<40	>		1,237			978
Lakeshore Villas⁽²⁾	Harris County, TX	16.9 Acres		1,499		215			—			—
Rasor⁽²⁾	Plano, TX	24.5 Acres		1,211		174			—			—
Thompson II	Dallas County, TX	.2 Acres		21		20			—			<11	>
Vista Ridge	Lewisville, TX	10.0 Acres		1,525		130			1,220			401

Shopping Center
Oaktree Village⁽²⁾	Lubbock, TX	45,623 Sq.Ft.		2,302		131			1,389	⁽³⁾		—

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued

Property	Location	Sq. Ft./ Units/Acres	Sales Price		Net Cash Received/ (Paid)			Debt Discharged			Gain/ (Loss) on Sale
*Second Quarter*
Apartments
Oak Hill	Tallahassee, FL	92 Units	$	3,200	$	156	⁽⁴⁾	$	2,550		$	285
Regency	Tampa, FL	78 Units		3,200		851			1,710			541
Stonebridge	Florissant, MO	100 Units		4,340		1,142			2,893			3,081
Office Building
Centura	Dallas, TX	410,901 Sq.Ft.		50,000		—			43,739	⁽³⁾		5,762	⁽⁵⁾

Land
Hollywood Casino	Farmers Branch, TX	42.8 Acres		16,987		—			6,222	⁽³⁾		7,520	⁽⁵⁾
Marine Creek	Ft. Worth, TX	54.2 Acres		3,700		—			1,500	⁽³⁾		1,334	⁽⁵⁾
Mason Goodrich	Houston, TX	7.9 Acres		672		46			554			268
Mason Goodrich	Houston, TX	10.3 Acres		1,444		93			1,225			895
Mason Goodrich	Houston, TX	18.0 Acres		2,790		—			2,690	⁽³⁾		1,982	⁽⁵⁾
Monterrey	Riverside, CA	61.0 Acres		4,625		—			—			61	⁽⁵⁾
Nashville	Nashville, TN	16.6 Acres		1,890		—			955	⁽³⁾		1,016	⁽⁵⁾

*Third Quarter*
Apartments
Conradi House	Tallahassee, FL	98 Units		1,809		388			1,047			452
Lee Hills	Tallahassee, FL	16 Units		445		355			—			131
Morning Star	Tallahassee, FL	82 Units		2,217		718			1,187			638
Pheasant Ridge	Bellevue, NE	264 Units		10,400		2,576			6,237			6,763
Stonegate	Tallahassee, FL	83 Units		1,785		486			1,026			<124	>
Valley Hi	Tallahassee, FL	54 Units		1,452		75			1,159			436
White Pines	Tallahassee, FL	85 Units		764		10			593			<49	>
Woodsong	Smyrna, GA	190 Units		9,200		<45	>		8,196			7,128

Land
Elm Fork	Denton County, TX	14.5 Acres		2,745		<105	>		2,633			1,615
Elm Fork	Denton County, TX	14.2 Acres		1,526		<54	>		701			527
Elm Fork	Denton County, TX	16.7 Acres		1,617		<299	>		1,554			429
Katrina	Palm Desert, CA	80.0 Acres		6,778		<1,382	>		2,500			<2,045	>
Messick	Palm Desert, CA	71.0 Acres		6,015		<163	>		1,300			2,058

⁽¹⁾	Exchanged for Governor’s Square, Grand Lagoon, Park Avenue, Greenbriar, Regency and Westwood Apartments.

⁽²⁾	Exchanged with TCI for the Plaza on Bachman Creek Shopping Center.

⁽³⁾	Debt assumed by purchaser.

⁽⁴⁾	Represents dividends on and redemption of Innovo Preferred Stock. See NOTE 6. “NOTES PAYABLE.”

⁽⁵⁾	Sold to TCI. Gain deferred until sales to unrelated parties in the third quarter of 2002 ($34,000 gain recognized) and the third quarter of 2003 ($27,000 gain recognized).

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued

At September 30, 2003, ARI had the following properties under construction:

Property	Location	Units	Amount Expended		Additional Amount to Expend		Construction Loan Funding
Apartments
Breakwater Bay	Beaumont, TX	176 Units	$	2,487	$	7,980	$	9,545
Capitol Hill	Little Rock, AR	156 Units		3,111		7,468		9,500
DeSoto Ranch	DeSoto, TX	248 Units		15,872		2,348		16,273
Echo Valley	Dallas, TX	216 Units		10,031		4,189		12,715
Heather Creek	Mesquite, TX	200 Units		3,073		10,229		12,079
Kingsland Ranch	Houston, TX	398 Units		4,323		21,332		23,000
Verandas at City View	Fort Worth, TX	314 Units		13,745		9,098		19,393
Vistas at Pinnacle Park	Dallas, TX	322 Units		2,788		18,394		19,149

During the nine months ended September 30, 2003, ARI completed the 186 unit Blue Lake Villas in Waxahachie, Texas, the 284 unit Falcon Lakes in Arlington, Texas, the 180 unit River Oaks Apartments in Wiley, Texas, the 384 unit Sendero Ridge Apartments in San Antonio, Texas and the 256 unit Spyglass Apartments in Mansfield, Texas.

NOTE 3. NOTES RECEIVABLE

In February 2003, ARI sold an 89.3 acre tract of its Katrina land parcel for $8.5 million, paying $410,000 after payment of closing costs and debt paydown and providing purchase money financing of $5.6 million. The note bears interest at 8.0% per annum and matures three years after the recording of the Deed of Trust. Interest will begin accruing after improvements to the site have been completed by ARI. ARI expects that the improvements will be completed by the end of February 2004. The future costs to ARI to complete the improvements, estimated to be $2.5 million, were accrued in 2002. A principal payment of $450,000 is due within ten days after a Tentative Parcel Map (the “Map”) is recorded. ARI expects that the Map will be recorded by the end of November 2003. Interest payments will be due on the first day of each calendar quarter, beginning with the first quarter following the completion of the site improvements.

In March 2003, ARI sold the Grand Hotel Sofia for $24.8 million, receiving $6.3 million in cash after paying closing costs and debt assumption and providing purchase money financing of $13.5 million. The note was non-interest-bearing for 90 days, then bore interest at 9.0% per annum for the next 90 days and matured in September 2003. In September 2003, the note was collected in full.

In March 2003, ARI sold the 90,000 sq. ft., 4135 Beltline Office Building in Addison, Texas, for $4.4 million. No cash was received or paid by ARI, after debt assumption and providing purchase money financing of $1.5 million. The note bears interest at 12.0% per annum, requires quarterly payments of accrued interest and matures in March 2004.

In June 2003, ARI sold the 104 unit Willow Wick Apartments in North Augusta, South Carolina, for $2.7 million, receiving $255,000 after payment of closing costs and debt pay down and providing purchase money financing of $42,000. The note bears interest at 5.0% per annum and requires all interest and principal be paid at maturity in December 2003.

In September 2003, ARI sold a 367.4 acre tract of its Pioneer Crossing land parcel for $22.5 million, receiving $4.9 million after payment of closing costs and providing purchase money financing of $16.9 million. The note bears interest at 8.0% per annum, matures in September 2006 and requires quarterly payments of accrued interest beginning in January 2004. All principal and accrued but unpaid interest are due at maturity. In November 2003, ARI sold an interest in $8.0 million of the note for $7.5 million, receiving $7.2 million in cash after payment of closing costs and debt paydown.

In September 2002, ARI sold its Messick land parcel and an 80.0 acre tract of its Katrina land parcel for $12.8 million, paying $1.5 million after payment of closing costs and debt paydown and providing purchase money financing of $9.6 million. The note bore interest at 8.0% per annum, matured in September 2004 and required quarterly payments of accrued interest. All principal and accrued interest were due at maturity. In February 2003, ARI accepted $7.4 million as full payment for $7.7 million in principal and accrued interest. In March 2003, the remaining $1.9 million note balance was sold to an unrelated party for $1.8 million plus accrued and unpaid interest.

In December 2002, ARI sold its Willow Springs land parcel for $9.8 million, paying $1.3 million after payment of closing costs and debt paydown and providing purchase money financing of $7.8 million. The note bore interest at 8.0% per annum, matured in December 2005 and required periodic interest payments beginning in June 2003. In March 2003, the note was sold to an unrelated party for $7.5 million plus accrued and unpaid interest. The buyer of the note has limited recourse against a 53 acre parcel of ARI’s

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued

Katrina land, in event of default by the borrower. ARI recognized a previously deferred gain of $4.9 million upon completion of the sale of the note.

In December 2002, ARI sold a 238.0 acre tract of its Desert Wells land parcel for $23.8 million, receiving $321,000 after payment of closing costs and debt paydown and providing purchase money financing of $21.4 million. The first lien financing of $17.8 million bore interest at 8.0% per annum, matured in December 2004 and required payments beginning in March 2003. In March 2003, the note was sold to an unrelated party for $17.1 million plus accrued and unpaid interest. The buyer of the note has limited recourse against a 53 acre parcel of ARI’s Katrina land, in event of default by the borrower. ARI recognized a previously deferred gain of $15.0 million upon completion of the sale of the note. The second lien financing of $3.6 million bore interest at 8.0% per annum and matured on March 31, 2003. All principal and interest were due at maturity. At November 2003, negotiations are underway to modify and extend the terms of the note. In July 2003, ARI advanced an additional $357,000 to the borrower. The new note bears interest at 8.0% per annum and matures in July 2004. All principal and interest are due at maturity.

In December 2002, ARI sold a 171.1 acre tract of its Desert Wells land parcel for $11.9 million receiving $1.4 million after payment of closing costs and debt paydown and providing purchase money financing of $8.9 million. The note bore no interest and matured in March 2003. The principal was due at maturity. In December 2002, an interest in $7.7 million of the note was sold to an unrelated party for $7.7 million. ARI retained a junior interest in $1.2 million of the note. In March 2003, the note was collected in full.

In July 2001, ARI agreed to fund a $4.4 million line of credit secured by a second lien on 1,714.16 acres of unimproved land in Tarrant Country, Texas. As of April 2003, ARI had funded $2.9 million of the line of credit and it was classified as nonperforming. In May 2003, ARI received a $433,000 principal paydown. Also during May 2003, ARI received 14.373 acres of unimproved land in Tarrant County, Texas, valued at $1.1 million, as a principal paydown. As of July 2003, the line of credit has been paid in full.

In September 1999, in conjunction with the sale of two apartments in Austin, Texas, $2.1 million in purchase money financing was provided, secured by limited partnership interests in two limited partnerships owned by the buyer. The financing bore interest at 16.0% per annum, required monthly payments of interest only at 6.0% per annum, beginning in February 2000 and required a $200,000 principal paydown in December 1999, which was not received, and matured in August 2000. ARI had the option of obtaining the buyer’s general and limited partnership interests in the collateral partnerships in full satisfaction of the financing. In March 2000, ARI agreed to forbear foreclosing on the collateral securing the note and released one of the partnership interests, in exchange for a payment of $250,000 and executed deeds of trusts on certain properties owned by the buyer. In March 2000, the borrower made a $1.1 million payment, upon receipt of which ARI returned the deeds of trust. The borrower executed a replacement promissory note for the remaining note balance of $1.0 million, which was unsecured, non-interest bearing and matured in April 2003. At November 2003, negotiations are underway to modify the terms of the note.

Related Party. In May 2003, ARI sold the Clarion Kansas City Airport Hotel to One Realco Hotel for $5.3 million. No cash was received or paid by ARI, after debt assumption and providing purchase money financing of $400,000. The note bore interest at 12.0% per annum, matured in May 2004 and required quarterly interest payments beginning in June 2003. In August 2003, the hotel was sold through foreclosure proceedings. ARI is pursuing collection of the note from One Realco Hotel. In September 2003, One Realco Hotel filed for bankruptcy protection under Chapter 11.

On June 2, 2003, ARI exchanged all of its 674,971 IORI shares with BCM, receiving 650,000 TCI shares from BCM. In addition, BCM has executed a promissory note in favor of ARI in the amount of $526,000. The note bears interest at 2% over the prime rate, currently 6.00% per annum, matures in June 2004 and requires monthly interest payments beginning in June 2003 and quarterly principal payments beginning in September 2003.

In July 2003, ARI sold its interest in MRI to Gruppa for $18.5 million, receiving $7.4 million in cash after debt assumption and providing purchase money financing of $2.3 million (see NOTE 1. “BASIS OF PRESENTATION”). The note bore interest at 10.0% per annum, matured in August 2013 and required monthly payments of principal and interest beginning in September 2003. ARI owns 20% of Gruppa, thereby retaining a 20% interest in MRI. Due to debt guarantees and ARI’s continuing ownership interest in MRI, management has determined that this should be accounted for as a financing transaction. In September 2003, ARI sold the note to Syntek West for $2.3 million, plus accrued but unpaid interest, to reduce affiliate debt.

In August 2003, ARI sold the Williamsburg Hospitality House to One Realco Hotel for $19.5 million, receiving $250,000 after debt assumption and providing purchase money financing of $5.7 million. The note bears interest at 12.0% per annum, matures in August 2006 and requires semi-annual payments of principal and interest beginning in June 2004. In September 2003, One Realco Hotel filed for bankruptcy protection under Chapter 11. The parent company of One Realco Hotel has guaranteed the note; therefore, management has not established reserves or classified the note as nonperforming.

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued

In August 2003, ARI sold the City Suites, Majestic, and Willows hotels to One Realco Hotel for $13.5 million in a single transaction, receiving $250,000 after debt assumption and providing purchase money financing of $2.7 million. The note bears interest at 12.0% per annum, matures in August 2006 and requires semi-annual payments of principal and interest beginning in June 2004. In September 2003, One Realco Hotel filed for bankruptcy protection under Chapter 11. The parent company of One Realco Hotel has guaranteed the note; therefore, management has not established reserves or classified the note as nonperforming.

In October 2003, ARI advanced $1.6 million to the Class A Limited Partners of Encino Executive Plaza, Ltd., of which ARI is the general partner. The loans bear interest at 8.5% per annum and mature in June 2006. Interest due to ARI will be deducted from the quarterly return owed by ARI to the Class A Limited Partners, eliminating the quarterly payments. The outstanding principal is due at maturity.

In March 2001, ARI funded $13.6 million of a $15.0 million unsecured line of credit to One Realco. A wholly-owned subsidiary of One Realco owns approximately 2.1% of the outstanding shares of ARI’s Common Stock. One Realco periodically borrows money to meet its cash obligations. The line of credit bears interest at 12.0% per annum. All principal and interest were due at maturity in February 2002. The line of credit is guaranteed by BCM. In June 2001, $394,000 in principal and $416,000 in interest was collected. In December 2001, $21,000 in principal and $804,000 in interest was collected. In February 2002, the line of credit was increased to $18.0 million, accrued but unpaid interest of $217,000 was added to the principal and the maturity date was extended to February 2004. In March 2002, ARI funded an additional $1.8 million, increasing the outstanding principal balance to $15.5 million. In October 2002, $856,900 in interest was collected, by the return of 85,690 shares of ARI Series A Preferred Stock. In June 2003, ARI sold a participating interest in $5.8 million of the $15.5 million balance to BCM, receiving 314,141 TCI shares from BCM (see NOTE 1. “BASIS OF PRESENTATION”). All principal and interest are due at maturity. Ronald E. Kimbrough, Acting Principal Executive Officer, Executive Vice President and Chief Financial Officer of ARI, is a 10% shareholder of One Realco. Mr. Kimbrough does not participate in the day-to-day operations or management of One Realco.

In December 2000, an unsecured loan with a remaining principal balance of $1.8 million to Warwick of Summit, Inc. (“Warwick”) matured. The loan was made to provide funds to purchase, renovate and expand a shopping center property in Warwick, Rhode Island. All principal and interest were due at maturity. In February 2002, $275,000 of interest was received. In March 2003, $27,000 of principal and $223,000 of interest was received. In April 2003, $149,000 of principal and $26,000 of interest was received. In July 2003, $10,000 of interest was received. At November 2003, the loan, and $97,000 of accrued interest, remained unpaid. Richard D. Morgan, a Warwick shareholder, served as a director of ARI until October 2001.

In December 2000, a loan with a principal balance of $1.6 million to Bordeaux Investments Two, L.L.C. (“Bordeaux”), matured. The loan, to provide funds to purchase and renovate a shopping center property in Oklahoma City, Oklahoma, was secured by (1) a 100% interest in Bordeaux, which owns a shopping center in Oklahoma City, Oklahoma; (2) 100% of the stock of Bordeaux Investments One, Inc., which owns 6.5 acres of undeveloped land in Oklahoma City, Oklahoma; and (3) the personal guarantees of the Bordeaux members. Richard D. Morgan, a Bordeaux member until July 2003, served as a director of ARI until October 2001. In July 2003, the members of Bordeaux assigned 100% of the membership interest in Bordeaux to ARI in payment of the note. ARI recorded real estate assets of $8.8 million and assumed $7.2 million of mortgage debt and other liabilities on the shopping center and the undeveloped land. No gain or loss was recorded on this transaction.

In March 2000, a loan with a remaining principal balance of $2.6 million to Lordstown, L.P., matured. The loan, to provide funds to purchase for resale various parcels of land, is secured by a second lien on land in Ohio and Florida, by 100% of the general and limited partner interest in Partners Capital, Ltd., the limited partner of Lordstown, L.P., and a profits interest in subsequent land sales. At November 2003, the loan, and $1.3 million of accrued interest, remained unpaid. A corporation controlled by Richard D. Morgan is the general partner of Lordstown, L.P. Mr. Morgan served as a director of ARI until October 2001.

NOTE 4. INVESTMENTS IN EQUITY INVESTEES

Real estate entities. Before 2003, ARI’s investment in real estate entities included equity securities of IORI and TCI, and interests in real estate joint venture partnerships. BCM, ARI’s advisor until June 30, 2003, served as advisor to IORI and TCI until June 30, 2003.

Through March 31, 2003, ARI accounted for its investment in IORI and TCI and the joint venture partnerships using the equity method. ARI began consolidation of TCI’s and IORI’s accounts and operations effective March 31, 2003. See NOTE 1. “BASIS OF PRESENTATION.” The effect of consolidating TCI’s and IORI’s operations from the completion of the tender offer through March 31, 2003 was determined to be immaterial. On June 2, 2003, ARI exchanged all of its 674,971 IORI shares with BCM, receiving 650,000 TCI shares from BCM. In addition, BCM has executed a promissory note in favor of ARI in the amount of $526,000 (see NOTE 3. “NOTES RECEIVABLE”). After the exchange, ARI owned 72.9% of the outstanding shares of TCI. On June 30, 2003, ARI sold a participating interest in $5.8 million of its $15.5 million line of credit receivable from One Realco to BCM, receiving 314,141

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued

TCI shares from BCM (see NOTE 3. “NOTES RECEIVABLE”). After the transaction, ARI owned 76.8% of the outstanding shares of TCI. ARI no longer directly owns any IORI shares. At June 30, 2003, ARI owned 18.4% of IORI through TCI’s ownership of IORI shares. ARI ceased consolidation of IORI’s accounts and operations effective June 2, 2003.

Effective July 1, 2003, Prime became the advisor to ARI and TCI. Prime is owned by Realty Advisors (79%) and Syntek West (21%), related parties. Syntek West is owned by Gene Phillips. Effective August 18, 2003, Prime changed its name to Prime Income Asset Management, Inc. On October 1, 2003, Prime LLC, which is 100% owned by Prime, replaced Prime as the advisor to ARI and TCI.

ARI’s investment in real estate entities, accounted for using the equity method, at September 30, 2003 was as follows:

Investee	Percentage of ARI’s Ownership at Sept. 30, 2003		Carrying Value of Investment at Sept. 30, 2003		Equivalent Investee Book Value at Sept. 30, 2003		Market Value of Investment at Sept. 30, 2003
IORI	18.4	%	$	3,660	$	8,642	$	4,425
Other				533

			$	4,193

Set forth below are summarized results of operations of TCI and IORI for the three months ended March 31, 2003, prior to their consolidation by ARI:

Revenues	$	31,321
Property operating expenses		23,746
Depreciation		5,460
Interest		11,528

Loss from continuing operations		<9,413	>
Loss from discontinued operations		<459	>
Equity in investees’ gain from sale of real estate		1,509

Net loss	$	<8,363	>

Set forth below are summarized results of operations of IORI for the four months of June—September 2003, following ARI’s exchange of its IORI shares:

Revenues	$	4,712
Property operating expenses		2,697
Depreciation		189
Interest		1,018

Net income from continuing operations		808
Loss from discontinued operations		<541	>

Net income	$	267

ARI’s share of equity investees’ loss before gains on the sale of discontinued operations was $4.3 million for the nine months ended September 30, 2003, and its share of equity investees’ loss on sale of real estate was $165,000 for the nine months ended September 30, 2003.

ARI’s cash flow from IORI is dependent on the ability of IORI to make distributions. In the fourth quarter of 2000, IORI suspended distributions.

ART Florida Portfolio II, Ltd. In January 2002, Investors Choice Florida Public Funds II, in which ART Florida Portfolio II, Ltd., a subsidiary of ARI, owned an interest, sold Villas Continental Apartments. ARI initially received $1.0 million in cash from the sale. In the nine months ended September 30, 2002, ARI recognized a $531,000 loss on the sale, which is included in loss on sale of investments in equity investees in the Consolidated Statements of Operations. Subsequently, ARI received an additional $245,000 in sales proceeds, reducing the total loss to $286,000.

NOTE 5. MARKETABLE EQUITY SECURITIES

Since 1994, ARI has been purchasing equity securities to diversify and increase the liquidity of its margin accounts. These equity securities are considered a trading portfolio and are carried at market value. In the first nine months of 2003, ARI purchased $1.6 million and sold $1.7 million of equity securities. At September 30, 2003, ARI recognized an unrealized increase in the market value

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued

of its trading portfolio securities of $7,000. Unrealized and realized gains and losses on trading portfolio securities are included in other income in the accompanying Consolidated Statements of Operations.

In March 2003, ARI obtained a loan in the amount of $5.0 million to acquire equity securities of Realty Korea CR-REIT Co., Ltd. No 1 representing approximately a 9.2% ownership interest. As of May 2003, the loan was paid in full. This investment is considered an available-for-sale security. The change in market value between the date of purchase and September 30, 2003 was not material.

NOTE 6. NOTES PAYABLE

In February 2003, the lender on one of ARI’s hotel properties located in Virginia and three hotel properties in Chicago notified ARI that the loans on the properties were in default, due to ARI’s failure to make timely debt service payments. The balance owed on the loans is $21.2 million. In April 2003, the lender and ARI agreed to terms to cure the default and extend the maturity dates of the loans. In May 2003, ARI failed to satisfy the conditions in the lender’s Loan Modification Offer (the “Offer”), and the Offer was revoked. In August 2003, ARI sold the hotels to a related party (see NOTE 2. “REAL ESTATE”).

In May 2003, the lender on one of ARI’s commercial properties located in Texas notified ARI that the loan on the property was in default, due to ARI’s failure to make timely debt service payments. The balance owed on the loan is $6.5 million. In July 2003, the maturity date of the note was extended to December 2003.

In August 2003, ARI received a loan for $5.0 million that is secured by its investment in equity securities of Realty Korea CR-REIT Co., Ltd. No. 1. The loan is also secured by a second deed of trust on commercial properties in North Carolina and Texas. The loan bears interest at the prime rate plus 1%, currently 5.0%, requires monthly interest only payments and matures in August 2004.

In September 2003, the lender on one of ARI’s commercial properties located in Oklahoma notified ARI that the loan on the property was in default, due to ARI’s failure to make timely debt service payments. The balance owed on the loan is $3.3 million. At November 2003, negotiations with the lender are ongoing.

In October 2003, ARI received a construction loan for $15.5 million for the construction of a new apartment development in Lewisville, Texas.

In 2003, ARI financed/refinanced or obtained second mortgage financing on the following:

Property

Location

Units/ Acres/Sq.
Ft.

Debt
Incurred

Debt
Discharged

Net Cash
Received/
<Paid>

Interest
Rate

Maturity
Date

First Quarter

Land

Elm Fork

Denton County, TX

101.0 Acres

5,000

1,551

2,885

10.750

03/04

Nashville

Nashville,TN

113.8 Acres

6,059

807

4,725

14.000

03/04

Vineyards II

Tarrant County, TX

18.6 Acres

3,280

3,750

<583

6.750

⁽¹⁾

02/06

Apartments

Arlington Place

Pasadena, TX

230 Units

1,500

—

⁽²⁾

5.000

05/03

⁽³⁾

Second Quarter

Shopping Centers

Bridgeview

LaCrosse, WI

116,008 Sq.Ft.

6,500

—

6,152

6.250

⁽¹⁾

04/05

Cullman

Cullman, AL

92,433 Sq.Ft.

1,700

2,650

1,048

6.250

⁽¹⁾

04/05

Apartments

Plantation

Tulsa, OK

138 Units

2,320

1,924

173

5.600

06/29

Industrial Warehouse

Ogden Industrial

Ogden, UT

107,112 Sq.Ft.

1,800

—

1,722

6.250

⁽¹⁾

04/05

Land

Katrina

Palm Desert, CA

52.0 Acres

5,100

3,000

1,795

6.250

⁽¹⁾

05/05

Keller

Tarrant County, TX

30.1 Acres

2,016

⁽⁴⁾

450

1,494

7.500

07/04

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued

Property	Location	Units/ Acres/ Sq. Ft.	Debt Incurred			Debt Discharged		Net Cash Received/ <Paid>			Interest Rate		Maturity Date
*Second Quarter* (Continued)
Land (Continued)
Lacy Longhorn	Farmers Branch, TX	17.1 Acres	$	—	⁽⁴⁾	$	—	$	—		—		—
Las Colinas	Las Colinas, TX	13.0 Acres		—	⁽⁴⁾		—		—		—		—
Mason Goodrich	Houston, TX	84.0 Acres		3,750			757		2,850		6.250	%⁽¹⁾	06/04
McKinney Corners II	Collin County, TX	11.0 Acres		—	⁽⁴⁾		—		—		—		—
Nashville	Nashville, TN	113.8 Acres		941			—		737		14.000		03/04
Thompson	Farmers Branch, TX	3.3 Acres		—	⁽⁴⁾		—		—		—		—
Tomlin	Farmers Branch, TX	9.0 Acres		—	⁽⁴⁾		—		—		—		—

*Third Quarter*
Apartments
Tree House	Irving, TX	160 Units		5,100			2,518		2,132		5.000	⁽¹⁾	08/13
Windsor Tower	Ocala, FL	64 Units		2,000			1,989		<104	>	4.750		08/08

*Fourth Quarter*
Land
Las Colinas	Las Colinas, TX	55.7 Acres		6,885			17,338		<11,622	>	7.000	⁽¹⁾	11/04
Rasor	Plano, TX	23.7 Acres		1,260			—		1,214		7.000	⁽¹⁾	11/04
Valwood	Dallas County, TX	235.0 Acres		8,100			5,400		1,745		7.000	⁽¹⁾	11/06

⁽¹⁾	Variable interest rate.

⁽²⁾	Cash of $1.5 million was received by BCM and applied to ARI’s affiliate debt.

⁽³⁾	Paid in July 2003.

⁽⁴⁾	Single note, with all properties as collateral.

In 2002, ARI financed/refinanced or obtained second mortgage financing on the following:

Property

Location

Units/ Acres/
Sq.Ft.

Debt
Incurred

Debt
Discharged

Net

Cash
Received/
<Paid>

Interest
Rate

Maturity
Date

First Quarter

Land

Walker

Dallas County,TX

90.6 Acres

8,500

<1,411

11.250

%⁽¹⁾

01/03

Shopping Center

Plaza on Bachman Creek

Dallas, TX

80,278 Sq.Ft.

5,000

—

4,444

6.625

⁽¹⁾

04/04

Second Quarter

Apartments

Lee Hills

Tallahassee, FL

16 Units

1,750

⁽²⁾

117

590

6.625

⁽¹⁾

06/05

Valley Hi

Tallahassee, FL

54 Units

—

⁽²⁾

878

—

White Pines

Tallahassee, FL

85 Units

—

⁽²⁾

—

Office Buildings

Four Hickory Centre

Farmers Branch, TX

221,000 Sq.Ft.

12,500

⁽³⁾

—

3,399

13.000

05/03

Related Party Transactions. In each of the following transactions, except those footnoted as (6), a related party purchased an entity, which owns the listed property asset, from ARI. ARI guaranteed that the asset will produce at least a 12% return on the purchase price for a period of three years from the purchase date. If the asset fails to produce the 12% return, ARI will pay the purchaser any shortfall. In addition, if the asset fails to produce the 12% return for a calendar year, the purchaser may require ARI to repurchase the entity for the purchase price. Management has classified these related party transactions as notes payable.

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued

Property	Location	Sq.Ft./Units	Debt Incurred		Debt Discharged		Net Cash Received		Interest Rate		Maturity Date
*First Quarter*
Office Building
Rosedale Towers	Minneapolis, MN	84,798 Sq.Ft.	$	5,109	$	—	$	5,109	12.000	%	01/05	⁽⁴⁾
Two Hickory Centre	Farmers Branch, TX	96,127 Sq.Ft.		4,448		—		4,448	12.000		01/05	⁽⁵⁾

*Second Quarter*
Apartments
Bay Anchor	Panama City, FL	12 Units		255		—		203	5.000		05/03	^(6)(13)
Confederate Point	Jacksonville, FL	206 Units		1,929		—		—	12.000		04/05	⁽⁷⁾
Foxwood	Memphis, TN	220 Units		1,093		—		—	12.000		04/05	⁽⁸⁾
Governor Square	Tallahassee, FL	168 Units		4,480		3,196		611	7.120		05/07	⁽⁶⁾
Grand Lagoon	Panama City, FL	54 Units		2,083		1,209		655	5.000		05/03	^(6)(10)
Oak Hill	Tallahassee, FL	92 Units		2,550		1,875		478	5.000		05/03	^(6)(12)
Park Avenue	Tallahassee, FL	121 Units		4,400		2,756		1,341	7.120		05/07	⁽⁶⁾
Seville	Tallahassee, FL	62 Units		1,955		1,263		473	5.000		05/03	^(6)(13)
Westwood	Mary Ester, FL	120 Units		3,382		2,327		1,023	7.570		05/12	⁽⁶⁾
Windsor Tower	Ocala, FL	64 Units		1,989		1,128		702	5.000		05/03	⁽⁶⁾
Woodhollow	San Antonio, TX	546 Units		8,160		5,349		2,775	7.120		05/07	⁽⁶⁾
Woodsong	Smyrna, GA	190 Units		2,544		—		—	12.000		04/05	⁽⁹⁾

Office Building
One Hickory Centre	Farmers Branch, TX	102,615 Sq.Ft.		4,468		—		—	12.000		04/05	⁽¹¹⁾

⁽¹⁾	Variable interest rate.

⁽²⁾	Single note with all properties as collateral.

⁽³⁾	$10.1 million funded at September 30, 2002.

⁽⁴⁾

IORI purchased 100% of the outstanding common shares of Rosedale Corporation (“Rosedale”), a wholly-owned subsidiary of ARI, for $5.1 million. The purchase price was determined based upon the market value of the property, using a market rate multiple of net operating income. Rosedale owned the Rosedale Towers Office Building. The business purpose of this transaction was for IORI to make an equity investment in Rosedale, anticipating a profitable return, and for ARI to receive cash for its equity investment. After the property was sold to an unrelated buyer in December 2002, ARI owed $2.1 million to IORI for remaining principal and 12% return. In April 2003, ARI repaid $2.0 million in principal and accrued interest. In August 2003, ARI repaid the remaining principal and accrued interest.

⁽⁵⁾

TCI purchased 100% of the common shares of ART Two Hickory Corporation (“Two Hickory”), a wholly-owned subsidiary of ARI, for $4.4 million. The purchase price was determined based upon the market value of the property, using a market rate multiple of net operating income. Two Hickory owns the Two Hickory Centre Office Building. The business purpose of this transaction was for TCI to make an equity investment in Two Hickory, anticipating a profitable return, and for ARI to receive cash for its equity investment.

⁽⁶⁾

Properties sold to partnerships controlled by Metra Capital, LLC (“Metra”). Innovo Group, Inc. (“Innovo”) is a limited partner in the partnerships that purchased the properties. Joseph Mizrachi, a Director of ARI until July 2003, controls approximately 11.67% of the outstanding common stock of Innovo. Management has determined to treat this sale as a refinancing transaction. ARI will continue to report the assets and the new debt incurred by Metra on its financial statements. ARI also received $6.3 million of 8% non-recourse, non-convertible Series A Preferred Stock (“Preferred Shares”) of Innovo.

The dividend on the Preferred Shares will be funded entirely and solely through member distributions from cash flows generated by the operation and subsequent sale of the sold properties. In the event the cash flows for the properties are insufficient to cover the 8% annual dividend, Innovo will have no obligation to cover any shortfall.

The Preferred Shares have a mandatory redemption feature, and are redeemable from the cash proceeds received by Innovo from the operation and sale of the properties. All member distributions that are in excess of current and accrued 8% dividends

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued

must be used by Innovo to redeem the Preferred Shares. Since redemption of these shares is subject to the above future events, management has elected to record no basis in the Preferred Shares.

⁽⁷⁾

TCI purchased all of the general and limited partnership interests in Garden Confederate Point, L.P. (“Confederate Point”) from ARI for $1.9 million. The purchase price was determined based upon the market value of the property, using a market rate multiple of net operating income. Confederate Point owns the Confederate Point Apartments. The business purpose of this transaction was for TCI to make an equity investment in Confederate Point, anticipating a profitable return, and to reduce ARI’s payable to BCM.

⁽⁸⁾

TCI purchased all of the general and limited partnership interests in Garden Foxwood, L.P. (“Foxwood”) from ARI for $1.1 million. The purchase price was determined based upon the market value of the property, using a market rate multiple of net operating income. Foxwood owns the Foxwood Apartments. The business purpose of this transaction was for TCI to make an equity investment in Foxwood, anticipating a profitable return, and to reduce ARI’s payable to BCM.

⁽⁹⁾

TCI purchased all of the general and limited partnership interests in Garden Woodsong, L.P. (“Woodsong”) from ARI for $2.5 million. The purchase price was determined based upon the market value of the property, using a market rate multiple of net operating income. Woodsong owns the Woodsong Apartments. The business purpose of this transaction was for TCI to make an equity investment in Woodsong, anticipating a profitable return, and to reduce ARI’s payable to BCM. TCI sold the Woodsong Apartments in July 2002.

⁽¹⁰⁾	Sold to unrelated buyer in December 2002.

⁽¹¹⁾

TCI purchased 100% of the common shares of ART One Hickory Corporation (“One Hickory”), a wholly-owned subsidiary of ARI, for $4.5 million. The purchase price was determined based upon the market value of the property, using a market rate multiple of net operating income. One Hickory owns the One Hickory Centre Office Building. The business purpose of this transaction was for TCI to make an equity investment in One Hickory, anticipating a profitable return, and to reduce ARI’s payable to BCM.

⁽¹²⁾	Sold to unrelated party in June 2002.

⁽¹³⁾	Sold to unrelated party in January 2003.

NOTE 7. MARGIN BORROWINGS

ARI has margin arrangements with various financial institutions and brokerage firms which provide for borrowing of up to 50% of the market value of marketable equity securities. The borrowings under such margin arrangements are secured by equity securities of TCI and ARI’s trading portfolio securities and bear interest rates ranging from 5.00% to 24.0%. Margin borrowing totaled $25.2 million at September 30, 2003.

Sunset Management Loan. In September 2001, ARI obtained a security loan in the amount of $20.0 million from Sunset Management, LLC (“Sunset”). ARI received net cash of $16.1 million after the payment of various closing costs and $3.4 million repayment of principal and accrued interest on an existing loan with the same lender. Of the total loan amount, $19.5 million bears interest at 24% per annum, while the remaining $500,000 bears interest at 20% per annum. The loan is secured by 3,672,305 shares of TCI common stock held by BCM and wholly-owned subsidiaries of ARI. The loan was also secured by a lien on real property owned by ART Williamsburg, Inc. (“AWI”). The loan required monthly payments of interest only and matured in September 2002. In September 2002, $15.0 million in principal was repaid. Sunset orally agreed in September 2002 to extend the maturity date of the loan and accept substitute collateral for the shares of TCI common stock after the $15.0 million paydown. Sunset did not honor the agreement, which resulted in litigation filed in Texas state court during October 2002, styled American Realty Trust, Inc., ART Williamsburg, Inc., Basic Capital Management, Inc. and EQK Holdings, Inc. v. Sunset Management, LLC, et al., Cause No. 02-09433-I in the 162nd Judicial Court of Dallas County, Texas (the “Texas Litigation”).

The Texas Litigation alleged breach of contract, misrepresentation, breach of duty of good faith and fair dealing and slander of title by Sunset and sought certain declaratory relief against Sunset as well as a temporary and permanent anti-suit injunction against Sunset.

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued

stay of the Nevada Litigation may be appropriate, which stay of litigation (including claims against TCI) was granted on May 2, 2003. Notwithstanding the stay of the Nevada Litigation, Sunset continued to seek to relitigate the underlying fact issues already determined in the Texas Litigation and the Nevada Litigation through cross-claims and counterclaims in the Texas Litigation and a renewed motion for preliminary injunction and appointment of receiver over TCI in the Nevada Litigation.

Sunset has sought expedited relief and an expedited hearing of the Texas Litigation, which the court refused to grant. The matter was set for a jury trial on December 8, 2003. In addition, the borrowers on the loan have sought to tender cash collateral to the court in lieu of the TCI stock, which motion was denied. TCI has only recently been added to the Texas Litigation as a party.

Even though the relief sought by Sunset in the Texas Litigation and the Nevada Litigation has either been denied or stayed, on June 10, 2003, an attorney representing Sunset appeared at the Annual Meeting of Shareholders of TCI attempting to vote 3,673,115 Shares of common stock of TCI under purported irrevocable proxies against the election of the four directors nominated in favor of the election of four affiliates of Sunset that Sunset seeks to nominate to serve as directors of TCI. The Inspector of Election at the Annual Meeting advised that Sunset’s attempt to exercise voting rights under proxies for the 3,673,115 shares was improper and would not be allowed, advising that BCM and the ARI subsidiaries held the absolute right to vote the 3,673,115 shares of TCI common stock so long as there was no event of default under the Sunset loan agreement. The Inspector of Election also observed at the Stockholders meeting that no evidence was before the Inspector from a court of law finding an event of default had occurred with respect the Sunset loan documents, and therefore, such proxies would not be honored at that time. Subsequently, representatives of Sunset delivered on July 7, 2003 to TCI a form captioned Schedule 13D for an event occurring June 10, 2003, making certain disclosures, including an allegation that “Sunset acquired voting rights to 3,673,115 shares of TCI to protect the value of Sunset’s security interest in the 3,673,115 shares of TCI pledged as collateral for . . . obligations to Sunset.” Actually, only 3,672,305 shares of TCI common stock were pledged [810 shares less than Sunset alleges]. Such schedule 13D also provides that “Sunset plans to foreclose on the pledged TCI shares as soon as possible.” Such Schedule 13D advises that “Sunset would prefer to replace the four management directors [of TCI] with neutral individuals . . . or if neutral individuals are unavailable, Sunset intends to nominate and [vote] for the election of affiliates of Sunset as directors of TCI on an interim basis until neutral individuals with satisfactory backgrounds and knowledge can be elected as directors.”

On September 10, 2003, AWI removed the Texas Litigation to the bankruptcy court for the Northern District of Texas. On September 25, 2003, the Texas Litigation was transferred to the Eastern District of Texas. A scheduling conference on this matter is set for December 3, 2003.

Security Loans. In August 2003, ARI obtained a security loan in the amount of €5.0 million from a financial institution in Bulgaria. The funds were used for earnest money for a potential property acquisition in Bulgaria. The loan bore interest at 4.33% over the six-month EURIBOR rate, currently 6.583%, and matured in November 2003. Principal and accrued interest were due at maturity. The loan was secured by 825,666 shares of TCI common stock held by ARI. In October 2003, the earnest money was returned to ARI. In November, the loan was repaid.

In September 2003, ARI obtained a security loan in the amount of $12.5 million from a financial institution. The loan bears interest at 12% over the 30-day LIBOR rate, currently 13.12%, requires monthly payments of interest only and matures in September 2004. The loan is secured by 1,656,537 shares of TCI common stock held by ARI.

In September 2003, ARI obtained a security loan in the amount of $1.0 million from a financial institution. The loan bears interest at 12% over the 30-day LIBOR rate, currently 13.12%, requires monthly payments of interest only and matures in September 2004. The loan is secured by 250,000 shares of IORI common stock held by ARI.

In October 2001, ARI obtained a security loan in the amount of $1.0 million from a financial institution. The loan bore interest at 1% over the prime rate, currently 5.00% per annum, required monthly payments of interest only and matured in October 2003. The loan is callable upon 60 days prior notice, and is secured by 250,000 shares of ARI Common Stock held by BCM. In October 2003, the maturity date was extended to December 2003.

NOTE 8. RELATED PARTY TRANSACTIONS

In March 2003, ARI sold the Bridgeview Plaza and Cullman shopping centers to TCI for $10.7 million to satisfy debt. TCI assumed debt of $2.7 million on Cullman. TCI received $5.1 million cash on the subsequent financing of the shopping centers.

In April 2003, ARI paid $2.0 million in principal and accrued interest to IORI, in partial payment of a note payable on the Rosedale Tower Office Building. See NOTE 6. “NOTES PAYABLE.”

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued

In May 2003, ARI sold the Clarion Kansas City Airport Hotel to One Realco Hotel, a related party, for $5.3 million. No cash was received or paid by ARI, after debt assumption and providing purchase money financing of $400,000. The note bore interest at 12.0% per annum, matured in May 2004 and required quarterly interest payments beginning in June 2003. In August 2003, the hotel was sold through foreclosure proceedings. ARI is pursuing collection of the note from One Realco Hotel. In September 2003, One Realco Hotel filed for bankruptcy protection under Chapter 11.

On June 2, 2003, ARI exchanged all of its 674,971 IORI shares with BCM, receiving 650,000 TCI shares from BCM. In addition, BCM has executed a promissory note in favor of ARI in the amount of $526,000 (see NOTE 3. “NOTES RECEIVABLE”). After the exchange, ARI owned 72.9% of the outstanding shares of TCI. On June 30, 2003, ARI sold a participating interest in $5.8 million of its $15.5 million line of credit receivable from One Realco to BCM, receiving 314,141 TCI shares from BCM (see NOTE 3. “NOTES RECEIVABLE”). After the transaction, ARI owned 76.8% of the outstanding shares of TCI. ARI no longer directly owns any IORI shares. At September 30, 2003, ARI owned 18.4% of IORI through TCI’s ownership of IORI shares. ARI ceased consolidation of IORI’s accounts and operations effective June 2, 2003.

In June 2003, ARI received funds of $757,000 from an affiliate reducing the affiliate receivable. The funds paid down a note secured by undeveloped land in Harris County, Texas.

On June 30, 2003, ARI sold its 74.31% interest in RAK to Realty Advisors, a related party. The sales price was $6.0 million. Realty Advisors also paid ARI $600,000, representing 10% interest on the $6.0 million price paid by ARI to purchase the 74.31% interest in RAK in 2002. The $6.0 million sales price reduced ARI’s affiliate debt. The $600,000 interest was received in cash in August 2003.

Effective July 1, 2003, Prime became the advisor to ARI and TCI. Prime is owned by Realty Advisors (79%) and Syntek West, (21%). Syntek West is owned by Gene Phillips. Effective August 18, 2003, Prime changed its name to Prime Income Asset Management, Inc. On October 1, 2003, Prime LLC, which is 100% owned by Prime, replaced Prime as the advisor to ARI and TCI.

In July 2003, ARI sold its interest in MRI to Gruppa, for $18.5 million, receiving $7.4 million in cash after debt assumption and providing purchase money financing of $2.3 million (see NOTE 3. “NOTES RECEIVABLE”). ARI owns 20% of Gruppa, thereby retaining a 20% interest in MRI. ARI remains as the guarantor of $8.7 million of assumed debt and is one of the guarantors of $7.5 million in new debt obtained by Gruppa. Due to the debt guarantees and ARI’s continuing ownership interest in MRI, management has determined that this should be accounted for as a financing transaction. In September 2003, ARI sold the note to Syntek West for $2.3 million, plus accrued but unpaid interest.

In July 2003, ARI paid $3.1 million to BCM for prior year’s legal fees incurred by Gene Phillips. Mr. Phillips is a related party and advisor to ARI.

In October 2003, ARI purchased the Travelers land from IORI for $25.0 million, paying $1.9 million in cash and giving a wrap note payable to IORI for $22.8 million. The note does not have a stated interest rate, requires monthly payments sufficient to pay the installments due on the underlying debt and matures in October 2006. The principal is due at maturity.

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued

The following table reconciles the beginning and ending balances of accounts payable to affiliates as of September 30, 2003.

BCM

PRIME

IORI

Balance, December 31, 2002

<15,245

—

<8,714

Cash transfers to affiliates

103,018

76,125

650

Cash transfers from affiliates

<108,894

<80,519

—

Fees and reimbursements payable to Advisor

<2,446

—

Other additions

63,640

8,030

—

Other repayments

<28,943

<26,583

3,804

Balance, September 30, 2003 (Update)

11,130

<22,947

<4,260

Also at September 30, 2003, ARI owed $1.5 million to affiliates related to cash received upon the sale of apartments to Metra.

NOTE 9. OPERATING SEGMENTS

Significant differences among the accounting policies of the operating segments as compared to the Consolidated Financial Statements principally involve the calculation and allocation of administrative expenses. Management evaluates the performance of each of the operating segments and allocates resources to them based on their net operating income and cash flow. Items of income that are not reflected in the segments are equity in loss of investees, equity in gain <loss> on sale of real estate by equity investees, loss on sale of investments in equity investees and other income which totaled $314,000 and $<4.1> million for the three and nine months ended September 30, 2003 and $2.0 million and $858,000 for 2002. Expenses that are not reflected in the segments are discount on sale of notes receivable, general and administrative expenses, minority interest, incentive fees, advisory fees, net income fees, writedown of assets held for sale and discontinued operations which totaled $13.2 million and $35.2 million for the three and nine months ended September 30, 2003 and $6.2 million and $21.1 million for 2002. Excluded from operating segment assets are assets of $93.4 million in 2003 and $125.8 million in 2002, which are not identifiable with an operating segment. There are no intersegment revenues and expenses, and ARI conducted all of its business within the United States, with the exception of Hotel Sofia (Bulgaria), which began operations in 2001 and was sold in March 2003, Realty Advisors Korea, Ltd. (South Korea), which ARI acquired in 2002 and sold in June 2003, and Hotel Academia (Poland), which began operations in 2002.

Presented below are ARI’s reportable segments operating income for the three and nine months ended September 30, 2003 and 2002, and segment assets at September 30, 2003 and 2002.

Three Months Ended September 30, 2003	Commercial Properties		Apartments		Hotels		Land			Pizza Parlors		Receivables/ Other			Total
Operating revenue	$	20,838	$	22,076	$	6,736	$	212		$	8,330	$	29		$	58,221
Interest income		—		—		—		—			—		1,795			1,795
Operating expenses		11,595		16,383		4,929		1,445			6,592		<2	>		40,942

Operating income <loss>	$	9,243	$	5,693	$	1,807	$	<1,233	>	$	1,738	$	1,826		$	19,074

Depreciation	$	4,708	$	1,587	$	494	$	—		$	347	$	1		$	7,137
Interest		6,787		7,066		738		4,959			336		1,039			20,925
Capital expenditures		2,621		3,948		1,154		607			111		—			8,441
Assets		345,044		357,543		57,214		250,857			22,316		81,716			1,114,690

Property Sales:	Commercial Properties		Apartments		Hotels		Land								Total
Sales price	$	58,615	$	16,493	$	33,000	$	27,551							$	135,659
Cost of sale		49,095		7,928		28,507		12,080								97,610
Deferred current gain		—		—		4,356		—								4,356
Recognized prior deferred gain		—		—		—		27								27

Gain on sale	$	9,520	$	8,565	$	137	$	15,498							$	33,720

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued

Three Months Ended September 30, 2002	Commercial Properties		Apartments		Hotels			Land			Pizza Parlors		Receivables/ Other			Total
Operating revenue	$	5,380	$	6,902	$	5,759		$	16		$	8,157	$	<18	>	$	26,196
Interest income		—		—		—			—			—		509			509
Operating expenses		2,976		4,695		4,196			1,358			6,528		19			19,772

Operating income <loss>	$	2,404	$	2,207	$	1,563		$	<1,342	>	$	1,629	$	472		$	6,933

Depreciation	$	888	$	528	$	421		$	—		$	295	$	2		$	2,134
Interest		1,664		1,766		850			4,617			212		2,871			11,980
Capital expenditures		5,194		211		387			759			810		—			7,361
Assets		139,870		92,294		90,084			181,791			21,877		43,379			569,295

Property Sales:			Apartments					Land								Total
Sales price			$	28,072				$	18,681							$	46,753
Cost of sale				12,697					16,097								28,794
Deferred current gain				—					—								—
Recognized prior deferred gain				—					34								34

Gain on sale			$	15,375				$	2,618							$	17,993


Nine Months Ended September 30, 2003	Commercial Properties		Apartments		Hotels			Land			Pizza Parlors		Receivables/ Other			Total
Operating revenue	$	47,092	$	49,596	$	18,003		$	400		$	24,267	$	1,649		$	141,007
Interest income		—		—		—			—			—		7,431			7,431
Operating expenses		26,764		35,535		13,307			4,705			19,357		31			99,699

Operating income <loss>	$	20,328	$	14,061	$	4,696		$	<4,305	>	$	4,910	$	9,049		$	48,739

Depreciation	$	10,133	$	3,817	$	1,134		$	—		$	1,041	$	<6	>	$	16,119
Interest		15,735		15,597		1,547			13,074			738		4,826			51,517
Capital expenditures		4,316		13,532		2,245			1,332			1,397		—			22,822
Assets		345,044		357,543		57,214			250,857			22,316		81,716			1,114,690

Property Sales:	Commercial Properties		Apartments		Hotels			Land								Total
Sales price	$	87,849	$	45,063	$	63,062		$	39,654							$	235,628
Cost of sale		60,127		28,874		58,758			23,150								170,909
Deferred current gain		9,818		—		4,356			—								14,174
Recognized prior deferred gain		—		—		—			19,924								19,924

Gain <loss> on sale	$	17,904	$	16,189	$	<52	>	$	36,428							$	70,469


Nine Months Ended September 30, 2002	Commercial Properties		Apartments		Hotels			Land			Pizza Parlors		Receivables/ Other			Total
Operating revenue	$	17,462	$	19,283	$	15,664		$	76		$	23,979	$	425		$	76,889
Interest income		—		—		—			—			—		1,906			1,906
Operating expenses		10,504		12,653		11,799			5,438			18,821		141			59,356

Operating income <loss>	$	6,958	$	6,630	$	3,865		$	<5,362	>	$	5,158	$	2,190		$	19,439

Depreciation	$	2,431	$	1,556	$	1,131		$	—		$	835	$	6		$	5,959
Interest		5,279		6,238		1,852			16,013			631		9,167			39,180
Capital expenditures		12,227		759		745			2,064			2,034		—			17,829
Assets		139,870		92,294		90,084			181,791			21,877		43,379			569,295

Property Sales:	Commercial Properties		Apartments					Land								Total
Sales price	$	52,302	$	50,769				$	55,980							$	159,051
Cost of sale		46,540		27,629					38,916								113,085
Deferred current gain		5,762		—					11,913								17,675
Recognized prior deferred gain		—		—					830								830

Gain on sale	$	—	$	23,140				$	5,981							$	29,121

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued

NOTE 10. DISCONTINUED OPERATIONS

Effective January 1, 2002, ARI adopted Financial Accounting Standards Board Statement No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” which established a single accounting model for the impairment or disposal of long-lived assets, including discontinued operations. This statement requires that the operations related to properties that have been sold or properties that are intended to be sold be presented as discontinued operations in the statement of operations for all periods presented, and properties intended to be sold are to be designated as “held-for-sale” on the balance sheet.

For the three and nine months ended September 30, 2003 and 2002, income from discontinued operations relates to 23 properties and leasehold interest in oil and gas properties that ARI sold during 2002 and 29 properties that ARI sold during 2003. The following table summarizes revenue and expense information for these properties sold and held-for-sale.

	For the Three Months Ended September 30,						For the Nine Months Ended September 30,
	2003			2002			2003			2002
Revenue
Rental	$	4,248		$	9,080		$	16,956		$	32,609
Property operations		4,009			6,041			12,510			19,285

		239			3,039			4,446			13,324
Expenses
Interest		1,276			1,865			5,280			11,621
Depreciation		420			1,328			2,163			5,590

		1,696			3,193			7,443			17,211

Net loss from discontinued operations		<1,457	>		<154	>		<2,997	>		<3,887	>
Gain on sale of real estate		18,222			15,375			34,041			23,140

Equity in gain on sale of real estate by equity investees		<165	>		6,616			<165	>		14,896

Net income from discontinued operations	$	16,600		$	21,837		$	30,879		$	34,149

Discontinued operations have not been segregated in the consolidated statements of cash flows. Therefore, amounts for certain captions will not agree with respective consolidated statements of operations.

NOTE 11. COMMITMENTS AND CONTINGENCIES

Liquidity. Management expects that excess cash generated from operations during the remainder of 2003 will not be sufficient to discharge all of ARI’s debt obligations as they mature. Therefore, ARI will rely on aggressive land sales, selected income producing property sales and, to the extent necessary, additional borrowings to meet its cash requirements.

Commitments. During 2002, MRI, a then wholly-owned subsidiary of ARI, sold two restaurants to a corporation owned in part by an officer of MRI. In conjunction with the sale of these restaurants, MRI guaranteed the bank debt incurred by the related party. The guaranty applies to all current debt, and to all future debt of the related party until such time as the guaranty is terminated by MRI. The amount of the debt outstanding that is subject to the guaranty is $1.2 million at September 30, 2003. In July 2003, ARI sold its interest in MRI to Gruppa for $18.5 million, receiving $7.4 million in cash after debt assumption and providing purchase money financing of $2.3 million (see NOTE 3. “NOTES RECEIVABLE”). ARI owns 20% of Gruppa, thereby retaining a 20% interest in MRI. ARI remains as the guarantor of $8.7 million of assumed debt and is one of the guarantors of $7.5 million in new debt obtained by Gruppa. Due to the debt guarantees and ARI’s continuing ownership interest in MRI, management has determined that this should be accounted for as a financing transaction. In September 2003, ARI sold the note to Syntek West for $2.3 million, plus accrued but unpaid interest, to reduce affiliate debt.

ARI has entered into an agreement with one of the investors in the Realty Korea CR-REIT Co. Ltd. No. 1 (“REIT”), that is advised by RAK, whereby the investor has been granted the opportunity to require ARI to buy their shares in the REIT twelve months after the closing of the REIT offering for their original investment amount. Their investment is approximately $4.2 million.

Litigation. In August 2002, ARI obtained a favorable jury verdict in the legal action entitled American Realty Trust v. Matisse Partners, L.L.C. (“Matisse”). However, the judge set aside the jury verdict and imposed a judgment against ARI in excess of $6.0 million, including interest. The judgment is being appealed, and, in the opinion of ARI’s management and legal counsel, there is a

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued

reasonable probability that the adverse judgment will be set aside and the jury verdict reinstated. Therefore, ARI has not recognized any expense nor established any reserve for this judgment. In November 2002, ARI posted a $6.0 million supercedeas bond. In July 2003, ARI obtained a letter of credit, which was substituted for the $6.0 million bond. The $6.0 million cash was returned to ARI. In April 2003, an additional judgment was issued against ARI for $1.4 million in legal fees. ARI is also appealing this judgment and posted a $1.4 million bond in May 2003. ARI has not recognized any expense nor established any reserve for this additional judgment.

In September 2001, ARI obtained a security loan in the amount of $20.0 million from Sunset Management, LLC (“Sunset”). ARI received net cash of $16.1 million after the payment of various closing costs and $3.4 million repayment of principal and accrued interest on an existing loan with the same lender. Of the total loan amount, $19.5 million bears interest at 24% per annum, while the remaining $500,000 bears interest at 20% per annum. The loan is secured by 3,672,305 shares of TCI common stock held by BCM and wholly-owned subsidiaries of ARI. The loan required monthly payments of interest only and matured in September 2002. In September 2002, $15.0 million in principal was repaid. Sunset orally agreed in September 2002 to extend the maturity date of the loan and accept substitute collateral for the shares of TCI common stock after the $15.0 million paydown. Sunset did not honor the agreement, which resulted in litigation filed in Texas state court during October 2002, styled American Realty Trust, Inc., ART Williamsburg, Inc., Basic Capital Management, Inc. and EQK Holdings, Inc. v. Sunset Management, LLC, et al., Cause No. 02-09433-I in the 162nd Judicial Court of Dallas County, Texas. See NOTE 7. “MARGIN BORROWINGS.”

In addition to Matisse and Sunset, ARI is involved in various lawsuits arising in the ordinary course of business. In the opinion of management the outcome of these lawsuits will not have a material impact on ARI’s financial condition, results of operations or liquidity.

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Introduction

ARI’s predecessor was organized in 1961 to provide investors with a professionally managed, diversified portfolio of equity real estate and mortgage loan investments selected to provide opportunities for capital appreciation as well as current income.

On October 23, 2001, ARI, Transcontinental Realty Investors, Inc. (“TCI”), and Income Opportunity Realty Investors, Inc. (“IORI”) jointly announced a preliminary agreement with the plaintiff’s legal counsel of the derivative action entitled Olive et al. V. National Income Realty Trust, et al. for complete settlement of all disputes in the lawsuit (the “Olive Litigation”). In February 2002, the court granted final approval of the proposed settlement (the “Olive Settlement”). Under the Olive Settlement, ARI agreed to either (i) acquire all of the outstanding shares of IORI and TCI not currently owned by ARI for a cash payment or shares of ARI preferred stock or (ii) make a tender offer for all of the outstanding shares of IORI and TCI not currently owned by ARI. On November 15, 2002, ARI commenced the tender offer for the IORI and TCI shares. The tender offer was completed on March 19, 2003. ARI paid $19.00 cash per IORI share and $17.50 cash per TCI share for the stock held by non-affiliated stockholders. Pursuant to the tender offer, ARI acquired 265,036 IORI shares and 1,213,226 TCI shares. The completion of the tender offer fulfills the obligations under the Olive Settlement, and the Olive Litigation has been dismissed with prejudice.

After the tender offer, ARI owned 64.8% of the outstanding shares of TCI and 62.5% of the outstanding shares of IORI (46.9% owned directly by ARI and 15.6% through TCI’s ownership of IORI shares). ARI began consolidation of TCI’s and IORI’s accounts and operations effective March 31, 2003. The effect of consolidating TCI’s and IORI’s operations from the completion of the tender offer through March 31, 2003 was determined to be immaterial. Through June 30, 2003, ARI had the same advisor as TCI and IORI, and TCI and IORI had the same board of directors. Four of the directors of TCI and three of the directors of IORI also serve as directors of ARI. Effective July 1, 2003, ARI and TCI have the same advisor.

On June 2, 2003, ARI exchanged all of its 674,971 IORI shares with Basic Capital Management, Inc. (“BCM”), receiving 650,000 TCI shares from BCM. In addition, BCM has executed a promissory note in favor of ARI in the amount of $526,000 (see NOTE 3. “NOTES RECEIVABLE”). After the exchange, ARI owned 72.9% of the outstanding shares of TCI. On June 30, 2003, ARI sold a participating interest in $5.8 million of its $15.5 million line of credit receivable from One Realco Corporation (“One Realco”) to BCM, receiving 314,141 TCI shares from BCM (see NOTE 3. “NOTES RECEIVABLE”). After the transaction, ARI owned 76.8% of the outstanding shares of TCI. ARI no longer directly owns any IORI shares. At September 30, 2003, ARI owned 18.4% of IORI through TCI’s ownership of IORI shares. ARI ceased consolidation of IORI’s accounts and operations effective June 2, 2003.

In July 2003, ARI sold its interest in Milano Restaurants International Corporation (“MRI”) to Gruppa Florentina, LLC (“Gruppa”), for $18.5 million, receiving $7.4 million in cash after debt assumption and providing purchase money financing of $2.3 million (see NOTE 3. “NOTES RECEIVABLE”). ARI owns 20% of Gruppa, thereby retaining a 20% interest in MRI. ARI remains as the guarantor of $8.7 million of assumed debt and is one of the guarantors of $7.5 million in new debt obtained by Gruppa. Due to the debt guarantees and ARI’s continuing ownership interest in MRI, management has determined that this should be accounted for as a financing transaction. In September 2003, ARI sold the note to Syntek West for $2.3 million, plus accrued and unpaid interest, to reduce affiliate debt.

Critical Accounting Policies

Critical accounting policies are those that are both important to the presentation of ARI’s financial condition and results of operations and require management’s most difficult, complex or subjective judgements. ARI’s critical accounting policies relate to the evaluation of impairment of long-lived assets and the evaluation of the collectibility of accounts and notes receivable.

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued

If events or changes in circumstances indicate that the carrying value of a rental property to be held and used or land held for development may be impaired, management performs a recoverability analysis based on estimated undiscounted cash flows to be generated from the property in the future. If the analysis indicates that the carrying value is not recoverable from future cash flows, the property is written down to estimated fair value and an impairment loss is recognized. If management decides to sell rental properties or land held for development, management evaluates the recoverability of the carrying amounts of the assets. If the evaluation indicates that the carrying value is not recoverable from estimated net sales proceeds, the property is written down to estimated fair value less costs to sell and an impairment loss is recognized within income from continuing operations. ARI’s estimates of cash flow and fair values of the properties are based on current market conditions and consider matters such as rental rates and occupancies for comparable properties, recent sales data for comparable properties and, where applicable, contracts or the results of negotiations with purchasers or prospective purchasers. ARI’s estimates are subject to revision as market conditions and ARI’s assessments of them change.

ARI’s allowance for doubtful accounts receivable and notes receivable is established based on analysis of the risk of loss on specific accounts. The analysis places particular emphasis on past due accounts. Management considers such information as the nature and age of the receivable, the payment history of the tenant or other debtor, the financial condition of the tenant or other debtor and ARI’s assessment of its ability to meet its lease or interest obligations. ARI’s estimate of the required allowance, which is reviewed on a quarterly basis, is subject to revision as these factors change and is sensitive to the effects of economic and market conditions.

Liquidity and Capital Resources

ARI reported net income of $12.2 million for the nine months ended September 30, 2003, which included the following non-cash charges and credits: depreciation and amortization from real estate held for investment of $18.3 million, gain on sale of real estate of $70.3 million and equity in loss of equity investees of $4.3 million. Net cash used in operating activities amounted to $26.9 million for the nine months ended September 30, 2003, interest receivable increased by $4.0 million due to additional notes receivable from seller financings, other assets decreased by $10.2 million primarily due to reduced escrow deposits, interest payable increased by $269,000 due to an increased balance of notes payable and other liabilities decreased by $759,000 primarily due to a decrease in security deposits and property taxes.

Net cash provided by investing activities of $113.2 million was primarily due to real estate acquisitions of $12.0 million, payments made under interest rate swap contract of $31,000, additional fundings of notes receivable of $615,000, distributions to equity investees of $650,000, real estate improvements of $21.4 million, investments in real estate entities of $24.2 million, earnest money deposits of $13.3 million and purchases of pizza parlor equipment of $1.4 million. These outflows for investing activities were offset by the collection of $26.0 million on notes receivable, $134.5 million from the sale of real estate and $26.3 million from the sale of notes receivable.

Net cash used in financing activities of $87.4 million was comprised of proceeds received from the funding or refinancing of notes payable of $82.3 million and advances from affiliates of $7.8 million; offset by cash payments of $186.1 million to paydown existing notes payable, $5.4 million for financing costs and $1.8 million in dividends on Preferred Stock.

In 2003, ARI purchased the following properties:

Property

Location

Units/Acres

Purchase
Price

Net
Cash Paid

Debt
Incurred

Interest
Rate

Maturity
Date

First Quarter

Apartments

Capitol Hill⁽¹⁾

Little Rock, AR

156 Units

1,904

615

1,289

5.50

10/44

Second Quarter

Apartments

Breakwater Bay⁽¹⁾

Beaumont, TX

176 Units

1,979

383

1,554

5.50

08/44

Longwood

Long Beach, MS

200 Units

6,349

334

6,349

⁽²⁾

7.60

04/12

Land

Pulaski

Pulaski County, AR

21.9 Acres

2,000

695

1,400

6.50

05/05

Third Quarter

Land

Sheffield Village

Grand Prairie, TX

13.9 Acres

1,500

632

975

5.50

⁽³⁾

09/04

⁽¹⁾	Land purchased for apartment construction.

⁽²⁾	Assumed debt of seller.

⁽³⁾	Variable interest rate.

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued

Liquidity and Capital Resources (Continued)

In 2003, ARI sold the following properties:

Property	Location	Units/Sq.Ft./ Acres/Rooms	Sales Price		Net Cash Received/ (Paid)			Debt Discharged			Gain/(Loss) on Sale
*First Quarter*
Apartments
Bay Anchor	Panama City, FL	12 Units	$	369	$	—		$	291		$	143
Georgetown	Panama City, FL	44 Units		1,175		323			789	⁽³⁾		72
Northside Villas	Tallahassee, FL	81 Units		5,575		1,806			2,784			915
Rolling Hills	Tallahassee, FL	134 Units		5,061		1,361			2,785			1,182
Seville	Tallahassee, FL	62 Units		2,795		—			2,360			489

Shopping Centers
Bridgeview Plaza	LaCrosse, WI	116,008 Sq.Ft.		8,700		—			—			8,700	⁽¹⁾
Cullman	Cullman, AL	92,466 Sq.Ft.		2,000		—			2,650	⁽³⁾		1,118	⁽¹⁾

Office Building
4135 Beltline Road	Addison, TX	90,000 Sq.Ft.		4,358		—			2,858	⁽³⁾		178	⁽²⁾

Land
Katrina	Palm Desert, CA	89.3 Acres		8,550		<410	>		2,840			<40	>
Nashville	Nashville, TN	8.8 Acres		235		<11	>		217			114

Hotel
Grand Hotel Sofia	Sofia, Bulgaria	136 Rooms		24,750		6,258			4,209	⁽³⁾		49	⁽⁴⁾

*Second Quarter*
Apartments
Greenbriar	Tallahassee, FL	50 Units		1,700		594			976			1,025
Lake Chateau	Thomasville, GA	98 Units		1,600		460			1,033			147
Pinecrest	North Augusta, SC	120 Units		2,707		1,136			1,429			<304	>
Regency	Lincoln, NE	106 Units		4,880		838			3,179			2,815
Willow Wick	North Augusta, SC	104 Units		2,707		255			1,943			1,140

Industrial Warehouses
McLeod	Orlando, FL	110,914 Sq.Ft.		5,450		2,980			1,902			2,805
Tricon	Atlanta, GA	570,877 Sq.Ft.		13,084		3,364			9,395			5,579

Land
Mason Goodrich	Houston, TX	8.0 Acres		210		—	⁽⁵⁾		—			<149	>
Mason Goodrich	Houston, TX	1.6 Acres		209		12			169			113
Mason Goodrich	Houston, TX	7.7 Acres		900		36			764			466

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Liquidity and Capital Resources (Continued)

Property	Location	Units/Sq.Ft./ Acres/Rooms	Sales Price		Net Cash Received/ (Paid)			Debt Discharged			Gain/(Loss) on Sale
*Second Quarter* (Continued)
Land (Continued)
Solco-Valley	Farmers Branch, TX	6.1 Acres	$	1,999	$	<90	>⁽⁷⁾	$	—		$	529

Hotel
Clarion KC Airport ⁽⁶⁾	Kansas City, MO	196 Rooms		5,312		—			4,888	⁽³⁾		<101	>

*Third Quarter*
Apartments
Landings & Marina	Pensacola, FL	52 Units		1,825		576			1,162			492
Lincoln Court	Dallas, TX	55 Units		3,038		1,834			1,208			1,899
Quail Creek	Lawrence, KS	95 Units		4,700		1,188			3,260			1,683
Stone Oak	San Antonio, TX	252 Units		6,930		3,670			2,699			4,490

Office Buildings
Bonita Plaza	Bonita, CA	47,777 Sq.Ft.		8,034		1,698			5,944			2,798
Encino Executive Plaza	Encino, CA	177,211 Sq.Ft.		37,040		1,946			33,145	⁽³⁾		<2	>

Shopping Center
Oak Tree Village	Lubbock, TX	45,623 Sq.Ft.		3,366		1,527			1,328			820
Sheboygan	Sheboygan, WI	74,532 Sq.Ft.		1,225		669			569			181
Westwood	Tallahassee, FL	149, 855 Sq.Ft.		8,950		5,045			1,880			5,787

Land
Nashville	Nashville, TN	1.1 Acres		201		9			170			135
Palm Desert	Palm Desert, CA	25.1 Acres		2,600		<88	>⁽⁹⁾		—			797
Pioneer Crossing	Austin, TX	367.4 Acres		22,500		4,948			—			13,916
Vista Ridge	Lewisville, TX	14.5 Acres		2,250		713			1,343			622

Property
Hotels
City Suites	Chicago, IL	45 Rooms		4,806		89			4,081	⁽³⁾		943	⁽⁸⁾
Majestic	Chicago, IL	52 Rooms		3,550		66			2,448	⁽³⁾		704	⁽⁸⁾
Williamsburg Hospitality House	Williamsburg, VA	296 Rooms		19,500		250			12,332	⁽³⁾		1,731	⁽⁸⁾
Willows	Chicago, IL	55 Rooms		5,144		95			4,054	⁽³⁾		978	⁽⁸⁾

*Fourth Quarter*
Apartments
Summerfield	Orlando, FL	224 Units		9,415		4,845			4,476			4,268

Land
Keller	Tarrant County, TX	30.0 Acres		2,800		2,676			—			2,439
Pioneer Crossing	Austin, TX	343.7 Acres		8,136		3,479			—			2,197

⁽¹⁾	Sold to TCI to satisfy debt. Gain deferred until sale to unrelated party.

⁽²⁾	Sold to Tacco Office Investors, Inc., a related party. Gain deferred until sale to unrelated party.

⁽³⁾	Debt assumed by purchaser.

⁽⁴⁾	Includes recognition of $3.1 million of accumulated foreign currency translation gains.

⁽⁵⁾	Cash of $210,000 was received by BCM and applied to ARI’s affiliate debt.

⁽⁶⁾	Sold to One Realco Hotel Investors, Inc. (“One Realco Hotel”), a related party.

⁽⁷⁾	Cash of $2.0 million was received by BCM and applied to ARI’s affiliate debt.

⁽⁸⁾	Sold to One Realco Hotel. Gain deferred until sale to unrelated party.

⁽⁹⁾	Cash of $2.6 million was received by Prime and applied to ARI’s affiliate debt.

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued

Liquidity and Capital Resources (Continued)

In 2003, ARI financed/refinanced or obtained second mortgage financing on the following:

Property	Location	Units/ Acres/ Sq. Ft	Debt Incurred			Debt Discharged		Net Cash Received/ <Paid>			Interest Rate		Maturity Date
*First Quarter*
Land
Elm Fork	Denton County, TX	101.0 Acres	$	5,000		$	1,551	$	2,885		10.750	%	03/04
Nashville	Nashville, TN	113.8 Acres		6,059			807		4,725		14.000		03/04
Vineyards II	Tarrant County, TX	18.6 Acres		3,280			3,750		<583	>	6.750	⁽¹⁾	02/06

Apartments
Arlington Place	Pasadena, TX	230 Units		1,500			—		—	⁽²⁾	5.000		05/03	⁽³⁾

*Second Quarter*
Apartments
Plantation	Tulsa, OK	138 Units		2,320			1,924		173		5.600		06/29

Industrial Warehouse
Ogden Industrial	Ogden, UT	107,112 Sq.Ft.		1,800			—		1,722		6.250		04/05

Shopping Centers
Bridgeview	LaCrosse, WI	116,008 Sq.Ft.		6,500			—		6,152		6.250	⁽¹⁾	04/05
Cullman	Cullman, AL	92,433 Sq.Ft.		1,700			2,650		1,048		6.250	⁽¹⁾	04/05

Land
Katrina	Palm Desert, CA	110.6 Acres		5,100			3,000		1,795		6.250	⁽¹⁾	05/05
Keller	Tarrant County, TX	30.1 Acres		2,016	⁽⁴⁾		450		1,494		7.500		07/04
Lacy Longhorn	Farmers Branch, TX	17.1 Acres		—	⁽⁴⁾		—		—		—		—
Las Colinas	Las Colinas, TX	13.0 Acres		—	⁽⁴⁾		—		—		—		—
Mason Goodrich	Houston, TX	84.0 Acres		3,750			757		2,850		6.250	⁽¹⁾	06/04
McKinney Corners II	Collin County, TX	11.0 Acres		—	⁽⁴⁾		—		—		—		—
Nashville	Nashville, TN	113.8 Acres		941			—		737		14.000		03/04
Thompson	Farmers Branch, TX	3.3 Acres		—	⁽⁴⁾		—		—		—		—
Tomlin	Farmers Branch, TX	9.0 Acres		—	⁽⁴⁾		—		—		—		—

*Third Quarter*
Apartments
Tree House	Irving, TX	160 Units		5,100			2,518		2,132		5.000	⁽¹⁾	08/13
Windsor Tower	Ocala, FL	64 Units		2,000			1,989		<104>		4.750		08/08

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued

Liquidity and Capital Resources (Continued)

Property

Location

Units/ Acres/
Sq. Ft

Debt
Incurred

Debt
Discharged

Net Cash
Received/
<Paid>

Interest
Rate

Maturity
Date

Fourth Quarter

Land

Las Colinas

Las Colinas, TX

55.7 Acres

6,885

17,338

<11,622

7.000

%⁽¹⁾

11/04

Rasor

Plano, TX

23.7 Acres

1,260

—

1,214

7.000

⁽¹⁾

11/04

Valwood

Dallas County, TX

235.0 Acres

8,100

5,400

1,745

7.000

⁽¹⁾

11/06

⁽¹⁾	Variable interest rate.

⁽²⁾	Cash of $1.5 million was received by BCM and applied to ARI’s affiliate debt.

⁽³⁾	Paid in July 2003.

⁽⁴⁾	Single note, with all properties as collateral.

ARI has margin arrangements with various financial institutions and brokerage firms which provide for borrowing up to 50% of the market value of ARI’s marketable equity securities. The borrowings under such margin arrangements are secured by equity securities of IORI and TCI and ARI’s trading portfolio and bear interest rates ranging from 5.00% to 24.0%. Margin borrowing totaled $25.2 million at September 30, 2003.

Management expects that it will be necessary for ARI to sell $102.0 million, $34.1 million and $1.2 million of its land holdings during each of the next three years to satisfy the debt on such land as it matures. If ARI is unable to sell at least the minimum amount of land to satisfy the debt obligations on such land as it matures, or, if it was not able to extend such debt, ARI would either sell other of its assets to pay such debt or transfer the property to the lender.

Management reviews the carrying values of ARI’s properties and mortgage notes receivable at least annually and whenever events or a change in circumstances indicate that impairment may exist. Impairment is considered to exist if, in the case of a property, the future cash flow from the property (undiscounted and without interest) is less than the carrying amount of the property. For notes receivable, impairment is considered to exist if it is probable that all amounts due under the terms of the note will not be collected. If impairment is found to exist, a provision for loss is recorded by a charge against earnings to the extent that the investment in the note exceeds management’s estimate of the fair value of the collateral property securing each note. The mortgage note receivable review includes an evaluation of the collateral property securing such note. The property review generally includes: (1) selective property inspections; (2) a review of the property’s current rents compared to market rents; (3) a review of the property’s expenses; (4) a review of maintenance requirements; (5) a review of the property’s cash flow; (6) discussions with the manager of the property; and (7) a review of properties in the surrounding area.

Related Party Transactions

In April 2003, ARI paid $2.0 million in principal and accrued interest to IORI, in partial payment of a note payable on the Rosedale Tower Office Building. See NOTE 6. “NOTES PAYABLE.”

In May 2003, ARI sold the Clarion Kansas City Airport Hotel to One Realco Hotel for $5.3 million. No cash was received or paid by ARI, after debt assumption and providing purchase money financing of $400,000. The note bore interest at 12.0% per annum, matured in May 2004 and required quarterly interest payments beginning in June 2003. In August 2003, the hotel was sold through foreclosure proceedings. ARI is pursuing collection of the note from One Realco Hotel. In September 2003, One Realco Hotel filed for bankruptcy protection under Chapter 11.

On June 2, 2003, ARI exchanged all of its 674,971 IORI shares with BCM, receiving 650,000 TCI shares from BCM. In addition, BCM has executed a promissory note in favor of ARI in the amount of $526,000 (see NOTE 3. “NOTES RECEIVABLE”). After the exchange, ARI owned 72.9% of the outstanding shares of TCI. On June 30, 2003, ARI sold a participating interest in $5.8 million of its $15.5 million line of credit receivable from One Realco Corporation (“One Realco”) to BCM, receiving 314,141 TCI shares from BCM (see NOTE 3. “NOTES RECEIVABLE”). After the transaction, ARI owned 76.8% of the outstanding shares of TCI. ARI no longer directly owns any IORI shares. At September 30, 2003, ARI owned 18.4% of IORI through TCI’s ownership of IORI shares. ARI ceased consolidation of IORI’s accounts and operations effective June 2, 2003.

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued

Related Party Transactions (Continued)

In June 2003, ARI received funds of $757,000 from an affiliate reducing the affiliate receivable. The funds paid down a note secured by undeveloped land in Harris County, Texas.

On June 30, 2003, ARI sold its 73.41% interest in RAK to Realty Advisors, a related party. The sales price was $6.0 million. Realty Advisors also paid ARI $600,000, representing 10% interest on the $6.0 million price paid by ARI to purchase the 73.41% interest in RAK in 2002. The $6.0 million sales price reduced ARI’s affiliate debt. The $600,000 interest was received in cash in August 2003.

In July 2003, ARI sold its interest in MRI to Gruppa for $18.5 million, receiving $7.4 million in cash after debt assumption and providing purchase money financing of $2.3 million (see NOTE 1. “BASIS OF PRESENTATION”). The loan bears interest at 10.0% per annum, matures in August 2013 and requires monthly payments of principal and interest beginning in September 2003. ARI owns 20% of Gruppa, thereby retaining a 20% interest in MRI. Due to debt guarantees and ARI’s continuing ownership interest in MRI, management has determined that this should be accounted for as a financing transaction. In September 2003, ARI sold the note to Syntek West for $2.3 million, plus accrued but unpaid interest, to reduce affiliate debt.

In July 2003, ARI paid $3.1 million to BCM for prior year’s legal fees incurred by Gene Phillips. Mr. Phillips is a related party and advisor to ARI.

In August 2003, ARI sold the City Suites, Majestic and Willows hotels to One Realco Hotel for $13.5 million in a single transaction, receiving $250,000 after debt assumption and providing purchase money financing of $2.7 million. The note bears interest at 12.0% per annum, matures in August 2006 and requires semi-annual payments of principal and interest beginning in June 2004. In September 2003, One Realco Hotel filed for bankruptcy protection under Chapter 11. The parent company of One Realco Hotel has guaranteed the note; therefore, management has not established reserves or classified the note as nonperforming.

Commitments and Contingencies

ARI has contractual obligations and commitments primarily with regards to payment of mortgages.

Results of Operations

For the nine months ended September 30, 2003, ARI reported net income of $12.2 million, compared to a net loss of $16.7 million for the nine months ended September 30, 2002. The primary factors contributing to ARI’s net income are discussed in the following paragraphs.

Rents increased to $49.9 million and $116.7 million in the three and nine months ended September 30, 2003, from $18.0 million and $52.9 million in 2002. Rents from commercial properties increased to $47.1 million for the nine months ended September 30, 2003, from $17.5 million in 2002, rent from hotels increased to $18.0 million in the nine months ended September 30, 2003, from $15.7 million in 2002 and rent from apartments increased to $49.6 million in the nine months ended September 30, 2003, from $19.3 million in 2002. The increase in rents was primarily attributable to the consolidation of TCI’s operations by ARI effective March 31, 2003,

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued

Results of Operations (Continued)

following ARI’s acquisition of more than 50% of TCI’s common stock. Without the effect of the consolidation of TCI’s operations, rents increased to $20.0 million and $58.9 million in the three and nine months ended September 20, 2003. The increase was primarily attributable to increased apartment rents, due to the acquisition of two apartments and the construction of an apartment in 2002.

Property operations expense increased to $34.4 million and $80.3 million in the three and nine months ended September 30, 2003, from $13.2 million and $40.5 million in 2002. Property operations expense for commercial properties increased to $26.8 million in the nine months ended September 30, 2003, from $10.5 million in 2002. For hotels, property operations expense increased to $13.3 million in the nine months ended September 30, 2003, from $11.8 million in 2002. For land, property operations expense decreased to $4.7 million in the nine months ended September 30, 2003 from $5.4 million in 2002. For apartments, property operations expense increased to $35.5 million in the nine months ended September 30, 2003, from $12.7 million in 2002. The increase in commercial, hotel and apartment property operations expense was primarily attributable to the consolidation of TCI’s operations by ARI effective March 31, 2003, following ARI’s acquisition of more than 50% of TCI’s common shares. The decrease in land property operations expense was primarily attributable to decreased real estate taxes as a result of land sales in 2002. Without the effect of the consolidation of TCI’s operations, property operations expense increased to $14.6 million and $43.1 million in the three and nine months ended September 30, 2003. The increase was primarily attributable to increased apartment operating expenses, due to the acquisition of two apartments and the construction of one apartment in 2002.

Pizza parlor sales and cost of sales of $8.3 million and $6.6 million, respectively, in the three months ended September 30, 2003 and $24.3 million and $19.4 million in the nine months ended September 30, 2003 approximated the $8.2 million and $6.5 million, respectively, in the three months ended September 30, 2002 and $24.0 million and $18.8 million in the nine months ended September 30, 2002.

Interest income increased to $1.8 million and $7.4 million in the three and nine months ended September 30, 2003 from $509,000 and $1.9 million in 2002. The increase was primarily attributable to the addition of $67.5 million of mortgage notes receivable in 2002.

Equity in loss of investees improved to $<204,000> and $<4.3> million in the three and nine months ended September 30, 2003, from $<4.8> million and $<14.0> million in 2002. The improvement was primarily attributable to the consolidation of TCI’s operations by ARI effective March 31, 2003, following ARI’s acquisition of more than 50% of TCI’s common shares. Prior to March 31, 2003, and in 2002, ARI’s equity in loss of investees included equity in TCI’s operations.

Loss on the sale of investments in equity investees was $531,000 for the nine months ended September 30, 2002. See NOTE 4. “INVESTMENTS IN EQUITY INVESTEES.”

Other income of $55,000 and $307,000 in the three and nine months ended September 30, 2003 approximated the $190,000 and $516,000 in the three and nine months ended September 30, 2002.

Interest expense increased to $20.9 million and $51.5 million in the three and nine months ended September 30, 2003 from $12.0 million and $39.2 million in 2002. The increase is primarily attributable to the consolidation of TCI’s operations by ARI effective March 31, 2003, following ARI’s acquisition of more than 50% of TCI’s common shares. Without the effect of consolidation of TCI’s operations, interest expense decreased to $10.0 million and $30.9 million in the three and nine months ended September 30, 2003. The decrease was primarily attributable to reduced balances payable on stock loans and land mortgages.

Depreciation and amortization expense increased to $7.1 million and $16.1 million in the three and nine months ended September 30, 2003, from $2.1 million and $6.0 million in 2002. The increase is primarily attributable to the consolidation of TCI’s operations by ARI effective March 31, 2003, following ARI’s acquisition of more than 50% of TCI’s common shares.

Discount on sale of notes receivable was $1.6 million in the nine months ended September 30, 2003. This represents the discount from the face amount given by ARI to purchasers of notes receivable. See NOTE 3. “NOTES RECEIVABLE.”

General and administrative expenses increased to $6.1 million and $16.9 million in the three and nine months ended September 30, 2003, from $3.3 million and $9.8 million in 2002. The increase is primarily attributable to the consolidation of TCI’s operations by ARI effective March 31, 2003, following ARI’s acquisition of more than 50% of TCI’s common shares. In addition, the three and nine months of 2003 include $3.1 million of one-time reimbursements to BCM for legal fees and $1.0 million for loss on foreign currency transaction.

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued

Results of Operations (Continued)

Advisory fees increased to $3.7 million and $8.5 million in the three and nine months ended September 30, 2003 from $1.6 million and $4.8 million in 2002. The increase is primarily attributable to the consolidation of TCI’s operations by ARI effective March 31, 2003, following ARI’s acquisition of more than 50% of TCI’s common shares.

Net income fee to affiliate was $675,000 in the three and nine months ended September 30, 2003. The net income fee payable to ARI’s advisor is 10% of the year-to-date net income, in excess of a 10% return on shareholders’ equity.

Incentive fee to affiliate was $1.1 million in the three and nine months ended September 30, 2003. The incentive fee is only due if ARI is also subject to the net income fee. This fee represents 10% of the excess of net capital gains over net capital losses from sales of operating properties. The amount of this fee for the remainder of 2003 will be dependent on the number of operating properties sold, the net capital gains realized and whether the net income fee is due.

Writedown of assets held for sale was $2.4 million in the nine months ended September 30, 2003. The carrying value of an office building in Encino, California, sold in the third quarter of 2003, was reduced to its net realizable value in the second quarter of 2003.

Minority interest decreased to $20,000 and $1.2 million in the three and nine months ended September 30, 2003, from $436,000 and $2.0 million in 2002. The decrease is primarily attributable to reduced minority participation in ARI partnerships and in the consolidation of TCI’s operations by ARI effective March 31, 2003, following ARI’s acquisition of more than 50% of TCI’s common shares.

Net income from discontinued operations decreased to $16.6 million and $30.9 million in the three and nine months ended September 30, 2003 from $21.8 million and $34.1 million in 2002. The net income relates to 23 properties and leasehold interests in oil and gas properties that ARI sold during 2002 and 29 properties that ARI sold in 2003. The following table summarizes revenue and expense information for the properties sold.

	For the Three Months Ended September 30,						For the Nine Months Ended September 30,
	2003			2002			2003			2002
Revenue
Rental	$	4,248		$	9,080		$	16,956		$	32,609
Property operations		4,009			6,041			12,510			19,285

		239			3,039			4,446			13,324
Expenses
Interest		1,276			1,865			5,280			11,621
Depreciation		420			1,328			2,163			5,590

		1,696			3,193			7,443			17,211

Net loss from discontinued operations		<1,457	>		<154	>		<2,997	>		<3,887	>
Gain on sale of real estate		18,222			15,375			34,041			23,140
Equity in gain on sale of real estate by equity investees		<165	>		6,616			<165	>		14,896

Net income from discontinued operations	$	16,600		$	21,837		$	30,879		$	34,149

Tax Matters

Financial statement income varies from taxable income principally due to the accounting for income and losses of investees, gains and losses from asset sales, depreciation on owned properties, amortization of discounts on notes receivable and payable and the difference in the allowance for estimated losses. ARI had no taxable income after the use of NOL carryforwards or provision for income taxes in the three and nine months ended September 30, 2003 or 2002.

At September 30, 2003, ARI had a net deferred tax asset of $113.8 million due to tax deductions available to it in future years. However, as management cannot determine that it is more likely than not that ARI will realize the benefit of the deferred tax asset, a 100% valuation allowance has been established.

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued

Environmental Matters

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

Management is not aware of any environmental liability relating to the above matters that would have a material adverse effect on ARI’s business, assets or results of operations.

Inflation

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

ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS

At September 30, 2003, ARI’s exposure to a change in interest rates on its debt is as follows:

	Balance		Weighted Average Interest Rate		Effect of 1% Increase In Base Rates
Notes payable:
Variable rate	$	226,737	7.116	%	$	2,267

Total decrease in ARI’s annual net income					$	2,267

Per share					$	21

ITEM 4.

CONTROLS AND PROCEDURES

(a)

As of the end of the period covered by this report, ARI carried out an evaluation, under the supervision and with the participation of ARI’s management, including ARI’s Acting Principal Executive Officer and principal accounting officer, of the effectiveness of the design and operation of ARI’s disclosure controls and procedures pursuant to Exchange Act Rule 13a-14. Based upon the evaluation, ARI’s Acting Principal Executive Officer and principal accounting officer concluded that ARI’s disclosure controls and procedures are effective in timely alerting him to material information relating to ARI (including its consolidated subsidiaries) required to be included in ARI’s periodic SEC filings.

(b)	There have been no significant changes in ARI’s internal controls or in other factors that could significantly affect ARI’s internal controls subsequent to the date ARI carried out this evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

PART II. OTHER INFORMATION

ITEM 1.

LEGAL PROCEEDINGS

Matisse. In August 2002, ARI obtained a favorable jury verdict in the legal action entitled American Realty Trust v. Matisse Partners, L.L.C. (“Matisse”). However, the judge set aside the jury verdict and imposed a judgment against ARI in excess of $6.0 million, including interest. The judgment is being appealed, and, in the opinion of ARI’s management and legal counsel, there is a reasonable probability that the adverse judgment will be set aside and the jury verdict reinstated. Therefore, ARI has not recognized any expense nor established any reserve for this judgment. In November 2002, ARI posted a $6.0 million supercedeas bond. In July 2003, ARI obtained a letter of credit, which was substituted for the $6.0 million bond. The $6.0 million cash was returned to ARI. In April 2003,

an additional judgment was issued against ARI for $1.4 million in legal fees. ARI is also appealing this judgment and posted a $1.4 million bond in May 2003. ARI has not recognized any expense nor established any reserve for this additional judgment.

Sunset Management. In September 2001, ARI obtained a security loan in the amount of $20.0 million from Sunset Management, LLC (“Sunset”). ARI received net cash of $16.1 million after the payment of various closing costs and $3.4 million repayment of principal and accrued interest on an existing loan with the same lender. Of the total loan amount, $19.5 million bears interest at 24% per annum, while the remaining $500,000 bears interest at 20% per annum. The loan is secured by 3,672,305 shares of TCI common stock held by BCM and wholly-owned subsidiaries of ARI. The loan was also secured by a lien on real property owned by ART Williamsburg, Inc. (“AWI”). The loan required monthly payments of interest only and matured in September 2002. In September 2002, $15.0 million in principal was repaid. Sunset orally agreed in September 2002 to extend the maturity date of the loan and accept substitute collateral for the shares of TCI common stock after the $15.0 million paydown. Sunset did not honor the agreement, which resulted in litigation filed in Texas state court during October 2002, styled American Realty Trust, Inc., ART Williamsburg, Inc., Basic Capital Management, Inc. and EQK Holdings, Inc. v. Sunset Management, LLC, et al., Cause No. 02-09433-I in the 162nd Judicial Court of Dallas County, Texas (the “Texas Litigation”).

During January 2003, without notice to the plaintiffs in the Texas Litigation, Sunset instituted an action in a federal district court in Las Vegas, Nevada against Commonwealth Land Title (“Commonwealth”) seeking disposition of the TCI common stock held by Commonwealth as Pledge Holder. On January 31, 2003, after a Temporary Restraining Order was issued in the Texas Litigation, Sunset instigated a separate lawsuit in state court in Nevada styled Sunset Management, LLC v. American Realty Trust, Inc. et al., Case No. A462587 pending in the District Court of Clark County, Nevada (the “Nevada Litigation”). On February 12, 2003, the Nevada state court held a hearing on Sunset’s request for emergency relief and denied all Sunset’s requested relief and indicated that a stay of the Nevada Litigation may be appropriate, which stay of litigation (including claims against TCI) was granted on May 2, 2003. Notwithstanding the stay of the Nevada Litigation, Sunset continued to seek to relitigate the underlying fact issues already determined in the Texas Litigation and the Nevada Litigation through cross-claims and counterclaims in the Texas Litigation and a renewed motion for preliminary injunction and appointment of receiver over TCI in the Nevada Litigation.

On September 10, 2003, AWI removed the Texas Litigation to the bankruptcy court for the Northern Division of Texas. On September 25, 2003, the Texas Litigation was transferred to the Eastern District of Texas. The scheduling conference in this matter is set for December 3, 2003.

ITEM 4.

SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

The annual meeting was held on August 26, 2003, at which stockholders were asked to consider and vote upon the election of Directors and a proposal that Article Fourth of the Restated Articles of Incorporation of ARI be amended to eliminate the designation for Series B Convertible Preferred Stock. At the meeting, stockholders elected the following individuals as Directors:

	Shares Voting
Director	For	Withheld Authority
Henry A. Butler	10,453,124	120,131
Earl D. Cecil	10,453,258	119,997
Ted P. Stokely	10,453,589	119,666
Martin L. White	10,453,953	119,302

There were no abstentions or broker non-votes on the election of Directors.

Also at the meeting, the shareholders voted on the amendment of Articles of Incorporation:

Shares Voting
For	Against	Abstain
10,511,605	33,677	27,973

ITEM 6.

EXHIBITS AND REPORTS ON FORM 8-K

(a)

Exhibits:

Exhibit Number		Description

3.3		Articles of Amendment to the Restated Articles of Incorporation of American Realty Investors, Inc. decreasing the number of authorized shares of and eliminating Series B Cumulative Convertible Preferred Stock dated as of August 26, 2003, filed herewith.

3.4		Articles of Amendment to the Restated Articles of Incorporation of American Realty Investors, Inc. decreasing the number of authorized shares of and eliminating Series I Cumulative Preferred Stock dates as of October 1, 2003, filed herewith.

31.1		Certification Pursuant to Rules 13a-14 and 15d-14 Under the Securities Exchange Act of 1934, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, filed herewith.

32.1		Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, filed herewith.

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

A Current Report on Form 8-K, dated July 1, 2003, was filed with respect to Item 5. “Other Events” and Item 7. “Financial Statements and Exhibits,” which reports the termination of ARI’s Advisory Agreement with BCM, the establishment of ARI’s Advisory Agreement with Prime Asset Management, Inc., the resignation of Richard W. Humphrey from the ARI Board of Directors and the election of Henry A. Butler and Martin L. White as directors of ARI.

A Current Report on Form 8-K, dated July 7, 2003, was filed with respect to Item 5. “Other Events,” which reports the current litigation filed in Texas styled American Realty Trust, Inc., ART Williamsburg, Inc., Basic Capital Management, Inc. and EQK Holdings, Inc. v. Sunset Management, LLC, et al., Cause No. 02-09433-I pending in the 162nd Judicial District Court of Dallas County, Texas.

A Current Report on Form 8-K, dated July 14, 2003, was filed with respect to Item 5. “Other Events,” which reports the resignation of Joseph Mizrachi from the ARI Board of Directors.

A Current Report on Form 8-K, dated August 11, 2003, was filed with respect to Item 2. “Acquisition or Disposition of Assets” and Item 7. “Financial Statements and Exhibits,” which reports the disposition of 10 apartments, one commercial property, three hotels and five land parcels.

A Current Report on Form 8-K, dated October 1, 2003, was filed with respect to Item 5. “Other Events” and Item 7. “Financial Statements and Exhibits,” which reports the assignment of ARI’s Advisory Agreement with Prime to Prime LLC effective October 1, 2003.

SIGNATURE PAGE

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

	AMERICAN REALTY INVESTORS, INC.

Date: November 14, 2003	By:	/s/ RONALD E. KIMBROUGH

		Ronald E. Kimbrough Executive Vice President and Chief Financial Officer (Principal Financial and Accounting Officer and Acting Principal Executive Officer)

AMERICAN REALTY INVESTORS, INC.

EXHIBITS TO

QUARTERLY REPORT ON FORM 10-Q

For the Quarter ended September 30, 2003

Exhibit Number	Description	Page Number

3.3	Articles of Amendment to the Restated Articles of Incorporation of American Realty Investors, Inc. decreasing the number of authorized shares of and eliminating Series B Cumulative Convertible Preferred Stock dates as of August 26, 2003, filed herewith.

3.4	Articles of Amendment to the Restated Articles of Incorporation of American Realty Investors, Inc. decreasing the number of authorized shares of and eliminating Series I Cumulative Preferred Stock dated as of October 1, 2003, filed herewith.

31.1	Certification Pursuant to Rules 13a-14 and 15d-14 Under the Securities Exchange Act of 1934, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1	Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.