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Article by DailyStocks_admin    (09-23-08 04:24 AM)

American Spectrum Realty Inc. CEO WILLIAM J CARDEN bought 10233 shares on 9-17-2008 at $29.98

BUSINESS OVERVIEW

General Description of Business

American Spectrum Realty, Inc. (“ASR” or, collectively, as a consolidated entity with its subsidiaries, the “Company”) is a Maryland corporation established on August 8, 2000. The Company is a full-service real estate corporation which owns, manages and operates income-producing properties. Substantially all of the Company’s assets are held through an operating partnership (the “Operating Partnership”) in which the Company, as of December 31, 2007, held the sole general partner interest of .98% and a limited partnership interest totaling 86.08%. As of December 31, 2007, through its majority-owned subsidiary, the Operating Partnership, the Company owned and operated 29 properties, which consisted of 22 office buildings, four industrial properties, and three retail properties. The 29 properties are located in six states.

During 2007, the Company acquired a 400,000 square foot industrial park and two retail properties aggregating 76,000 square feet. All three properties are located in Houston, Texas. No properties were sold during 2007. During 2006, the Company purchased six office properties located in Houston, Texas and one office property located in Victoria, Texas. Three properties were sold during 2006, which consisted of an industrial property and an office building located in San Diego, California and an office building located in Palatine, Illinois. During 2005, the Company sold three properties, which consisted of a vacant single tenant industrial property located in San Diego, California, a shopping center located in Columbia, South Carolina and an apartment complex located in Hazelwood, Missouri. No properties were acquired in 2005. The property acquisitions are part of the Company’s strategy to acquire multi-tenant value-added properties located in its core markets of Texas, California and Arizona.

The Company is the sole general partner of the Operating Partnership. As the sole general partner of the Operating Partnership, the Company generally has the exclusive power to manage and conduct the business of the Operating Partnership under its partnership agreement. The Company’s interest as a limited partner in the Operating Partnership entitles it to share in any cash distributions from, and in profits and losses of, the Operating Partnership. If the Company receives any distributions from the Operating Partnership, it intends, in turn, if permitted by law, to pay dividends to its common stockholders so that the amount of dividends paid on each share of common stock equals four times the amount of distributions paid on each limited partnership unit in the Operating Partnership (“OP Unit”). The intended dividend of four times the distribution from each limited partnership unit is a result of the Company’s one-for-four reverse stock split in 2004. The properties are owned by the Operating Partnership through subsidiary limited partnerships or limited liability companies.

Holders of the OP Units have the option to redeem their units and to receive, at the option of the Company, in exchange for each four OP Units (i) one share of Common Stock of the Company, or (ii) cash equal to the market value of one share of Common Stock of the Company at the date of conversion, but no fractional shares will be issued.

The Board of Directors has concluded that it is not in the best interests of the Company to elect to be treated as a real estate investment trust (or REIT), as defined under the Internal Revenue Code of 1986, as amended. In May 2006, the Company’s stockholders approved an amendment to the Company’s Articles of Incorporation, which removed a provision restricting the ability of stockholders to acquire shares in excess of certain ownership limitations. This provision had been included in the Articles to preserve the Company’s ability to elect to be taxed as a REIT in the future, since one of the requirements of REIT status is that not more than 50% of a REIT’s equity securities may be held by 5 or fewer stockholders.

The Company expects to meet its short-term liquidity requirements for normal property operating expenses and general and administrative expenses from cash generated by operations. In addition, the Company expects to incur capital costs related to leasing space and making improvements to properties provided the leasing of space is completed. The Company anticipates meeting these obligations with cash currently held, the use of funds held in escrow by lenders, and proceeds from sales and refinancing activities.

Business Objectives and Strategy

The Company’s fundamental business objective is to maximize stockholder value. The Company intends to achieve its business objective through opportunistic investments with effective asset management.

The Company’s future growth will be focused on the acquisition of multi-tenant value-added properties in its high growth core-markets of Texas, Arizona and California. The Company also intends to seek additional third party leasing and property management business in its core-markets. Properties in non-core markets are expected to be sold and the net proceeds redeployed into funding future acquisitions in core markets and to pay for capital expenditures and reduce debt.

Opportunities to Acquire Undervalued and Undermanaged Properties. The Company believes it is positioned to invest in properties, either individually or in portfolios, at attractive prices, often at costs lower than replacement cost. This will be accomplished using the Company’s knowledge of its core geographical markets and core property types, as well as its established capability to identify and negotiate with highly-motivated sellers, which include individuals as well as institutions such as banks, insurance companies and pension funds. The Company will not set a maximum target purchase price but rather it will tailor its acquisitions to under performing properties, which the Company believes are attractively priced generally due to relative physical or operating deficiencies. The Company believes that its real estate expertise will allow it to, when necessary, reposition, renovate or redevelop these properties to make them competitive in their local markets.

Competitive Advantages. The Company believes it has competitive advantages that will enable it to be selective with respect to real estate investment opportunities and allow it to successfully pursue its growth strategy. Based on its management’s experience, the Company expects that its presence in geographically diverse markets will increase its exposure to opportunities for attractive acquisitions of various types of properties throughout its operating region and provide it with competitive advantages which enhance its ability to do so, including:


• strong local market expertise;

• long-standing relationships with tenants, real estate brokers, institutions and other owners of real estate in each local market;

• fully integrated real estate operations which allow quick response to acquisition opportunities;

• access to capital markets at competitive rates as a public company;

• ability to acquire properties in exchange for ASR shares or OP Units which may make it a more attractive purchaser when compared to purchasers who are not similarly structured or are unable to make similar use of equity to purchase properties.

Property Management Strategies. The Company has procedures and expertise which permit it to manage effectively a variety of types of properties throughout the United States. The decentralized structure with strong local management enables it to operate efficiently. In seeking to maximize revenues, minimize costs and increase the value of the properties, the Company follows aggressive property management policies. Among the property management techniques emphasized are regular and comprehensive maintenance programs, regular and comprehensive financial analyses, the use of a master property and casualty insurance program, aggressive restructuring or conversion of tenant spaces and frequent appearances before property tax assessors, planning commissions and other local governmental bodies. The Company believes that its management of the properties will be a substantial factor in its ability to realize its objectives of maximizing earnings.

Managing and Monitoring Investments. The Company has actively managed the property portfolio and administered its investments. The Company will monitor issues including the financial advantages of property sales, minimization of real estate taxes, and insurance costs. Also, the Company will actively analyze diversification, review tenant financial statements to deal with potential problems quickly and will restructure investments in the case of underperforming and non-performing properties.

Competition

The Company competes with other entities both to locate suitable properties for acquisition and to locate purchasers for its properties. While the markets in which it competes are highly fragmented with no dominant competitors, the Company faces substantial competition in both its leasing and property acquisition activities. There are numerous other similar types of properties located in close proximity to each of its properties. The amount of leasable space available in any market could have a material adverse effect on the Company’s ability to rent space and on the rents charged. Competition for acquisition of existing properties from institutional investors and publicly traded REITs has increased substantially in the past several years. In many of the Company’s markets, institutional investors and owners and developers of properties compete vigorously for the acquisition, development and leasing of space. Many of these competitors have greater resources and more experience than the Company.

Employees

As of December 31, 2007, ASR employed 44 individuals, including on-site property management and maintenance personnel.

Environmental Matters

Various federal, state and local laws and regulations subject property owners and operators to liability for reporting, investigating, remediating, and monitoring of regulated hazardous substances released on or from a property. These laws and regulations often impose strict liability without regard to whether the owner or operator knew of, or actually caused, the release. The presence of, or the failure to properly report, investigate, remediate, or monitor hazardous substances could adversely affect the financial condition of the Company or the ability of the Company to operate the properties. In addition, these factors could hinder the Company’s ability to borrow against the properties. The presence of hazardous substances on a property also could result in personal injury or similar claims by private plaintiffs. In addition, there are federal, state and local laws and regulations which impose requirements on the storage, use, management and disposal of regulated hazardous materials or substances. The failure to comply with those requirements could result in the imposition of liability, including penalties or fines, on the owner or operator of the properties. Future laws or regulations could also impose unanticipated material environmental liabilities on the Company in connection with any of the properties.

The Company is aware that two of its properties or former properties may contain hazardous substances above reportable levels. One of the properties is located in the State of Indiana. The Company retained an environmental expert that developed a clean up and monitoring plan that has been approved by the State of Indiana. In 2005, the Company accrued $75,000 for the future environmental cleanup and monitoring, of which $64,000 has been spent to date. The Company does not anticipate that future clean up costs will materially exceed the remaining accrual of $11,000 at December 31, 2007. The other property, which was sold on February 28, 2008, is located in the State of South Carolina and is included in a special fund sponsored by the state. The timing of the cleanup is dependent on the state’s priorities and state funds will cover the costs for the cleanup. As such, no liability has been accrued on the Company’s books for this property.

The Company may decide to acquire a property with known or suspected environmental contamination after it evaluates that business risk, the potential costs of investigation or remediation, and the potential costs to cure identified non-compliances with environmental laws or regulations. In connection with its acquisition of properties, the Company may seek to have the seller indemnify it against environmental conditions or non-compliances existing as of the date of purchase, and under appropriate circumstances, it may obtain environmental insurance. In some instances, the Company may become the assignee of or successor to the seller’s indemnification rights arising from the seller’s acquisition agreement for the property. Additionally, the Company may try to structure its leases for the property to require the tenant to assume all or some of the responsibility for environmental compliance and remediation, and to provide that material non-compliance with environmental laws or regulations will be deemed a default under the lease. However, there can be no assurances that, despite these efforts, liability will not be imposed on the Company under applicable federal, state, or local environmental laws or regulations relating to the properties.

Insurance

The Company currently carries comprehensive liability, fire, terrorism, extended coverage and rental loss insurance covering all of its properties, with policy specifications and insured limits which the Company believes are adequate and appropriate under the circumstances. There are, however, types of losses that are not generally insured because they are either uninsurable or not economically feasible to insure. In addition, costs to carry all of the types of insurance above may not always be economically feasible.

Should an uninsured loss or a loss in excess of insured limits occur, the Company could lose its capital invested in the property, as well as the anticipated future revenues from the property and, in the case of debt which is with recourse to the Company, would remain obligated for any mortgage debt or other financial obligations related to the property. Any such loss would adversely affect the Company. Moreover, the Company will generally be liable for any unsatisfied obligations other than non-recourse obligations. The Company believes that its properties are adequately insured. No assurance can be given that material losses in excess of insurance proceeds will not occur in the future.

Capital Expenditures

Capital expenditure requirements include both normal recurring capital expenditures, and tenant improvements and lease commissions relating to the leasing of space to new or renewing tenants. The Company has a history of acquiring properties which required renovation, repositioning or management changes to improve their performance and to enable them to compete effectively. The Company plans to continue to invest in these types of properties. These properties may require major capital expenditures or significant tenant improvements in order to maximize their cash flows.

Acquisitions

In March and April 2007, the Company the Company completed the acquisition of a multi-tenant industrial park located in Houston, Texas. The industrial park consists of approximately 400,000 leasable square feet. The park includes 12 acres of land on which the Company anticipates developing an additional 100,000 square feet of multi-tenant industrial space. The Company also acquired two retail properties located in Houston Texas in April 2007. These two properties have an aggregate rentable square footage of 76,000. Acquisition costs for the three properties were primarily funded with mortgage debt with the remainder in cash.

Dispositions

No properties were sold during 2007. In February 2008, the Company sold its 58,783 square foot retail property located in South Carolina.

Company Website

All of our filings with the Securities and Exchange Commission, including our annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, are available free of charge at our website at www.americanspectrum.com, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission. These filings can also be accessed through the Securities and Exchange Commission’s website at www.sec.gov. Alternatively, we will provide paper copies of our filings free of charge upon request.

CEO BACKGROUND

William J. Carden — Mr. Carden is Chairman of the Board, Chief Executive Officer and President (positions he has held since the formation of the Company). Mr. Carden served as the Company’s Acting Chief Financial Officer from August 2002 to March 2007. He received an accounting degree from California State University, in Long Beach, California.

G. Anthony Eppolito — Mr. Eppolito was appointed Chief Financial Officer in March 2007. Mr. Eppolito has served as Vice President, Treasurer and Secretary since January 2006 and as Controller since November 2004. Mr. Eppolito has been with the Company since inception and served as Assistant Controller from March 2002 through October 2004. Mr. Eppolito holds a Bachelor of Business Administration in Accounting from Texas A&M University in College Station, Texas and is a Certified Public Accountant.

Richard M. Holland — Mr. Holland was appointed Vice President in January 2006. Mr. Holland has served as Director of Leasing for the Company since October 2002. Mr. Holland’s experience includes in excess of twenty years of leasing experience with a wide variety of tenants and has a broad knowledge of office, industrial and retail properties. Mr. Holland holds a Bachelor of Business Administration in Marketing from the University of Houston in Clear Lake, Texas and has held a Texas Real Estate Broker’s license since 1981. Mr. Carden is the uncle of Mr. Holland.

Timothy R. Brown — Mr. Brown is a director of the Company and has been a Senior Partner in the law firm of Thompson & Knight L.L.P. since 1999. He received his B.A. from Stanford University and his JD from the University of Texas School of Law. Mr. Brown is Chairman of the Company’s Compensation and Nominating/Corporate Governance Committees and is a member of the Company’s Audit Committee.

John N. Galardi — Mr. Galardi is a director of the Company. Mr. Galardi has been the Chairman and Chief Executive Officer of Galardi Group, Inc., a privately-held franchising company encompassing more than 450 restaurants, including the Wienerschnitzel and Tastee Freez chains. Mr. Galardi has been a director of CGS Real Estate Company, Inc. (“CGS”) since 1989. Mr. Galardi served on the Boards of BCT International, Inc. in Fort Lauderdale, Florida, and Renovar Energy Corporation in Midland, Texas. He has also served on the Board of Advisors of National Bank of Southern California and Marine National Bank. Mr. Galardi attended Southwest Baptist University in Missouri.

William W. Geary, Jr. — Mr. Geary is a director of the Company and has served as the President of Carlsberg Management Company, a real estate development company, since February 1986. Mr. Geary received his M.B.A. and B.S. degrees from Northwestern University in Chicago, Illinois. Mr. Geary holds the designations of Charter Financial Analyst, Certified Property Manager (CPM), Specialist in Real Estate Securities (SRS) and the Certified Commercial-Investment Member (CCIM). He is a Member of Los Angeles Society of Security Analysts. Mr. Geary is a member of the Company’s Audit, Compensation and Nominating/Corporate Governance Committees.

Presley E. Werlein, III — Mr. Werlein is a shareholder in Werlein & Harris, P.C., a certified public accounting firm in Houston, Texas. He serves as President and Chief Executive Officer of Noise Reduction Technologies, Inc., a holding company that owns Executive Wall Concepts, Inc., which is a specialty subcontractor specializing in acoustical fabric panels. Mr. Werlein is a Certified Public Accountant and holds a Bachelor of Business Administration in Accounting from the University of Texas in Austin, Texas. Mr. Werlein is Chairman of the Company’s Audit Committee and is a member of the Company’s Compensation and Nominating/Corporate Governance Committees.

MANAGEMENT DISCUSSION FROM LATEST 10K

OVERVIEW

American Spectrum Realty, Inc. (“ASR” or, collectively, as a consolidated entity with its subsidiaries, the “Company”) is a Maryland corporation established on August 8, 2000. The Company is a full-service real estate corporation which owns, manages and operates income-producing properties. Substantially all of the Company’s assets are held through an operating partnership (the “Operating Partnership”) in which the Company, as of December 31, 2007, held the sole general partner interest of .98% and a limited partnership interest totaling 86.08%. As of December 31, 2007, through its majority-owned subsidiary, the Operating Partnership, the Company owned and operated 29 properties, which consisted of 22 office buildings, four industrial properties, and three retail properties. The 29 properties are located in six states.

During 2007, the Company acquired a 400,000 square foot industrial park and two retail properties aggregating 76,000 square feet. All three properties are located in Houston, Texas. The industrial park includes 12 acres of land on which the Company anticipates developing an additional 100,000 square feet of multi-tenant industrial space. No properties were sold during 2007. During 2006, the Company purchased six office properties located in Houston, Texas and one office property located in Victoria, Texas. Three properties were sold during 2006, which consisted of an industrial property located in San Diego, California, an office building located in San Diego, California and an office building located in Palatine, Illinois. The property acquisitions are part of the Company’s strategy to acquire multi-tenant value-added properties located in its core markets of Texas, California and Arizona.

The Company’s properties were 86% occupied at December 31, 2007 compared to 90% at December 31, 2006. The weighted average occupancy for 2007 and 2006 was 88% for both years. The Company continues to aggressively pursue prospective tenants to increase its occupancy, which if successful, should have the effect of improving operational results.

As of December 31, 2007, Columbia Northeast, a 58,783 square foot retail property located in South Carolina, was classified as “Real estate held for sale”. The property was sold on February 28, 2008.

In the accompanying financial statements, the results of operations of the property classified as “Real estate held for sale” and the three properties sold during 2006 are shown in the section “Discontinued operations”. No properties were sold during 2007. Therefore the revenues and expenses reported for the fiscal years ended December 31, 2006 and 2007 reflect results from properties currently held for investment by the Company. The following discussion and analysis of the financial condition and results of operations of the Company should be read in conjunction with the selected financial data in Item 6 and the consolidated financial statements of the Company, including the notes thereto, included in Item 15.

The Company intends to continue to seek to acquire additional properties in core markets and further reduce its non-core assets while focusing on an aggressive leasing program during 2008.

CRITICAL ACCOUNTING POLICIES

The major accounting policies followed by the Company are listed in Note 2 — Summary of Significant Accounting Policies — of the Notes to the Consolidated Financial Statements. The consolidated financial statements of the Company are prepared in accordance with accounting principles generally accepted in the United States of America, which requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the results of operations during the reporting period. Actual results could differ materially from those estimates.

The Company believes the following critical accounting policies affect its more significant judgments and estimates used in the preparation of its consolidated financial statements:


• Certain leases provide for tenant occupancy during periods for which no rent is due or where minimum rent payments increase during the term of the lease. The Company records rental income for the full term of each lease on a straight-line basis. Accordingly, a receivable, if deemed collectible, is recorded from tenants equal to the excess of the amount that would have been collected on a straight-line basis over the amount collected and currently due (Deferred Rent Receivable). When a property is acquired, the term of existing leases is considered to commence as of the acquisition date for purposes of this calculation.

• Many of the Company’s leases provide for Common Area Maintenance (“CAM”)/Escalations (“ESC”) as the additional tenant revenue amounts due to the Company in addition to base rent. CAM/ESC represents increases in certain property operating expenses (as defined in each respective lease agreement) over the actual operating expense of the property in the base year. The base year is stated in the lease agreement; typically, the year in which the lease commenced. Generally, each tenant is responsible for his prorated share of increases in operating expenses. Tenants are billed an estimated CAM/ESC charge based on the budgeted operating expenses for the year. Within 90 days after the end of each fiscal year, a reconciliation and true up billing of CAM/ESC charges is performed based on actual operating expenses.

• Rental properties are stated at cost, net of accumulated depreciation, unless circumstances indicate that cost, net of accumulated depreciation, cannot be recovered, in which case the carrying value of the property is reduced to estimated fair value. Estimated fair value (i) is based upon the Company’s plans for the continued operation of each property and (ii) is computed using estimated sales price, as determined by prevailing market values for comparable properties and/or the use of capitalization rates multiplied by annualized net operating income based upon the age, construction and use of the building. The fulfillment of the Company’s plans related to each of its properties is dependent upon, among other things, the presence of economic conditions which will enable the Company to continue to hold and operate the properties prior to their eventual sale. Due to uncertainties inherent in the valuation process and in the economy, the actual results of operating and disposing of the Company’s properties could be materially different than current expectations.

• Gains on property sales are accounted for in accordance with the provisions of SFAS No. 66, “Accounting for Sales of Real Estate”. Gains are recognized in full when real estate is sold, provided (i) the gain is determinable, that is, the collectibility of the sales price is reasonably assured or the amount that will not be collectible can be estimated, and (ii) the earnings process is virtually complete, that is, the Company is not obligated to perform significant activities after the sale to earn the gain. Losses on property sales are recognized immediately.

RESULTS OF OPERATIONS

Comparison of the year ended December 31, 2007 to the year ended December 31, 2006

Rental revenue. Rental revenue increased $5,100,000, or 20.2%, for the year ended December 31, 2007 in comparison to the year ended December 31, 2006. This increase was attributable to $3,729,000 in revenue generated from the two retail properties and one industrial property acquired during 2007 and from seven office properties acquired during 2006. The increase was also attributable to $1,371,000 in greater revenues from properties owned for the full years ended December 31, 2007 and December 31, 2006. The increase in revenue from properties owned for the full years ended December 31, 2007 and December 31, 2006 was primarily due to an increase in rental rates. Increases in lease buy-out revenue of approximately $275,000 and tenant security deposit forfeitures of approximately $100,000 also attributed to the rise in rental revenue. Occupancy, on a weighted average basis, remained relatively unchanged for 2007 in comparison to 2006. The weighted average occupancy for both years was 88%. As of December 31, 2007, the Company’s properties were 86% occupied. Rental revenue from the ten properties acquired in 2006 and 2007 is included in the Company’s results from their respective dates of acquisition.

Property operating expenses. The increase of $1,855,000, or 15.7%, was primarily due to additional operating expenses of $1,887,000 related to the ten acquired properties mentioned above. This increase was offset in part by a decrease in operating expenses of $32,000 from properties owned for the full years ended December 31, 2007 and 2006. This decrease was primarily due to a decrease in electricity rates. The decrease was also attributable to a reduction in bad debt expense incurred during the year ended December 31, 2007 in comparison to the year ended December 31, 2006.

General and administrative. General and administrative costs remaining virtually unchanged for the year ended December 2007 in comparison to the year ended December 31, 2006, increasing $2,000 or .06%. Increases in compensation costs, state franchise fees and other tax expenses during 2007 was offset in large part by a decrease in professional fees, principally legal. During 2006, legal costs of $150,000 were incurred due to the settlement of the Warren F. Ryan litigation matter. In addition, $148,000 was recognized in 2006 related to an obligation to reimburse John N. Galardi, a director and principal shareholder, for legal fees paid by him in prior years. These fees were incurred in connection with Mr. Galardi’s defense of a litigation matter in which he was named as a defendant by reason of his association with the Company.

Depreciation and amortization. Depreciation and amortization expense increased $2,334,000, or 21.5%, for the year ended December 31, 2007 in comparison to the year ended December 31, 2006. The increase was primarily attributable to depreciation and amortization of $1,531,000 related to the ten properties acquired in 2006 and 2007. The increase was also due to the depreciation of additional capital improvements and amortization of capitalized lease costs. During 2007 and 2006, the Company incurred $4,449,000 and $4,933,000, respectively, in capital improvements on its properties, primarily for renovations and tenant improvements.

Interest expense. Interest expense increased $2,419,000, or 25.0%, for the year ended December 31, 2007 in comparison to the year ended December 31, 2006. The increase was in large part attributable to interest expense associated with the ten properties acquired during 2006 and 2007, which accounted for $2,106,000 of the increase. Two corporate bank loans totaling $2,000,000 and a $2,000,000 line of credit, both funded during 2007, also attributed to the increase in interest expense. The increase was also due to the write-off of a loan premium on one of the Company’s loans refinanced in July 2007, which accounted for $167,000 of the increase in interest expense. The loan premium, which had an unamortized balance of $1,123,000 at the time of the refinance, was amortized as an offset to interest expense during 2006 and during the first six months of 2007. The unamortized balance is included as a component of the Company’s loss on extinguishment of debt on its consolidated statement of operations for the year ended December 31, 2007

Income taxes. The Company recorded a deferred income tax benefit from continuing operations of $4,318,000 for the year ended December 31, 2007 compared to a deferred income tax benefit of $4,047,000 from continuing operations for the year ended December 31, 2006. The increase was primarily due to an increase in taxable losses on continuing operations for the year ended December 31, 2007 in comparison to the year ended December 31, 2006.

Minority interest. The share of loss from continuing operations for the year ended December 31, 2007 for the holders of OP Units was $1,306,000 compared to $887,000 for the year ended December 31, 2006. The 2007 loss represents an average of 13.0% limited partner interest in the Operating Partnership not held by the Company during 2007. The 2006 loss represents an average of 13.4% limited partner interest in the Operating Partnership not held by the Company during 2006.

Loss on extinguishment of debt. During 2007, the Company recorded a loss on extinguishment of debt of $2,413,000 in connection with the loan refinance on 7700 Irvine Center, an office property located in Irvine, California. The loss consisted of a prepayment penalty of $3,536,000, partially offset by the write-off of unamortized loan premium of $1,123,000. During 2006, in connection with loan refinances on 12000 Westheimer and 2470 Gray Falls, the Company recorded a loss on extinguishment of debt of $567,000, which consisted of a prepayment penalty of $474,000 and the write-off of unamortized loan costs of $93,000.

Discontinued operations. The Company recorded a loss from discontinued operations of $16,000 for the year ended December 31, 2007. The loss represents the operating results of a property classified as “Real estate held for sale at December 31, 2007. The Company recorded income from discontinued operations of $11,870,000 for the year ended December 31, 2006. Income from discontinued operations included the operating results of the property classified as “Real estate held for sale” and the operating results and gain on sale of the three properties sold during 2006. See Note 4 — Discontinued Operations — of the Notes to Consolidated Financial Statements.

LIQUIDITY AND CAPITAL RESOURCES

During 2007, the Company derived cash primarily from the collection of rents and net proceeds from borrowings and refinancing activities. Major uses of cash included the acquisitions of three properties, payments for capital improvements to real estate assets, primarily for tenant improvements, payment of operational expenses and scheduled principal payments on borrowings.

Net cash provided by operating activities amounted to $2,236,000 for the year ended December 31, 2007. The net cash provided by operating activities included $1,051,000 generated by property operations and net change in operating assets and liabilities of $1,185,000. Net cash provided by operating activities amounted to $97,000 for the year ended December 31, 2006. Net income generated from operations of $123,000 was partially offset by a net change in operating assets and liabilities of $26,000.

Net cash used in investing activities amounted to $30,589,000 for the year ended December 31, 2007. Cash of $26,140,000 was used to acquire two retail properties and an industrial property. In addition, cash of $4,449,000 was used for capital expenditures, primarily tenant improvements. Net cash provided by investing activities for the year ended December 31, 2006 amounted to $31,230,000. This amount was due to proceeds of $36,163,000 received from the sale of three properties during 2006, offset by funds used for capital improvements of $4,933,000.

Net cash provided by financing activities amounted to $28,034,000 for the year ended December 31, 2007. Proceeds from borrowings totaled $53,560,000, which included a new loan on an office property located in Irvine, California and a new loan on an office property located in Houston, Texas. Other borrowings of $23,422,000 were obtained primarily to assist with the acquisition costs associated with three properties acquired during 2007. Repayment of borrowings related to refinances amounted to $44,523,000 and scheduled principal payments amounted to $4,154,000 for the year ended December 31, 2007. Net cash used by financing activities amounted to $30,461,000 for the year ended December 31, 2006. These uses included: i) repayments of borrowings on property sales of $26,165,000, ii) a principal pay-down of $4,877,000 on the Company’s note payable to the former limited partners of Sierra Pacific Development Fund II, LP, iii) scheduled principal payments of $1,717,000 and iv) repurchases of common stock of $395,000. These amounts were offset by net proceeds provided by loan refinances of $2,650,000.

The Company expects to meet its short-term liquidity requirements for normal property operating expenses and general and administrative expenses from cash generated by operations. In addition, the Company expects to incur capital costs related to leasing space and making improvements to properties provided the estimated leasing of space is completed. The Company anticipates meeting these obligations with cash currently held, the use of funds held in escrow by lenders, and proceeds from future sales and refinancing activities.

The Company has a short-term bank note of $1,500,000 and a mortgage note of $1,951,000 maturing during 2008. The Company intends to repay the notes with proceeds from anticipated refinancing activities or property sales. Should the anticipated refinancing activities or property sales not happen, the Company intends to seek maturity extensions. Additionally, the Company has restricted cash of $3,565,000 on deposit with the lender for its 7700 Irvine Center property, which would be released upon the completion of certain lease-up terms and conditions at the property. The Company anticipates meeting the lease-up terms and conditions during the second quarter of 2008. The Company also has a $2,000,000 line of credit available. The entire line was available to the Company as of December 31, 2007.

At December 31, 2007, the Company became non-compliant with a debt covenant on a mortgage loan secured by one of its office properties located in Houston, Texas. The debt covenant requires the Company to maintain a minimum tangible book net worth as defined in the debt agreement. In the event the lender elects to enforce the non-compliance matter, the Company will attempt to negotiate a revision to the loan covenant. If a refinance of the loan becomes necessary, the Company believes it could obtain a new mortgage loan for an amount in excess of the current debt balance and prepayment costs associated with the current loan.

MANAGEMENT DISCUSSION FOR LATEST QUARTER

RESULTS OF OPERATIONS
Discussion of the three months ended June 30, 2008 and 2007.

Rental revenue . Rental revenue increased $956,000, or 12.2%, for the three months ended June 30, 2008 in comparison to the three months ended June 30, 2007. This increase was primarily attributable to $654,000 in revenue generated from one office property acquired during the second quarter of 2008 and two retail properties and one industrial property acquired during the second quarter of 2007. Greater revenues from properties owned for the full three months ended June 30, 2008 and June 30, 2007 accounted for the remaining increase of $302,000. The increase in revenue from the properties owned for the full three months ended June 30, 2008 and June 30, 2007 was primarily due to increases in rental rates and lease termination revenue. The increase was also attributable to a reduction in rent concessions. The weighted average occupancy of the Company’s properties was 88% as of June 30, 2008.
Property operating expenses . Property operating expenses increased by $920,000, or 27.9%, for the three months ended June 30, 2008 in comparison to the three months ended June 30, 2007. The increase was partially due to operating expenses of $410,000 related to the four acquired properties mentioned above. Property operating expenses on properties owned for the full three months ended June 30, 2008 and 2007 accounted for the remaining increase of $510,000. This increase was in large part attributable to higher electricity rates and an increase in repairs and maintenance costs when compared to the same period in the prior year. The increase was also due to a increase in bad debt expense incurred during the period.
General and administrative . General and administrative costs increased $70,000, or 7.3%, for the three months ended June 30, 2008 in comparison to the three months ended June 30, 2007. The increase was principally due to professional fees incurred during the second quarter of 2008 related to a potential investment opportunity. The increase was also attributable to an increase in other professional fees, primarily accounting and tax.
Depreciation and amortization . Depreciation and amortization expense increased $458,000, or 14.8%, for the three months ended June 30, 2008 in comparison to the three months ended June 30, 2007. The increase was principally attributable to depreciation and amortization of $427,000 related to the acquired properties mentioned above. The increase was also due to the depreciation of additional capital improvements and amortization of capitalized lease costs incurred between periods.
Interest expense . Interest expense increased $284,000, or 9.2%, for the three months ended June 30, 2008 in comparison to the three months ended June 30, 2007. The increase was primarily due to interest expense associated with the acquired properties mentioned above of $212,000. The increase was also due to the write-off of a loan premium on one of the Company’s loans refinanced in July 2007, which also contributed to the increase in interest expense. The loan premium, which had an unamortized balance of $1,123,000 at the time of the refinance, was amortized as an offset to interest expense during the three months ended June 30, 2007.
Income taxes. The Company recognized a deferred income tax benefit from continuing operations of $1,165,000 for the three months ended June 30, 2008, compared to $1,092,000 for the three months ended June 30, 2007. The increase in deferred income tax benefit for the second quarter of 2008 corresponds to the increase in loss from continuing operations for the second quarter of 2008, in comparison to the second quarter of 2007.

Minority interest. The share of loss from continuing operations for the three months ended June 30, 2008 for the holders of OP Units was $280,000, compared to a share of loss of $193,000 for the three months ended June 30, 2007. The minority interest represents the approximate 13% interest in the Operating Partnership not held by the Company.

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